Car Loan or Savings -- What would you do?

[kork13]

I've been evaluating my budget and financial situation recently, and I'm a little torn on which course to follow... Bottom line, my question is "What would you do?"

To explain my conundrum, when I moved back to the states from Japan last summer, I bought a car and financed $19k for 3 years @ 1.79%, $520/mo payment, currently paying $600/mo. The maturity date is August 2015. Separately, I also bought a house -- I only financed the car in order to preserve cash for the downpayment & avoid cashing out too much of my investments in order to prevent PMI... otherwise I would have bought the car with cash on the spot. So with the added expenses, I realized that I needed to boost my emergency fund to $25k (~6 months' expenses), and I started saving towards that end.

I currently have a TOTAL of about $25.5k in liquid funds, saving an extra $600/mo. The majority is in I-Bonds and savings accounts earning ~2% & .9%. The breakout:
- $19,500 earmarked as my actual emergency fund, currently adding $400/mo
- $1000 float in checking
- $2500 in my "home account" (intended for repairs, upgrades, etc.), adding $100/mo
- $2000 in my "general savings" (basically my "fun money" for spending as desired, though infrequently tapped), adding $100/mo
- $500 in a couple other small savings accounts, basically untouched and serve as overdraft protection

What I'm looking at is possibly shifting all of my monthly cash savings toward accelerating my car loan payoff. The current balance is $15,350. So I would be paying $1200/mo toward the loan, which let me pay it off in about 13 months (March 2014). My concern is that I don't really (in my mind) have the 6 months' emergency fund, and I would basically be giving up on adding to my EF, General, and Home accounts for the next year. The reason I'm looking at doing this is simply that I hate being in debt, and my $130k mortgage (although totally reasonable and easily affordable for me) is emotionally a bit daunting for me as it is.

The other background info is all good... My income is solid, expenses well under control, and I save about 30% of gross (between my current cash savings, taxable investments, and retirement). My only plans to change that is to increase my savings upward toward 40% once I pay off the car loan. So once again, I'm coming to you all as my financial 'Jiminy Cricket' -- WHAT WOULD YOU DO??

[cooliemae]

My first thoughts would be as follows:

Drop the $400/month in emergency savings to $50
Maintain the $100/month towards home account
Drop $100/month in fun money to $50

Take the $400/month that was going to savings and start paying the house off. Of course this assumes that mortgage rate is higher than the car loan.

Why...because you see the most savings by paying off the mortgage. Take the $400 and add it to the car loan you'll saving around $200, take the same amount and add it to the mortgage and you'll save somewhere around $40,000 (assuming 30/yr 4% fixed) in interest. Just a little bit more than the car loan interest savings.

Of course you might look at refinancing you car loan at a bank like penfed where you can get 1.49% and save about $75 over the life of the loan, but it might not be worth the hassle.

[siggy_freud]

He'd probably pay at least 75 in fees to refinance the car loan. Even at 400 a month extra, you're looking still at 15-20 years to pay off the house. Despite it being a lower interest rate, I'd go ahead and pay off the car quicker, rid yourself of that payment, and then snowball in the 500 a month payment into the home.

Yes, the house is a higher interest rate, but freeing yourself of 500 a month sooner could come in handy, and would reduce your emergency fund needs.

[cooliemae]

He'd probably pay at least 75 in fees to refinance the car loan.

True, there might be fees, but I just refinanced my loan at a cost of $10, but it does depend on the state you live in and if there's a penalty for early payoff. However, I'm assuming there's no penalty otherwise he wouldn't be asking if he should pay it off early.

Even at 400 a month extra, you're looking still at 15-20 years to pay off the house. Despite it being a lower interest rate, I'd go ahead and pay off the car quicker, rid yourself of that payment, and then snowball in the 500 a month payment into the home.

Yes, the house is a higher interest rate, but freeing yourself of 500 a month sooner could come in handy, and would reduce your emergency fund needs.

That's certainly one way to go, but if he starts paying off the house with the extra $400 in the 2015 takes the $500 he's putting towards the car and rolls it into the house, he can have the house paid for in half the time (again with 30yr 4% fixed) and will have paid only $25k in interest versus $40k without adding the $500 and $93k without adding the $400 to start.

If he thinks his job is secure and is obviously doing a good job saving, I would go ahead do something close to what I've recommended.

[kork13]

For clarity, my mortgage is at 2.75% over 15 years. I'm currently paying a bit of extra principle (~1 month's payment per year), so on pace right now to take a year off the term. I went the 15-yr route to reduce the interest payments as much as possible, and at present my payments (incl. extra principle) represent about 20% of my gross, so I was comfortable with that going forward. I do expect that I'll start paying more principle down eventually, though not sure when I was planning that. Perhaps once the car loan is paid off. However, after the tax deduction, my mortgage interest is nearly as low as the car loan, so I think I'd rather just get the car paid off quickly. Likewise, I don't think I want to mess with refinancing an already-quite-low car loan that I'm planning to pay off ASAP.

For some reason I've not considered anything but an all-or-nothing approach -- not sure where that thought process broke down... Anyway, perhaps as cooliemae suggested, trimming the cash savings down and funneling the rest to the car loan might be my best option.

Thanks for the thoughts so far, honestly I appreciate just being able to bounce my ideas off of you all and get some different perspectives than my own. These forums rock.

[MonkeyMama]

I'd put it all to the car. In general, it is really no big deal to ignore a financial goal for a year. Being debt-adverse, I have done many times. When you are done, you will be adding $1200/month to cash savings, and will catch that up in no time. Exception would be if there were something foreseeable on the horizon (like potential job loss). Another option is just to save up the cash and pay it off at the end of the year (or in 13 months, as is your plan). Which is what I generally tend to do with a lower income (income cut with my spouse unemployed). "I'd like to pay an extra $5k on debt this year, and I have the cash, but let's make sure I am still employed and no one ends up in the hospital this year." So I do generally have an "end of the year rule" for any big diversions of cash. The psychology of being debt-free often has very little to do with the interest - so it would not bother me to pay interest for one year, personally, while conserving cash flow.

[lindsay06]

All into the car -- for sure!

[grumpter]

"3 years @ 1.79%" - S....A.....V....E

[OpenMinded4Growth]

"I'd like to pay an extra $5k on debt this year, and I have the cash, but let's make sure I am still employed and no one ends up in the hospital this year." So I do generally have an "end of the year rule" for any big diversions of cash. The psychology of being debt-free often has very little to do with the interest - so it would not bother me to pay interest for one year, personally, while conserving cash flow.

This section of your statement actually resonated with me. I have the same philosophy because no one ever really knows what is coming around the corner. Additionally, if the interest rate is low and I already have the cash, a few more months in extra savings is worth the wait before I make that considerable cash transaction at the end of the year. I always want to make sure that after I pay off a debt, I'm not at "0;" it is good to have something left over. No matter what, since I am 29 y/o without any children, no significant other, currently renting without a car, my "emergency situations" are limited (barring any health setbacks), I generally try to focus on building my emergency fund (which will be capped at $2500) and then will start working on 3-6 months of income.