Live Debt Free

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Reasons To Pay Off Your Car

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It’s better to be debt free than owe money.

I’m talking everything: your credit cards, student loans – even on your home.

It can be done – if – we make the right choices.

Regarding auto loans: if you have a choice, pay it off ASAP!

Here’s why.

Owning a car is expensive enough without a loan

Owning a car comes with many expenses: gas, insurance, registration, taxes, maintenance, care, and repair. Together these can total several thousand dollars per year. But throw a monthly car loan on top, and you have thousands more.

The secret to success? Pay cash for cars and save money for their regular care. If you take care of them they’ll take care of you.

If you lose your job, it’s one less payment

Living light never feels better than when you lose your job. Suddenly income evaporates (or is lowered to the level of an unemployment check) and one of your primary new tasks is to cut spending. If you own your car, one major expense is already out of the way.

In today’s unstable job market, this is a goal worth making reality!

The RISK of not making your payments

Most of us take the risk of auto loans a bit too lightly. After all, stop paying your credit cards and you may get nasty phone calls and a series of threatening letters, but nothing will be taken from you, at least not for a while. Stop paying on your mortgage and you’ll get to stay in the house for as long as the slow wheels of the foreclosure process will allow.

But – stop making payments on your car, and you’ll lose it, and quick!

If you lose your car you’re probably not able to earn a living. Do you see the vicious cycle here?

Never take this risk of borrowing money lightly.

Own important things free and clear, whenever possible

Call it peace of mind or whatever you want but owning things without debt is as a sanity issue.

If everything you own has a loan attached to it, life can be maddening. Debt is everywhere you look—even when you’re out driving your car.

A debt free car is like a mental and emotional oasis, it’s one very important asset you can own free and clear, and we all need as many of these victories as we can get.

Keep your options open

Few things in life are constant.

As we go through life, our circumstances change,  our directions change, and even we change. Even if you have no intention of it, your future can hold an unexpected life change.

If change does come – trust me – you’ll be better served by having all of your financial ducks in a row. And owning your car free and clear is one great way to prepare.

Benefits of owning your vehicle

Owning your vehicle free and clear benefits you in several ways, including but not limited to:

Sell your car. A car loan is a limiting factor if you should decide to sell. Auto loans reduce the amount of money you’ll clear on the sale ,and (if the loan is large enough) could even render the sale impossible.

Buy your next car. A loan means less money from a sale or trade-in, and that means a lower down payment on your next car.

A lower down payment means an even larger loan on the new car, and the cycle of ever higher car debt to continue. By being debt free on your car, the cycle is broken.

Start a new business. If you want to start a new business, being debt free on your car makes it easier. It’s not just one less bill to pay, it’s also one less obligation to worry about. If you start your own business you’ll want the fewest obligations possible.

Accept a lower paying job. There are at least two reasons this could happen, 1) you’re laid off and forced to take a pay cut, or 2) you move into a job that you really like but it pays less. The car loan, so easy to handle at your current pay level, may be impossible to manage in a lower paying job. By owing your car you’re in a position to move when you need or want.

Raise children at home. How much easier would this be to do if you owned your car debt free?

Just to take some time off. Each of us need to do this from time to time, especially between jobs or before starting a new career or business venture. It’s a way of clearing our heads before the next big move. Whatever the reason, it’s easier to do with no car loan to worry about.

We should work to be debt free in as many areas of our lives that we can – but – your car is one asset to be especially motivated to pay off.

Once you do, many risks and burdens go away, trust me!

Can you see why being debt free on your car is so important? Do you see why it should be one of the first debts to pay off?

How To Pay Off Debt With a Lump Sum

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How To Pay Off Debt With A Lump SumThe question:

DFA reader Denise asked:

My husband will be getting a lump sum next week of about 110 k. This is a settlement from a workers comp case. It’ll change a lot of things for us. For one. We will be able to pay off almost all debt (mostly medical bills) and another is our monthly income will be reduced by $860 a month. Yikes! We also have a car loan with about 15k left and my student loan which is in collections and is being garnished from my paycheck each week. not much I can do about that. Another 30k plus to go!

My question is basically what is the best way to go about paying off the car loan which is financed at over 20%, to make the most positive impact on our credit report? Ideally we would love to do it within six months.The answer:

Thanks for your question Denise.

As I see it you have several options:

  1. pay off the car in one lump sum
  2. bank the money and continue making regular payments until the car is paid off
  3. start paying your student loans.

Let’s take a closer look to see what works best for your situation.

Lump sum aka windfall

Today the term windfall refers to a piece of unexpected good fortune, typically one that involves receiving a large amount of money, but originates from an apple or other fruit being blown down from a tree or bush by the wind.

Windfall’s can be – and should be used as – great kickstarts for getting out of debt!

Your credit score

You mentioned your credit score which shows you are concerned about how to make it higher.

I have my own opinion about credit scores, but we’ll set that aside for now to best answer your question. (Use this credit score resource to help find or improve your score.)

The best way to improve your credit score will be to get your student loans current and out of collections. Use the combined resource of your monetary lump sum and the flexibility of repayment offered by your student loan guarantor. (Use this student loan resource to find your best solution.)

Your auto loan

Since you’re paying around 20% interest on your auto loan you want to get that paid of as soon as possible.

To give you a better idea of how much this loan is costing you let’s take a look at an example amount being financed at 20%.

According to BankRate.com’s auto loan calculator, a 4-year $15,000 loan at 20% means a $450/month car payment with $250 of that going toward interest. At the end of this loan you will have paid nearly $7,000 in interest!

That is unacceptable, so pay it off as soon as possible.

Conclusion

If it were me I would use the lump sum in this order:

  1. pay off the medical bills
  2. get the student loans current
  3. use the rest to pay off (or down) the auto loan.

Once you have the auto loan paid down (or paid off) you can set up automatic payments to your student loan guarantor so you no longer have to worry about late payments, collections, and wage garnishment.

Note: although it may not apply to this situation, others reading will also want to consider investing some of the lump sum. I usually recommend passive investing strategies.

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photo by Steenbergs

Understanding Debt [Part I]

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Statistically speaking, it’s very likely you’re in debt.  Although the data is all over the place, most people agree that somewhere around 80% of people (excluding minors) have debt.  There are many ways you can borrow money, so I wanted to take a look at the different types of debt and my thoughts on each.  In part I, we’ll discuss credit card debt, student loan debt, payday loans, vehicle loans, and personal loans.

1.) Credit Card Debt

The average credit card debt per household with credit card debt is $15,799.  Considering the average APR on a credit card with a balance is 13.1%, people are wasting way too much money paying interest.  I have yet to meet anyone who has purposely gone into deep credit card debt.  It happens slowly.  A little emergency comes up, you take a vacation you can’t afford, or you just can’t seem to stop buying new clothes.  Either way, it tends to creep up on people.  Credit card debt is a major problem in our country and I suggest staying away from them at all costs.

2.) Student Loan Debt

This one is a major hot topic.   I used to think that student loan debt was a necessary evil.   The more I read, talk with experts, and work with clients who have tons of student loan debt, I am convinced that student loan debt is also a terrible idea.  In fact, delinquency rates on student loans are now higher than mortgages, home equity loans, and auto loans.  Credit cards are the only other debt that has a higher delinquency rate.  Not only that, but you cannot bankrupt student loans.  Contrary to popular belief, it is possible to go to college without debt.  Working hard to get merit scholarships, having a job (or two) while in school and in the summer, and utilizing community and in-state schools are just a few ways to make it happen.

3.) Payday Loans

Payday loans are a terrible way to make poor people poorer.  If you notice, there usually are not millionaires filing in and out of a payday loan store.  It’s a place for desperate people to go to find money and they pay dearly for it.  The APR on most payday loans range from 390% to 780%.  Wow!  How would you like to pay that rate on your mortgage?  You woudln’t and you also shouldn’t get anywhere near a payday loan store!

4.) Vehicle Loans

Vehicle loans are not a terrible thing.  Most people have them and most  people always will.   There are nothing like credit cards or payday loans in terms of interest rate.  There are two problems I do have with vehicle loans, though.  First, when you do not have a vehicle loan and instead, pay yourself a car payment to your savings, then  you have much more flexibility.  There have been quite a few months when things have run tight for Mandy and I and we simply didn’t put our “car payment” into our savings that month.  If we would have had to make a car payment, that would not have been an option.  I am not sure what we would have done other than raid our emergency fund, which we try to avoid if at all possible.  The second problem is that people often buy cars they cannot afford when buying with payments.  By saving and paying cash for a car, it is impossible for Mandy and I to buy something we cannot afford.  We either have the money or we do not.  I have met with way too many people who have a  $25,000 with a $40,000 a year income.  That is just crazy and I have only seen it happen when someone buys with a vehicle loan.

5.) Personal Loans

To be clear, by personal loans, I mean borrowing from a friend or family member.  Not a good idea.  It really changes the dynamics of the relationship.  For example, instead of just Dad/Daughter, it is now Lender/Borrower.  It often leads to an inappropriate amount of control in the life of the borrower by the lender.  Personal loans are certainly better than payday loans, but I suggest avoiding them as well if at all possible.

In part two, I discuss medical debt, home equity loans, unsecured bank loans, and mortgages.  Stay tuned and let me know what you think so far!