Car Loan vs Home Mortgage

[Investing.Newbie]

Hey Guys
Long time reader first time user. We paid off my wife's student loan today As far as debt goes we have a car loan & mortgage. We pay off our credit cards every month. We also max out 401K ,ROTH's. Contribute around $9,000/yr for our kids 529's. They are preschoolers. We have around 5 months emergency fund.
I have $600/month which used to go towards the student loan. Can you tell me if I should use this to make extra payments towards my car loan or mortgage ?
Car Loan
3 years 2 months left. Interest: around 1%. Monthly payment $440
Mortgage: 20 Interest: 3.5% Monthly payment: $1762. We pay $338 extra/month towards principal

Thanks !
Novice Investor

[kiddoc]

If I were you, I would choose to put the extra payment towards the mortgage. Paying towards the car loan and eliminating it faster is called the "debt snowball method". Paying extra towards the higher interest (but larger) loan is sometimes called the "debt avalanche method". Google these two terms and you will find a lot of good comparisons.

Paying the high interest loan does save you more money over time but seeing the number of debts going down leads to extra cash flow and can be very motivating.

[Investing.Newbie]

Thanks Kiddoc ! Learnt about debt avalanche and debt snowball methods . Very useful information!
Novice Investor

[chevca]

Technically, it should go to the higher interest mortgage.

For me though, I'd stop the extra mortgage payments, take that and the new extra with the SL being gone, and throw all that at the car payment. Just my personal preference to get rid of the smaller balance first and free up the cash flow.

Either way, it's better than paying the minimums and living paycheck to paycheck. Congrats on getting rid of the student loan and continuing to get rid of debt!

[Investing.Newbie]

Thanks chevca !

[mortfree]

I would do the mortgage in this case. I have experience doing that and did payoff a house before.

Chances are you will have more car loans in your future than mortgages. Why not get rid of the mortgage.

If not debt, you could always start a taxable investing account and/or add to your EF if you desire to be financially independent before usual retirement age.

[RCL]

With that low a mortgage interest rate of 3.5% (assume fixed rate?), I think I would consider investing the now extra $600.
Sounds like you are doing a good job so far; Thumbs up to you!!

[Investing.Newbie]

Thanks a lot guys ! found your feedback very helpful !
Novice Investor

[Cycle]

I'd sell the car and house and buy something I can afford without borrowing money, but I'm anti-personal debt.

Congrats on paying off student loans. For your question, I'd pay off the car loan first to pick that low hanging fruit, then work towards getting that big mortgage paid off. One loan is simpler than two.

[avoidingdumbmistakes]

I'd sell the car and house and buy something I can afford without borrowing money, but I'm anti-personal debt.

Congrats on paying off student loans. For your question, I'd pay off the car loan first to pick that low hanging fruit, then work towards getting that big mortgage paid off. One loan is simpler than two.

I think the same way. When I have to take a car loan I usually go 36 months tops and set it to pay in 24. With a good rate the interest is pretty insignificant with short terms like that and a good starting rate of course. Cars depreciate so knocking out debt against a vehicle is psychologically pleasing. I keep my cars 10-15 years though and do all the work on them myself unless it's major or computer related. Buying a 2-3 year old low mile vehicle nowadays is almost as good as brand new but a 20%+ savings in price out of the gate. Getting 10+ more years of use after payoff any car debt is my personal strategy and works well for my situation.

I also pay extra principle on my house so I'm on pace to have a 30 year note paid off in 18 years. We all have to consider our future when paying down mortgages. This house is the last one I'm carrying a loan on. When it's paid off in 12 years we are planning on downsizing and moving to a LCOL area and retire or semi-retire with no house payment + a nice capital gain stashed in investment accounts. If I was planning on moving in the next 2-3 years I would probably invest what I would apply towards principle if I felt the markets could beat my return on paying extra towards a 3.75% mortgage.

Questions like these are hard to answer because we are all in different places in our lives and our future goals are different. I can never see how paying off a car loan early is a bad thing unless it's a special 0%apr deal from a manufacturer. I don't buy new cars so I don't get those types of deals by default.

[CurlyDave]

Me, I wouldn't do either.

I would open up a taxable account and invest the $600/month.

You can easily do better than a 1% return on the car loan with nothing more exotic than TIPS, and even the most pessimistic nominal stock return projections beat the stuffing out of a 3.5% mortgage.

Think of investing the money as a second tier emergency fund. If you pay down the mortgage and some bad thing happens, the mortgage company is not going to let you skip a few payments because you once paid extra. Same with the car loan.

Those extra dollars are going to do you a lot more good in a brokerage account, where they will produce a higher return than paying down either loan.

[grabiner]

Me, I wouldn't do either.

I would open up a taxable account and invest the $600/month.

You can easily do better than a 1% return on the car loan with nothing more exotic than TIPS, and even the most pessimistic nominal stock return projections beat the stuffing out of a 3.5% mortgage.

This isn't a fair comparison; see Paying down loans versus investing on the wiki. Paying down the mortgage is a risk-free 3.5%. If you want to earn more than 3.5% with some risk, you can invest in stock, but you can do that even if you do pay down the mortgage; move an equal amount of your 401(k) from bonds to stock.

The fair comparison to paying down the mortgage is a bond fund with the same duration as the mortgage. A 20-year mortgage has a duration of about eight years, and eight-year municipal bonds yield about 3% (2.84% yield on Vanguard Long-Term Tax-Exempt Admiral with a seven-year duration).

Therefore, if you can't deduct your mortgage interest, you come out slightly ahead paying down the mortgage rather than investing in bonds; if you can deduct your mortgage interest, you come out slightly ahead investing in bonds and keeping the mortgage.

The car loan at 1% isn't worth paying off from an investment standpoint. However, you may get some other benefit from paying off the loan; for example, if your lender requires you to carry a $500 collision deductible, you can raise your deductible when the loan is paid off, and save more money that way.

[CurlyDave]

This isn't a fair comparison; see Paying down loans versus investing on the wiki. Paying down the mortgage is a risk-free 3.5%. If you want to earn more than 3.5% with some risk, you can invest in stock, but you can do that even if you do pay down the mortgage; move an equal amount of your 401(k) from bonds to stock.

The fair comparison to paying down the mortgage is a bond fund with the same duration as the mortgage. A 20-year mortgage has a duration of about eight years, and eight-year municipal bonds yield about 3% (2.84% yield on Vanguard Long-Term Tax-Exempt Admiral with a seven-year duration).

Therefore, if you can't deduct your mortgage interest, you come out slightly ahead paying down the mortgage rather than investing in bonds; if you can deduct your mortgage interest, you come out slightly ahead investing in bonds and keeping the mortgage.

The car loan at 1% isn't worth paying off from an investment standpoint. However, you may get some other benefit from paying off the loan; for example, if your lender requires you to carry a $500 collision deductible, you can raise your deductible when the loan is paid off, and save more money that way.

I think reasonable people may sometimes disagree with the wiki.

Many would place some value on the liquidity of taxable investments vs. the combination of paying down a mortgage and changing AA in tax advantaged accounts.

Some of us even follow Mr. Bogle's advice and consider future SS and pensions as bond-like investments when determining AA, which can lead to very high equity allocations. For most of my life, especially at the beginning of a career, it just wasn't possible to achieve anything like a reasonable AA even with 100% equities in the accounts under my control. I realize this is not a popular stance here, but it is the advice Mr. Bogle gives.

Sometimes one needs to ask the question: "what percentage of rolling 8 year periods over the past century have had equity CAGR of less than 3.5%, and am I willing to take a chance on that continuing over the next several years?" Especially with what is very close to "new" money. The OP is doing well, meeting all obligations, has a substantial EF, and is saving at a good rate. It may be time to be a little less conservative.

[9-5 Suited]

I think reasonable people may sometimes disagree with the wiki.

Many would place some value on the liquidity of taxable investments vs. the combination of paying down a mortgage and changing AA in tax advantaged accounts.

Some of us even follow Mr. Bogle's advice and consider future SS and pensions as bond-like investments when determining AA, which can lead to very high equity allocations. For most of my life, especially at the beginning of a career, it just wasn't possible to achieve anything like a reasonable AA even with 100% equities in the accounts under my control. I realize this is not a popular stance here, but it is the advice Mr. Bogle gives.

Sometimes one needs to ask the question: "what percentage of rolling 8 year periods over the past century have had equity CAGR of less than 3.5%, and am I willing to take a chance on that continuing over the next several years?" Especially with what is very close to "new" money. The OP is doing well, meeting all obligations, has a substantial EF, and is saving at a good rate. It may be time to be a little less conservative.

It's interesting to me that when someone says they are contemplating investing in debt reduction, there are always a lot of comments pushing the person to invest in equities instead. But when someone suggests they are going to invest in bonds, virtually no one pushes them out of it and into equities even though the exact same arguments could be cited (except for liquidity, but that's an over-stated benefit because most people with enough money to pay down their mortgage have sufficient liquidity for everyday situations.

If OP opts to invest in the stock market, that's a completely different risk/reward proposition that he would have to evaluate vs. paying down debt. The correct comparison there, as Grabiner notes, is an equivalent duration fixed income investment until OP determines he wants more leverage.

[grabiner]

Sometimes one needs to ask the question: "what percentage of rolling 8 year periods over the past century have had equity CAGR of less than 3.5%, and am I willing to take a chance on that continuing over the next several years?" Especially with what is very close to "new" money. The OP is doing well, meeting all obligations, has a substantial EF, and is saving at a good rate. It may be time to be a little less conservative.

You can ask the same question when you decide whether to hold bonds or stocks. If you would buy stocks rather than paying down a mortgage at 3.5%, then you should also buy stocks rather than buying bonds which yield 3%. If you have the risk tolerance, you could reasonably take both risks, and hold 100% stock and a mortgage, but few investors do that.

Liquidity is a separate issue; the liquidity may be worth holding bonds and having a mortgage at a slightly higher rate.

[Leemiller]

Are you dual or single income? I’d put more into post-tax savings to have more of a 12 month+ fund that could pay living expenses if needed. For single income I might even bump that, but I know too many people who were financial destroyed in the financial crisis. I’d rather have a portfolio drop 50% and remain liquid than have money locked up in a home that wasn’t 100% paid off. Also, given the extra payments in how many years will your home be paid off? Having less than 15 would be great given your kids ages.

[Nate79]

I think reasonable people may sometimes disagree with the wiki.

Many would place some value on the liquidity of taxable investments vs. the combination of paying down a mortgage and changing AA in tax advantaged accounts.

Some of us even follow Mr. Bogle's advice and consider future SS and pensions as bond-like investments when determining AA, which can lead to very high equity allocations. For most of my life, especially at the beginning of a career, it just wasn't possible to achieve anything like a reasonable AA even with 100% equities in the accounts under my control. I realize this is not a popular stance here, but it is the advice Mr. Bogle gives.

Sometimes one needs to ask the question: "what percentage of rolling 8 year periods over the past century have had equity CAGR of less than 3.5%, and am I willing to take a chance on that continuing over the next several years?" Especially with what is very close to "new" money. The OP is doing well, meeting all obligations, has a substantial EF, and is saving at a good rate. It may be time to be a little less conservative.

It's interesting to me that when someone says they are contemplating investing in debt reduction, there are always a lot of comments pushing the person to invest in equities instead. But when someone suggests they are going to invest in bonds, virtually no one pushes them out of it and into equities even though the exact same arguments could be cited (except for liquidity, but that's an over-stated benefit because most people with enough money to pay down their mortgage have sufficient liquidity for everyday situations.

If OP opts to invest in the stock market, that's a completely different risk/reward proposition that he would have to evaluate vs. paying down debt. The correct comparison there, as Grabiner notes, is an equivalent duration fixed income investment until OP determines he wants more leverage.

I see this mentality on a lot of financial forum sites where people who want to get out of debt are pushed to just invest the money and practically called stupid for not doing so. I mean stocks have yielded X% of the last XX years who would be dumb enough to pay off a loan at (X-1)%? Literally I have seen it justified that you should invest even if the interest rate is 1% less than expected stock returns. People often mistakenly look at the long term returns of the stock market and equate that to the short term return of paying off a loan. Of course these same people aren't bold enough to take out margin loans.... And then they justify it saying hey I got 20% return last year, look how much ahead I am not paying off these loans. There is a lot of overconfidence in the expected return of the stock market but historically a decade of no return is very possible.


For the OP, I would snowball the debt, paying off the car loan first and then start paying off the mortgage.

[Watty]

At first glance paying down a 3.5% loan instead of a 1% loan would seem like an obvious choice but it is more complex than that since the loans also impact your cash flow and future loans that you might need.

Part of the problem is that you don't know what interest rates will be in five or ten years so you could be paying more than 3.5% for future car loans if you don't have enough to pay cash when you need to buy your next car.

If you can get "one car ahead" and keep saving your "car payment" to pay cash for future cars then getting a car loan paid off is something that you will only have to do once in your life.

I once worked with a guy that was in his 60's and he had just bought a new car, in talking with him it came out that he and his wife had almost always had one or two car loans for the last 40 years. If you don't want to be like that guy then you might as well get "one car ahead" sooner rather than later. Not having car payments when your kids are in college will make paying some of the college expenses out of your cash flow easier to do.

A lot of what to do depends on your personal preferences but in your situation I would even prioritized getting the car paid off over paying down the mortgage faster. You have;

1) $440 car payment
2) $600 student loan payment
3) $388 mortgage prepayment

Which combined is $1,428 a month that you could use to pay off the car loan quickly.

You would need to figure out your own numbers but after the car is paid off you could then maybe put $250(??) a month into a seperate car fund to be able to pay cash for your next car when it is eventually needed and then then use the rest to prepay the mortgage.

We have around 5 months emergency fund.

Not having a car loan will also help your cash flow if something happens like a layoff or some other big expense. For example if you want six months expenses in your emergency fund then you would need an extra $2,640 (6x440) in your emergency fund to cover the car payment for six months in an emergency.

[CurlyDave]

... If you would buy stocks rather than paying down a mortgage at 3.5%, then you should also buy stocks rather than buying bonds which yield 3%. If you have the risk tolerance, you could reasonably take both risks, and hold 100% stock and a mortgage, but few investors do that.

Liquidity is a separate issue; the liquidity may be worth holding bonds and having a mortgage at a slightly higher rate.

1. You are exactly right. I do take both risks. And have for 50 years. Long before mutual funds became popular and before index funds had been invented. Before the days of tax-advantaged investments. It has worked out well for me.

2. Analysis of liquidity can be done separately, and in the world of economics there is a "liquidity premium" which people are willing to pay, both for bonds and for equities.

While it can be analyzed separately, it is still part of the overall decision making process of what to do with the money.

[GAAP]

As a rough guess, and not quite clear on your mortgage, I think you'll pay it down about 5 years early with your current plan and ~9 years early with an extra $600 payment. Use the tool at https://www.calculator.net/mortgage-pay ... 6#loanterm to get a better answer for your situation.

I would pay off the car first -- don't like paying interest to own a depreciating asset. Houses at least usually appreciate approximately with inflation -- although that is extremely local (I've had one go down significantly). 3.5% nominal is pretty cheap for a real asset. 1% nominal on top of 10-25% depreciation, not so much.

[grabiner]

I would pay off the car first -- don't like paying interest to own a depreciating asset. Houses at least usually appreciate approximately with inflation -- although that is extremely local (I've had one go down significantly). 3.5% nominal is pretty cheap for a real asset. 1% nominal on top of 10-25% depreciation, not so much.

The asset is irrelevant to the decision whether to pay down the loans (unless you default, or the asset imposes some other condition such as insurance). If you pay $1000 this year on a 3% loan, you will have a balance $1030 lower next year, a net gain of $30. It doesn't matter whether the loan was used to buy an appreciating house, a depreciating car, or a college degree that can't be taken as security.

[finite_difference]

1/3 car, 1/3 mortgage, 1/3 VTSAX in taxable.

[StealthRabbit]

1/3 car, 1/3 mortgage, 1/3 VTSAX in taxable.

I like this ^^^

but in my own case ... I would SELL the car and drive something I could afford, then pay down the house if is it not deductible. (my cheap car even burns FREE fuel!...as it has since 1976 (cooking oil, waste engine / heating oil, Jet-A, or home brew Bio-diesel, or many other 'free' fuels). But my house is not paid for, and likely never will be (I use it as my Bank for commercial property mortgages that often have only a 5 yr term and a 120 day 'Call'. )

For many... it is important to have NO DEBT. +/-

car debt ... unless you are using the car in a business... it can be MUCH cheaper to drive a beater, and RENT a car if you ever need something better than the beater. For cars... I use $0.10 / mile including cost of capital (the car) and expenses. Last weekend my 2018 rental car ended up being $0.20 / mile, that was a very good deal!

[Investing.Newbie]

Thanks for all the advice ! Wow I never knew so many scenarios existed... Bogleheads rock

[GAAP]

I would pay off the car first -- don't like paying interest to own a depreciating asset. Houses at least usually appreciate approximately with inflation -- although that is extremely local (I've had one go down significantly). 3.5% nominal is pretty cheap for a real asset. 1% nominal on top of 10-25% depreciation, not so much.

The asset is irrelevant to the decision whether to pay down the loans (unless you default, or the asset imposes some other condition such as insurance). If you pay $1000 this year on a 3% loan, you will have a balance $1030 lower next year, a net gain of $30. It doesn't matter whether the loan was used to buy an appreciating house, a depreciating car, or a college degree that can't be taken as security.

That was more of a philosophical comment than an analysis. I don't feel that anyone with sufficient financial resources to buy a house should still be paying interest to buy a car -- most in this country feel otherwise.

[dziuniek]

I would:

1. Stop paying extra on mortgage.

2. Take the $600 from student loand (now paid off) and extra mortgage principal and throw it at the car. You will be done in no time....

3. Increase Emergency fund to 1 full year - you certainly have the means to do so.

4. Lastly concentrate on the mortgage.

Not really a wrong answer here.

Good luck!

[mortfree]

That was more of a philosophical comment than an analysis. I don't feel that anyone with sufficient financial resources to buy a house should still be paying interest to buy a car -- most in this country feel otherwise.

$7500 vs $72 this year. Guess which is which.

And no tax incentives

[JBTX]

Me, I wouldn't do either.

I would open up a taxable account and invest the $600/month.

You can easily do better than a 1% return on the car loan with nothing more exotic than TIPS, and even the most pessimistic nominal stock return projections beat the stuffing out of a 3.5% mortgage.

Think of investing the money as a second tier emergency fund. If you pay down the mortgage and some bad thing happens, the mortgage company is not going to let you skip a few payments because you once paid extra. Same with the car loan.

Those extra dollars are going to do you a lot more good in a brokerage account, where they will produce a higher return than paying down either loan.

I agree with this. Maybe split between ibonds and a taxable investment in index funds. I would even consider stopping the extra pay down on mortgage. 3.5% is probably better than you can get now. If mortgage rates went back down to very low levels then I may start paying down a little.

[JBTX]

Sometimes one needs to ask the question: "what percentage of rolling 8 year periods over the past century have had equity CAGR of less than 3.5%, and am I willing to take a chance on that continuing over the next several years?" Especially with what is very close to "new" money. The OP is doing well, meeting all obligations, has a substantial EF, and is saving at a good rate. It may be time to be a little less conservative.

You can ask the same question when you decide whether to hold bonds or stocks. If you would buy stocks rather than paying down a mortgage at 3.5%, then you should also buy stocks rather than buying bonds which yield 3%. If you have the risk tolerance, you could reasonably take both risks, and hold 100% stock and a mortgage, but few investors do that.

Liquidity is a separate issue; the liquidity may be worth holding bonds and having a mortgage at a slightly higher rate.

Not only is there some value in liquidity, there is also value in a sub market rate mortgage. There is also value in a fixed rate mortgage, in that you can always pay it down but can keep it if interest rates go up. It is form of inflation protection. So I would happily keep a 3.5% mortgage and have it invested in bonds at 2.5-3.0%.