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Thread: What would you do?

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    Veteran Member alessandra's Avatar
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    Default What would you do?

    Hi financial gurus, I have a question for you, but first, a little background:

    I currently have a basic savings/emergency fund set aside at what was a great rate until recently with the interest rate drops. I also have a car loan @ 5.5% which was set up last year. I have no other outstanding debt, and have already invested my $4k for last year into my IRA. I am in college, and take out of my savings to pay for tuition every semester.

    My question is this: would it be prudent to take out a substantial amount of savings, and partially or even completely pay off the car loan? I paid half the purchase price with my downpayment, so I'm not using GAP insurance nor am "in the hole" on my loan vs the car's value.

    Thanks in advance

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    Featured Member la429's Avatar
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    Default Re: What would you do?

    They say you are supposed to have at least 3 months living expenses covered in your savings just in case!

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    Veteran Member alessandra's Avatar
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    Default Re: What would you do?

    Oh, it's well over that! I'm paranoid, especially with the current economy, so I have about 12 months of living expenses set aside

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    Default Re: What would you do?

    Quote Originally Posted by alessandra View Post
    Hi financial gurus, I have a question for you, but first, a little background:

    I currently have a basic savings/emergency fund set aside at what was a great rate until recently with the interest rate drops. I also have a car loan @ 5.5% which was set up last year. I have no other outstanding debt, and have already invested my $4k for last year into my IRA. I am in college, and take out of my savings to pay for tuition every semester.

    My question is this: would it be prudent to take out a substantial amount of savings, and partially or even completely pay off the car loan? I paid half the purchase price with my downpayment, so I'm not using GAP insurance nor am "in the hole" on my loan vs the car's value.

    Thanks in advance
    Car loan @5.5% is really cheap and makes no sense in paying it off.

    Also, many car loans have prepayment penalty meaning that you will actually lose
    money.

    The only reason why you'd want to payoff is, if you have too much cash in hand, you may be tempted to spend it all. But, you don't sound like that kind of a person

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    Default Re: What would you do?

    paying off car loan is going to provide you with something like a +3.5% return on investment versus simply socking more money into a 2.5% savings account (because the savings account interest earnings are taxable).

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    Veteran Member alessandra's Avatar
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    Default Re: What would you do?

    Quote Originally Posted by xanfiles1 View Post
    Car loan @5.5% is really cheap and makes no sense in paying it off.

    Also, many car loans have prepayment penalty meaning that you will actually lose
    money.

    The only reason why you'd want to payoff is, if you have too much cash in hand, you may be tempted to spend it all. But, you don't sound like that kind of a person
    There's no prepayment penalty on the loan, made sure of that when I signed the paperwork as I somewhat planned on paying it off early if everything went well financially.

    It's not that I'm tempted to spend it all, just that I was thinking paying off the loan @ 5.5% is a better idea then letting it sit in the saving account where it is now at 3.25% [until it drops again ].

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    Veteran Member alessandra's Avatar
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    Default Re: What would you do?

    Quote Originally Posted by Melonie View Post
    paying off car loan is going to provide you with something like a +3.5% return on investment versus simply socking more money into a 2.5% savings account (because the savings account interest earnings are taxable).
    Thanks Melonie, was hoping you'd drop in and offer some sage advice (and not scold for me buying a new car )

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    Default Re: What would you do?

    Quote Originally Posted by Melonie View Post
    paying off car loan is going to provide you with something like a +3.5% return on investment versus simply socking more money into a 2.5% savings account (because the savings account interest earnings are taxable).
    Yeah, when Alessandra hits an emergency and need $10000 who is going to lend her money at 5.5%?

    Once again, your point is valid but ignores the opportunity cost

    By not paying of the loan now, Alessandra has an option.

    I'm sure you know options are worth more than $0 in the market

    If not, you can study why BSC is trading at $11.90 and not the JPM offered price of $10

    I can run a Black-Schole model and value the option Alessandra has right now and give you the exact answer to the last basis point whether it is an economical decision or not. Then I'd have to pry into her personal life and calculate probabilities of emergencies.

    The point is 5.5 loan is cheap and it is stupid to pay it off in this environment. Even Investment Banks are holding on to Cash and not giving it away to other Banks

    Adding even more to the value of option........
    And I can't stress the importance of Cash at hand,
    If Gold falls to $500 or S&P 500 falls to 800 or you find a bargain Real Estate that you need down payment for, you can immediately use this Cash to buy those cheap assets. At this stage nobody will lend you money @5.5%

    If any of the asset price falls below its value, you have a fantastic opportunity to pick these up at bargain prices. You lose this ability when you pay-off your car loan for a measly $25 / month ROI that Melonie infers to.

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    God/dess Deogol's Avatar
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    Default Re: What would you do?

    Investment banks are holding on to their cash because they are up to their eye balls in bad debt, something that does not apply to Alessandra.

    I would prefer to keep 5% more of the money left on the loan than not. That is keeping your cash.

    If you are concerned about cash flow, I would keep the debt outstanding. If you are worried about the total amount of money going out of your pocket, it always pays to finish off a loan. That money is YOURS not THEIRS.

    Money is pretty simple. It's all this spreadsheet bullshit that has our economy in the fix it is in right now.

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    Default Re: What would you do?

    Quote Originally Posted by Deogol View Post
    Investment banks are holding on to their cash because they are up to their eye balls in bad debt, something that does not apply to Alessandra.

    I would prefer to keep 5% more of the money left on the loan than not. That is keeping your cash.

    If you are concerned about cash flow, I would keep the debt outstanding. If you are worried about the total amount of money going out of your pocket, it always pays to finish off a loan. That money is YOURS not THEIRS.

    Money is pretty simple. It's all this spreadsheet bullshit that has our economy in the fix it is in right now.
    Yes, the simple truth is money borrowed at 5.5% is cheap and should not be returned away.

    It was Melonie who went anal about the after tax 2.5% savings or $25 bucks / Month ROI. Well, if you are anal then you should be completely anal and include all costs (including opportunity costs).

    Simple argument: Paying off loans borrowed at 2% above CD rates is not economical
    Complex argument: Calculated at 1bps rounding, and valuing the option alessandra has and deducting the after-tax interest rate differential between the loan rate and the best savings rate, Alessandra will be ahead by not paying off the loan

    And for the spreadsheet comment, just because cars kill you doesn't mean everyone has to stop driving.

  11. #11
    OdysseusNJ
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    Default Re: What would you do?

    Alessandra there's no right answer here. Basically you will come out slightly ahead monetarily if you pay off the loan. However sometimes it is good to have that much cash on hand, for instance my father lost his job and then passed away some years back and I had to bail out my mom. If I hadn't kept a lot of cash on hand she might have lost her home.

    So it's a judgement call. I personally would not pay off a 5.5% loan, that is about as good a rate as you will get anywhere barring subsidized loans (some student loans, some car loans directly from manufacturer, etc). However if you really don't have to worry about needing a large safety net you can make a bit more money. If you have a solid family and friends for emergencies, perhaps you should pay it off. If you don't, well then keep the cash.

    Also there are still banks offering more than 2.5% APR. I think Orange is, and I'm sure Countrywide is.

    Once again no wrong answer. The fact you're considering something like this makes me think you are probably doing things right.

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    God/dess Deogol's Avatar
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    Default Re: What would you do?

    Quote Originally Posted by xanfiles1 View Post
    Yes, the simple truth is money borrowed at 5.5% is cheap and should not be returned away.

    It was Melonie who went anal about the after tax 2.5% savings or $25 bucks / Month ROI. Well, if you are anal then you should be completely anal and include all costs (including opportunity costs).

    Simple argument: Paying off loans borrowed at 2% above CD rates is not economical
    Complex argument: Calculated at 1bps rounding, and valuing the option alessandra has and deducting the after-tax interest rate differential between the loan rate and the best savings rate, Alessandra will be ahead by not paying off the loan

    And for the spreadsheet comment, just because cars kill you doesn't mean everyone has to stop driving.
    Opportunity costs are very hard to realize as an "actual effect" unless one knows exactly where the opportunity lies (if it even exists.) IOW, unless one has people lined up at the door asking to pay for the purchase of your money there really is no opportunity cost. Her known opportunities were to make less than 5%.

    Carrying debt when there is no need to is foolish. Paying more money for money she has to pay anyways is foolish. The only time she has to ask the question is if the money can make more than 5%.

    Otherwise, she is shelling out 5% more money out the door than she needs to. She can retain 5% of her income simply by paying off the debt. Then that 5% will be in her pocket for future opportunities that avail themselves.

    (I'll say this, she is at least being exposed to two very different philosophies on money management.)

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    Default Re: What would you do?

    reading between the lines of the original post, Allesandra is a dancer. She has a ton of cash sitting in a passbook savings account ... more than enough to fund her college tuition payments plus max out her IRA contribution and still have 12 months worth of living expenses set aside. This implies that she has a reasonably reliable dancer income. Thus a scenario where the pre-payment of her car loan would involve a major lost opportunity cost, i.e. causing a shortage of funds which could potentially be used for other investment purposes, is rather far-fetched.

    Also, given the past few months worth of history on Wall St. , right now a guaranteed tax-free 5.5% ROI doesn't look too shabby !

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    Veteran Member alessandra's Avatar
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    Default Re: What would you do?

    Quote Originally Posted by OdysseusNJ View Post
    Also there are still banks offering more than 2.5% APR. I think Orange is, and I'm sure Countrywide is.
    My bank is at 3.25%, for the time being

    Thanks for the various replies, I'm still not sure exactly what I'm going to do, so it's just going to sit right now.

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    Banned Katrine's Avatar
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    Default Re: What would you do?

    I would invest some of it into a non tax qualified portfolio so you have some flexibility and relative liquidy. Now is the time to buy! But I like the idea of dancers keeping at least 6-8 months of savings completely liquid and in an interest bearing account.

    For medium-term investments (non-qual), I've been recommending some diversified international bond holdings that pay out a decent dividend of at least 6%. Sure there is risk of capital loss upon sale of the security. But if she needs to cash out, she can write it off on her taxes up to $3K, and shouldn't face any redemption penalties if she doesn't go into a back-loaded fund, or even goes no-load. I would recommend a fund here to minimize her overall risk. And go international for further diversification.

    I am also a big fan of non-traded REITS, which payout 6-7% annually. But you will lose some liquidity there. The REIT will usually buy you back for par after 4 years. And the interest is partially tax advantaged.

    I have fucked up COUNTLESS times paying off my debts in full, then running into a cashflow crunch. If something changes for the OP and she cannot work, she might be stuck with a $300-400 low interest car payment, and almost a year of savings to draw down on.

    If she pays it off, then she is going to return to square one. If she runs into a cashflow crunch (injury, stripclubs start getting busted, business is bad, family emergency), then what does she do?

    You can't take out a reverse loan on a car. If you aren't upside down on the asset, I wouldn't pay it off quite yet. But you can always add extra to principal assuming the terms of the loan allow you to do so.


    I just googled and found a discussion that named some decent funds from families that I sometimes deal with:
    http://socialize.morningstar.com/New...ad/200580.aspx

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