should you pay off a car loan before mortgage?

KellyJef · #1 (**permalink**) 10-02-2006, 07:34 AM

My daughter is getting married in October 2007 and they will be applying for a home mortgage within the next few months.

Her fiance currently has a truck loan of about $400/month. He will be in a position to pay off the truck with a lump sum payment in a couple of months. But he's wondering if it's better to keep the loan active to show that he has been responsible in paying off the truck.

My feeling is that he should pay off the truck and that he has already demonstrated his financial responsibility with regard to this truck loan so paying it off early would not negatively affect his credit rating.

Any advice would be greatly appreciated.

sweeps · #2 (**permalink**) 10-02-2006, 07:45 AM

What is the interest rate on the truck loan? If it's very low, I personally would not pay it off.

Perhaps the answer here is none of the above. Do they have other debts? Do they have enough saved for emergencies? Do they have a large enough down payment for their home purchase? Are they contributing to retirement savings? Maybe the lump sum should go to one or more of these goals instead.

sakigt · #3 (**permalink**) 10-02-2006, 07:58 AM

Usually that $400 a month will make it easier for them to apply for the loan, but wont affect things like the intrest rate.

I was in the same situation when I bought my condo. WAIT!

Ask your lender what the best thing would be when you apply. For me, the monthly car payment was infringing on the mortgage payment, so I paid the car off. In my situation, the money was better allocated in this way, but every situation is different.

KellyJef · #4 (**permalink**) 10-02-2006, 08:14 AM

Quote:

Originally Posted by Sweepsplayer

Do they have other debts? Do they have enough saved for emergencies? Do they have a large enough down payment for their home purchase? Are they contributing to retirement savings? Maybe the lump sum should go to one or more of these goals instead.

They actually don't have any other debts -- no student loans, other car loans or any credit card balances (they pay off their Visa every month).

They have over 20% down payment for the house and they do have 401K's in place and they do have money for emergencies saved. So I think they are in good shape for such a young couple.

sweeps · #5 (**permalink**) 10-02-2006, 08:51 AM

Kudos to them, that's good news. Then again, I would go back to the interest rates. If his truck loan is minimal interest (0-3%, let's say), just pay the minimum and put the money toward the mortgage. If the rates are about the same or the truck's rate is more than the mortgage interest rate adjusted for tax deductions, then he should pay off the truck.

Demonstrating financial responsibility would not concern me much in this situation. Responsible handling of revolving debt is more important in that regard.

Ima saver · #6 (**permalink**) 10-02-2006, 08:54 AM

I would say, pay off the truck. It would be great to start married life with no debt whatsoever.

bjl584 · #7 (**permalink**) 10-02-2006, 11:04 AM

I say pay the truck off. The interest on the auto loan is lost money that is not tax deductable. Pay it off as quickly as possible to free up some cash for the mortgage that is looming on the horizon.

creditcardfree · #8 (**permalink**) 10-02-2006, 12:11 PM

I too would pay off the truck loan, if I were in there situation.

KellyJef · #9 (**permalink**) 10-02-2006, 02:49 PM

Thanks for all the replies -- I've passed this thread on to my daughter and her fiance.

greedy4chips · #10 (**permalink**) 10-02-2006, 06:55 PM

You really need to pay off the truck.

My reason is simple. $400 extra per month will go a long way towards easing your monthly budget constraints.

Moving into a new house will bring on all sorts of added expenses and paying off the truck is one less headache.

sweeps · #11 (**permalink**) 10-02-2006, 07:01 PM

There's still no word on the interest rates. Those of you who instantly chose "Pay off the truck": Would you rather put your money in a 1% savings account or a 5% savings account?

If you choose paying extra on a 1% truck loan instead of a 6% mortgage (5% after tax deduction), you've chosen a 1% savings account over a 5% savings account.

bjl584 · #12 (**permalink**) 10-03-2006, 04:11 AM

Interest rate doesn't matter to me. I'd rather have no debt than to have debt at a low interest rate. Of course, I would never finance a car in the first place. It's a depreciative asset. I only pay cash for things like cars. Being that this couple is just starting out with their first home, I'd say that they can benefit more from the extra $400 a month toward their expenses than they could by holding onto the car loan (which may be at a low interest rate) and investing the rest in a high interest account. If they were already established and had been in the home for a while, then I'd say that paying the minimun on the auto loan and investing the rest would be the best idea, but for now I'd want the extra $400 every month for those unexpected costs that always come up when someone first moves into a house.

jmjj215 · #13 (**permalink**) 10-03-2006, 07:55 AM

Quote:

I'd rather have no debt than to have debt at a low interest rate.

We're talking about two debts though: car, and mortgage. Would you rather carry more debt at a 3% rate, or 5% rate? That was sweep's point I believe. (Not to put words in Sweep's mouth or anything).

bjl584 · #14 (**permalink**) 10-03-2006, 08:32 AM

I still say pay the car off. Interest on a car loan is lost money. It's a depreciative asset (in most cases) and isn't tax deductible. I would rather finance real estate than a car no matter the interest rate. Real estate is tax deductible and builds your portfolio with a good solid appreciative asset. It just makes better sense as part of a long term investing strategy.

sweeps · #15 (**permalink**) 10-03-2006, 09:02 AM

That's a common misconception. Whether the underlying asset depreciates or appreciates (or even if there no underlying asset at all) is irrelevant. A debt is a debt. If you pay off a debt with an effective interest rate lower than another debt you may have, you're worse off financially. Similarly if you take money out of savings to pay a debt with a lower interest rate than you were earning from your savings, you're worse off financially.

Not to say there isn't a psychological component involved. If someone feels better paying off a car loan just because it's a car loan, I can't argue with that. But it probably wasn't the best financial decision.

bjl584 · #16 (**permalink**) 10-03-2006, 09:17 AM

That is true being that I have no idea what the interest rate or the terms are on either the house or the car, and I have no idea what kind of interest rate this individual is getting on their personal investments. It may in fact make more sense to keep the car loan, but that is on a case by case basis. In my case, it makes a lot more sense for me to get rid of the car loan and put my money toward a mortgage.

creditcardfree · #17 (**permalink**) 10-04-2006, 01:18 PM

Quote:

Originally Posted by Sweepsplayer

That's a common misconception. Whether the underlying asset depreciates or appreciates (or even if there no underlying asset at all) is irrelevant. A debt is a debt. If you pay off a debt with an effective interest rate lower than another debt you may have, you're worse off financially. Similarly if you take money out of savings to pay a debt with a lower interest rate than you were earning from your savings, you're worse off financially.

Not to say there isn't a psychological component involved. If someone feels better paying off a car loan just because it's a car loan, I can't argue with that. But it probably wasn't the best financial decision.

I'd be curious what Warren Buffet or Bill Gates might say. Are all the best financial decisions based only on the numbers?

I think I've heard Buffet refer to chosing a company based on the intrinisic values of management or the product itself...not to say he doesn't look at the numbers, but their are always other factors involved besides the numbers.

If it were me...I'd still pay off the truck and use the $400 towards paying down the mortgage. I like the simplicity of one payment.

sweeps · #18 (**permalink**) 10-04-2006, 02:12 PM

CCF, I hear what you're saying, but my response to that would be that it still comes down to the numbers -- the question is which numbers.

In your Buffet example, Buffet is considering what the company will be worth in the future considering the quality of management (or other factors). So based on those numbers, he's making an informed financial decision.

Here's another example that I think speaks to your point. Let's say KellyJef's daughter has a mortgage for 6% and a truck loan for 1%. Simply based on those figures, the best financial decision would be to put the windfall towards the mortgage. BUT what if there's another factor at play -- what if when KellyJef's daughter's truck is paid off, she gets so excited about paying off the debt that she puts more toward the mortgage than she would otherwise. Then, yes, that turned out to be a good financial decision. But the numbers changed.

creditcardfree · #19 (**permalink**) 10-04-2006, 03:03 PM

Quote:

Originally Posted by Sweepsplayer

CCF, I hear what you're saying, but my response to that would be that it still comes down to the numbers -- the question is which numbers.

In your Buffet example, Buffet is considering what the company will be worth in the future considering the quality of management (or other factors). So based on those numbers, he's making an informed financial decision.

Here's another example that I think speaks to your point. Let's say KellyJef's daughter has a mortgage for 6% and a truck loan for 1%. Simply based on those figures, the best financial decision would be to put the windfall towards the mortgage. BUT what if there's another factor at play -- what if when KellyJef's daughter's truck is paid off, she gets so excited about paying off the debt that she puts more toward the mortgage than she would otherwise. Then, yes, that turned out to be a good financial decision. But the numbers changed.

Good way of rephasing my example!!! I think that MAY be why you see so many of us on this board go with paying off something of that costs us less in interest. We know that it is a snowball effect of paying off debt.

I definitely see your point and it is a good one!!

debtdude · #20 (**permalink**) 10-06-2006, 09:32 AM

Two views:

1.) Emotional: Pay it off so there is only one loan over there head.

2.) Practical: Do the numbers with the percentage rates. I don't know the lump sum amount - $2K or $10k. See where it would be more beneficial. What if that lump sum amount for the truck could be bankrolled into more money down on the home?