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Thread: When paying off a car loan early causes more bad than good...

  1. #1
    PhillyDancer1982
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    Default When paying off a car loan early causes more bad than good...

    Okay I will demonstrate this with simple hypothetical examples, Person A and Person B.

    Person A and B each buy the exact same model of car. They put down the same size down payment. They get the exact same car loan with the same terms and interest rate. They each buy gap insurance* for his/her vehicle. In the end they end up paying $30,000 for their cars.

    * NOTE: For those that do not know, "gap insurance" is used to bridge the gap between the car's value and the (higher) balance that is still owed on the car loan. Most cars' values will depreciate drastically when the car is driven off the dealership lot, therefore people that do not put down a significantly large down payment will find themselves "upside-down," or owing more on the loan than the car's worth, for the first portion of their car loan. In the event of a major accident, "gap insurance" covers the difference between the high balance on the car loan and the car's decreased value.

    Unfortunately, Person A and Person B end up totalling their cars some time later(let's say 1 yr). By this time, each car has depreciated in value to $20,000.

    However, the way that Person A and Person B paid their car loans reflects how much money they've lost:

    Person A: Paid only the minimum payments. In a year's time, he paid down the loan from $30,000 to $25,000. So he still owes more on the loan than the car's worth, but hey that's what gap insurance is for. His insurance company covers $20,000(car's current value) and the gap insurance covers the $5,000 that was remaining on the car loan, and Person A gets nothing. He has invested $5,000 into the car that is now lost.

    Person B: Paid way above the minimum each and every month in an attempt to save money on the loan's interest, and because he knows it is unwise to carry large amounts of debt. He thought he was being "smart." In the same year's time, he paid down the loan from $30,000 to only $12,000. Basically he invested $18,000 into this car. When the car got totalled, he got paid $20,000(equivalent to the car's current value), of which $12,000 went to pay off the car loan and $8,000 went into his pockets. But subtract the $18,000 that he'd already "invested" into this now-defunct car, (8,000 - 18,000 = -10,000) and you'll see that he lost $10,000 in this car.

    As you can see, Person B thought he was "smart" by paying down his car loan early...but in the end, he lost more money than Person A!

    Now if Person B didn't get into the accident and he kept the car for a long time(10yrs+, or even better if he kept onto it for years until it reached "classic car" status, at which point the car's value would start increasing if is maintained nicely), I would say that he was better off paying off the car loan early. But it sucks that all was lost when his car got totalled.

    I am very similar to Person B with the way I conscientiously pay my car loan way ahead of schedule. I was thinking this horrifying scenario last night as I was desperately and frantically trying to navigate home in the icestorm. I guess the moral of the story is, be careful and avoid accidents as best you can. For example, on most days I purposely avoid driving in the snow because the last thing I want to do is total a car that I've already paid off most of the loan in such a short time.

    The other moral of the story is, perhaps it isn't worth scrimping and sacrificing so much just for the sake of paying off a car loan. If you can afford to make an extra payment each month, great; if not, it might not be worth it at the sacrifice of starting a savings account or getting that cavity filled.

    What do you guys think? My roommate and I were discussing this hypothetical last night after my nightmare drive home LOL.

  2. #2
    Banned Melonie's Avatar
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    Default Re: When paying off a car loan early causes more bad than good...

    this is exactly the same 'moral hazard' argument that also applies to subprime mortgage defaults, FDIC insurance on super high interest rate CD's being offered by 1/2 bankrupt financial institutions etc. As long as 'somebody else' takes the loss, what difference does it make ? Well, if you follow the financial news re MGIC and MBIA and AMBAC it DOES make a difference when the losses grow sufficiently large to bankrupt the supplementary insurer !

    So yes in the short term such 'moral hazard' rewards the financially irresponsible. However, in the long term, with supplementary insurance coverage becoming incredibly expensive or not available at all for high risk borrowers, the end result will be no new auto loans being written without a 33% down payment so that the lender doesn't have to assume any risk of a 'gap' loss.

  3. #3
    PhillyDancer1982
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    Default Re: When paying off a car loan early causes more bad than good...

    ^ Hmmm that is a very good point. Thanks for the detailed info.

    I understand the long-term effects and it sucks that these effects will affect EVERYONE, not just the people who choose to pay simply the required payments on their car and nothing more. Unfortunately, I do not think many of the people that skate by, simply paying the minimum on their loans, take the time out to think about that.

    I guess I am just really paranoid about driving my car in the winter weather because I understand that if I totalled it, I would be out all this money, a lot more than the average person who only pays what is required or maybe slightly more. That happened to my guy friend M--k a few years ago(yes, the same one that always seems to have bad stuff happen to him lol). That is why I am going to make sure I do not drive if there's the slightest bit of snow or ice on the roads! LOL.

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    Featured Member Vamp's Avatar
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    Default Re: When paying off a car loan early causes more bad than good...

    Well my first question is why are these people buying $30,000 cars? Why would anyone get a car loan that much and NOT have gap insurance? I know millionaires who wouldn't pay that much for a car. That is a down payment on a house!

    I never ever never buy a brand new car it is a waste of money to begin with. I have said this before but it looses at least $5k in value the second you drive it off the lot.

    Whether you total your car or not it will still loose value. Cars are not investments. Instead of fretting about the interest paid get a car that is less expensive, has good gas mileage, and has a good mechanical record. Take all the expense of a car into account before making a decision.

    Rate shop not just at banks but also credit unions.

    Always remember it is never a bad thing to pay off a loan early. The bad thing is getting a crappy loan with bad terms. Do it right from the beginning
    Nature knows no indecencies; man invents them. ~ Mark Twain


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    Default Re: When paying off a car loan early causes more bad than good...

    Quote Originally Posted by Vamp View Post
    Well my first question is why are these people buying $30,000 cars? Why would anyone get a car loan that much and NOT have gap insurance? I know millionaires who wouldn't pay that much for a car. That is a down payment on a house!

    I never ever never buy a brand new car it is a waste of money to begin with. I have said this before but it looses at least $5k in value the second you drive it off the lot.

    Whether you total your car or not it will still loose value. Cars are not investments. Instead of fretting about the interest paid get a car that is less expensive, has good gas mileage, and has a good mechanical record. Take all the expense of a car into account before making a decision.

    Rate shop not just at banks but also credit unions.

    Always remember it is never a bad thing to pay off a loan early. The bad thing is getting a crappy loan with bad terms. Do it right from the beginning
    I dont know how car prices compare between our two countries, but I brought a new car a few years back for just under $20,00 which is a fuck load of money really. I brought a new car because I no NOTHING about cars and every time I buy a second hand car it breaks, or I break it. Now I have a nice shiny car that works, and if it stopped working they fix it and give me a new one. Also coz I have my shiny new car with large debt I have to have comprehensive insurance, so if I break it my insurance fixes it.

    Not the most sophisticated reasoning I'm sure but thats realistically why people buy brand new cars.

    And ya know if I had $20,000 saving in my bank account I would USE it as a deposit for the house and get a bt extra on my mortgage to buy a car, but if you dont have that money in your pocket its not really comparable to getting a loan for that amount.

    But I dont want to get another car next year when this one is payed off, it's not so shiny and new any more but I plan on driving it til it dies an old and graceful death. SO if you aren't obsessed with always having the COOLEST car in the world it can be an investment for your life you know Oh and I got a good loan, which I can pay extra on or extend without penalties, and the loan I got was so good I am paying the same repayments for a 20,000 car as I would have for a 15,000 car with a different dealership's finance.
    [SIGPIC][/SIGPIC]

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    Default Re: When paying off a car loan early causes more bad than good...

    Cars break. One should put aside some money for new pieces and parts.

    I can't fathom buying a new car for 20,000+ when a decent car for 10,000 and maybe 1,000 in maintenance will do just fine. Paying $9,000 for ignorance about auto maintenance would have me reading a $20 dummies book on the toilet.

    Ya want it to look nice - get it detailed.

  7. #7
    madmaxine
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    Default Re: When paying off a car loan early causes more bad than good...

    It depends on how important a reliable vehicle is to your lifestyle. If having your car start each morning is the difference in whether you can keep a job or not, well, buy newer. If you can take public transit it your car isn't running/available, good for you.

    As for paying a car off early, it all depends on the individuals personal situation....A single person with no attachments can take the risk of paying off a car early and chancing a loss. Whereas someone with more obligations & more need to spread their money wisely might not want to risk it.

    (Also depends on state residency & auto insurance costs- my home state of California has nauseatingly high insurance rates.)

  8. #8
    PhillyDancer1982
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    Default Re: When paying off a car loan early causes more bad than good...

    When I described the situation of having a car get "totalled" within a few months of getting the car + car loan, I was referring to a no-fault car accident...e.g., someone else slams into you. In that instance, you'd only get the current value of the car + gap insurance would cover the remainder if you're not yet owing less than the car's current value.

    I did get gap insurance for my car, but the reason I somewhat regret it is because I ended up paying such large payments on my car loan, that I was already "rightside up"(i.e., owing less money than the car's value despite depreciation in value) within a very short time after purchasing the car. So basically I got stuck paying $1080 in gap insurance + interest($15/mo for gap insurance x 60 month length of the car loan), but the gap insurance was only needed for the first few months that I actually owed more than the car's value. Yeah I understand that it was still possible for me to get into an accident within those first few months that I was "upside-down" on the loan, so maybe it's good I had gap insurance "just in case"...but I also wonder if maybe the benefit of gap insurance is slightly overrated for someone that is planning to pay off the car early.

    I am definitely aware that paying down a car loan early is NEVER bad for your CREDIT, though. I was referring to the amount of money spent out of pocket on the car loan that would get essentially "lost". I guess there is also the argument that someone would lose money if they lacked gap insurance and got hit by someone else within the first month or two of having the car, though.

    I guess the moral of this story is, be very careful driving so to minimize the risk of an accident, since it can be very expensive. For example, I purposely avoid driving on bad weather days. I've even gone so far as to leave my car at work and take 3 busses home on days that it starts snowing, because I didn't want to risk totalling a car that I'd already spent so much money into(then I would get my car the next day at work...my work is a small office building with a secure parking lot).

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