As most of you know or have experienced, the rates for savings accounts have been dropping like a rock after the recent rate cut. With the additional rate cut today, I'm sure the rates will fall even further.

Given the fall in interest rates, the monthly interest paid on my savings account will continue to fall. Looking at the numbers today, it no longer makes sense for me to have $31,000 sitting in a low rate savings account when my car loan is at 8.43%.

The only thing stopping me from pulling the trigger is the thought of my savings account balance going way down. Granted, I will have a balance of around $7k left in the account but what if I have a $10,000 emergency? I don't want to have to use credit again to get me through a rough financial patch. Even though this is one of the major factors of me not paying off the loan, there are numerous benefits to paying the loan off.

By paying the loan off, I am freeing up $551 per month I am no longer sending to the bank each month. Actually, I paid an additional $250 on principal this month so I am freeing up even more cash each month. Paying off the car loan will not only improve my monthly cash flow, it will greatly decrease my debt to income ratio. Paying off my car loan will also help to increase my credit scores above the 720 goal I have set for 2008.

I've asked two of my close friends for advice on how they would handle the situation. Now, I would like to know what you guys think? Should I pay off the loan in full or should I continue to make extra principal payments?
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24 comments

  1. Frugal Bachelor // January 30, 2008 at 8:14 PM  

    I'm in similar situation, I have almost exactly the same cash position actually. My car loan has a fairly low rate, and it will be paid off in 6 months, but my student loan has a high rate (about ~7.5% rate) and will be years more if I keep paying the minimum, and have been considering just paying it off.

    Have you thought about shifting cash position into stocks? I've kicked the idea around but not sure I will take action.

  2. SingleGuyMoney // January 30, 2008 at 9:32 PM  

    *Frugal Bachelor: I've considered increasing the amount I have invested but like you, I have not taken action yet.

  3. Eden // January 30, 2008 at 9:51 PM  

    I don't think I would focus on the interest rate of my savings, but on what the savings is for. You talked about what if a $10K emergency happens- is your savings an emergency fund or is it just general savings?

    I wouldn't pay off my car loan with my emergency fund. If it is just cash savings then I wouldn't mind the 8% return on the money (maybe more like 5% with the difference in rates).

  4. Daizy // January 30, 2008 at 10:00 PM  

    I would pay it off! I had $31,000 in a money market account with a falling rate. When it went below 5% I decided that it would be more exciting to pay $25,000 down on my mortgage. I don't regret it. I have a 4 year plan to get rid of the mortgage, not enough time for stocks anyway. Getting rid of the mortgage is more exciting!

  5. Sarah // January 30, 2008 at 10:45 PM  

    I would pay off the car loan - with an extra $550 a month, you'll build your savings up from 7K to 10K in six months. And if a greater-than-7k emergency comes up in those six months, you could always trade in your current car for a cheaper one and put the difference towards the emergency.

    You'll build your savings from 7K back to 31K in 44 months with the $550. Or if you can continue to manage the $800 you paid last month, it will only take 30 months.

  6. MMJ // January 30, 2008 at 10:55 PM  

    If you feel more secure w/ 10k in the emergency fund, why not wait 6 months and then pay it off? That way you will have 34k in there and will be able to kill off the loan and feel a little better.

  7. dreamfool // January 30, 2008 at 11:02 PM  

    SingleGuy,
    Third option...you can refinance your auto loan! Here is my blogpost on my experience: http://dreamfool.blogspot.com/2006_12_01_archive.html
    There was no fee except to re-apply a new title, but it saved me several hundred dollars in interest! With the rates dropping like crazy, I think you should be able to find something around 5%. Good luck!

  8. Bethany // January 30, 2008 at 11:15 PM  

    In your shoes... I'd probably pay it off. Or at least make some *huge* payments on the principal (as in, maybe leave only 10K in savings). As another commentor pointed out, once you have the car paid off, going from 7-10K isn't going to be that big a deal anyway.

  9. RacerX // January 31, 2008 at 1:03 AM  

    Pay off the car loan. A $8000+ Emergency would be outside chance stuff, unless you have serious health issues.

    You are throwing away thousands other wise.

    Keep enough to cove the most likely emergencies. Look at the last two years, whateve the highes bill is, keep it.

  10. Single Ma // January 31, 2008 at 10:16 AM  

    I'd pay it off in full. It's an immediate 8.43% return. Where else are you going to find that ROR right now? And with an extra $551 cash flow, you can rebuild that e-fund stash in no time.

  11. My Two Dollars // January 31, 2008 at 12:30 PM  

    Pay it off in full, no doubt.

  12. Dimples // January 31, 2008 at 1:28 PM  

    I say pay it off. You can get the savings back to $10k in less than 6 months. And that is only considering the $551 car payment you will have freed up.

  13. MEG // January 31, 2008 at 5:00 PM  

    Do you send any money towards the savings account each month? You could just stop contributing to that account and direct all "savings" towards the auto loan. Or just take a set amount - like $1000 - out of the savings each month to put towards the car loan in addition to the payemtns you're already making.

    That way you pay it off much sooner but you don't immediately deplete your savings account. Personally if I had $31K in savings I'd have a hard time seeing it dip below $10,000. I'd keep it above that level.

  14. Pinyo // January 31, 2008 at 9:23 PM  

    Wow, that's a big car loan. I'd say pay it off. The chance that you will make 8%+ short term in the stock market is slim. Go for the sure thing and pay off the debt.

  15. Micah J. Child // January 31, 2008 at 10:11 PM  

    I've always been happier with less debt. I paid off my car loan, and was able to redirect that cash flow to focus on my remaining debt, and Pay off all of my unsecured debt, so the only debt I had left was my house. Since I only redirected the payment that I was paying on my car to a specific account until that account was paid off then another account it went quickly and I never missed the money in my pocket since it was already never going towards my pocket or savings streams. But since the debt was eliminated I was able to then redirect it towards savings and continue to live on my old budget as if I was still paying the debt. But with less financial stress since now I was keeping the money in the end. Since you have such a large amount of money in savings why not put it into a moneymarket account that might have a higher interest than a traditional savings? 32 and single ;-)

  16. Anonymous // January 31, 2008 at 10:43 PM  

    First off, you seem to be contradicting yourself... You want to pay off your debt, but you have a goal of increasing your credit score? The only reason to increase your credit score is so that you can borrow more money and go in debt again! STOP BORROWING MONEY!!! That is the REAL way to wealth-building! If your goal is to get a home loan, get a 15yr conventional. And as long as you do not have any debt, you can get a manually underwritten home loan so you don't need to have "a good credit score". Having a good credit score is a PRODUCT that society believes that we have to have in order to succeed. Think about it, who makes money when you use credit? It's not you, which is why they want you to play their game and continue to use credit.

    As far as the money goes, why does it have to be an all or nothing deal? If you do pay off the car, it'll just take a few months to get your account back up to 10K.

    A good emergency fund is 3-6 months of living expenses, and 10K probably doesn't do that for all people. Also, why the heck do you have 31k in a savings account of all places??? If this is an emergency fund (which you do need to have-and btw, GREAT job at saving 31k), stick that money in a money market fund and get 4-5% vs the 1-2% from the bank. At 4% average inflation every year, you're losing money pure and simple.

    Take Dave Ramsey's Financial Peace University. Fantastic class. Can be taken at a local church or online. See his website for a location near you. You won't believe how much you'll learn. The $100 class pays for itself many times over. He also has a radio show everyday for 3 hours, so you can listen to him for free there. He has a book too.

    But pay off the car and stay out of debt. Max your Roth IRA and 401K in good growth stock mutual funds that have a 10-12% average over 10 years. Also, give to charity. These are the keys to success, but very few people use them.

    Good luck, it sounds like you really want to do the right thing with your money. Don't believe people that says you need a good credit score, you simply don't, and with that as a goal, you'll just stay in debt for no reason at all. If you can't afford it, don't buy it. This generation today doesn't heed this advice, which is why they are all in debt. Be different, you'll win that way. Live like no one else so you can live like no one else.

  17. Dave // February 1, 2008 at 4:25 AM  

    I'm 29 and in a similar cash and savings situation as you, minus any student or car loans. For me, I'd rather have the 30K in the bank, earning me over $100 passive income a month in interest. Yeah, I'm getting dinged on that at the end of the year, but for our age group there aren't many tax shelters anyways.

    Sounds like you're driving a cool car. But its a rapidly depreciating asset and you're lucky to retain over half the original sticker price value a few years after buying it. Personally, I wouldn't sap the fund just because you're paying interest on the car. I would rather keep the security and freedom that the money in the bank affords you.

    Maybe a better question would be... to trade down that car into something more affordable in terms of principal owned on the car. Assuming you owe about what the car is worth at trade-in, perhaps this can open up some options for you in terms of more inexpensive new or reliable used cars. Just a thought.

  18. paradigmshifted // February 1, 2008 at 4:11 PM  

    how about a compromise? Siphon a few thousand out of the emergency fund (maybe 10K) towards the car. It'll make a big dent in overall payments because that's 10K less to pay interest on.

  19. JHuff15 // February 1, 2008 at 11:20 PM  

    First of all, this is a great blog and the first I've ever felt inspired to comment on. Keep it up. I'm in a similar situation, just not with as much in savings :). I've toyed with the idea of savings or paying the car off and I've decided on keeping it in savings because of the psychological benefits. If I were in your exact position I would leave $20k in savings and put the rest into paying the car loan off. Good luck with your decision.

  20. SingleGuyMoney // February 2, 2008 at 9:44 AM  

    Thanks for all the great comments. I've decided what I want to do. Stay tuned as the decision will be posted in the next couple of days.

  21. Major Tom // February 2, 2008 at 12:01 PM  

    What is your other debt? The most effective way has shown to be to pay it off from smallest debt to largest debt. This way you get to feel like you're making progress and you'll stay with it (like losing weight.) Although, doing this is not always the most mathematically correct way with interest payments and all, but if we were doing the math to begin with we wouldn't be in debt.

    Second, it sounds like you bought a car that was too expensive for you. That's usually big money mistake #1 for people under 30 since they all buy new cars out of college. Have you considered selling it? (gasp!) Because if I read your blog correctly, you could sell your car, get a paid-for used car for $2,000-3,000, and use the rest of the money to pay off your debt while still having some of that money in the bank. If this didn't get you out of debt, it would sure get you close; you could be out of debt very quickly. So I guess the question to you is, how bad do you want to be out of debt? Because you can do it, and do it fast if you're willing to make the sacrifice. Expensive cars are the absolute worst purchase someone can make. Drive a junker for a few years; it's not glamorous, but you'll save a TON of money doing it. Or, worry about what other people will think and keep your status symbol car, staying in debt like the rest of society. You can move up in junker cars too, just do it paying cash. You can drive a great used car for over $5,000. Then just funnel what you were paying for the car debt and roll that into your next debt. Snowball it; as you pay off one debt, just roll that payment into the next debt. The snowball gets bigger and bigger.

    Regarding the other post, Dave Ramsey rocks; listen to that dude!

  22. Sue // February 4, 2008 at 8:03 PM  

    I would pay off your car loan a little slower. Pay it off with existing cash from your current paycheck. For example, I put $600 a month extra towards my car lease, then when that was paid off I applied the $600 and my $230 car payment toward my financed car. Doing a debt snowball helps but you need to try to live within your means. Do you have credit card debt that you need to tackle? One of the main goals would not be to go back into debt but certainly pay down your loans each month more than the minimum. By the time my son is ten I have a goal of having my house paid off. In May, I have to decide how to handle another car payment (lease or finance) but the amount is worked into our mortgage paydown already. It would be easier to know how to advice on debt pay downs if you have all the terms, interest rates and amounts for your existing debts. Good luck!

  23. Shown Poolack // February 22, 2008 at 6:25 AM  

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  24. kentuckyliz // February 27, 2008 at 8:16 PM  

    I vote pay it off. You're losing money every month! (Paying more in interest than you're earning in savings. DUH)

    Consider the potential event risks in your life that would necessitate needing $31k. Heck, I was unemployed and underemployed for 14 months and didn't need near that much money.

    At least make sure you're nowhere near being upside down.

    That's a lot of car you've got there. It's a far better wealthbuilding strategy to keep your resources out of depreciating assets...meaning, drive a humble used car, a beater even...and direct those freed up resources elsewhere. Even more powerful of a strategy for young people, because early investments make you a lot wealthier in the long run.

    At least don't get upside down, that's a freakin' disaster.