The following is a post by MPFJ staff writer, Kevin Mercadante, who is a professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.
There are different ways to prioritizing the payoff of debt and no one method is right for everyone. As long as you’re paying off debt, you’re headed in the right direction.
The most common advice on paying off debt however usually centers on tackling credit card debt first. But we’re going to focus on a different approach and suggest that she should payoff your car loan ahead of your credit cards.
There are at least five reasons why paying off your car loan first will work to your advantage:
1. A Car Loan Payment is Usually Bigger than Any Single Credit Card Payment
One of the most compelling reasons to pay off your car loan ahead of your credit cards is that a typical car payment is much larger than any single credit card payment. In fact, it’s probably is big as several credit card payments. By paying it off first, you achieve the greatest budgetary relief.
One of the reasons why people often fail at paying off their debt is because they simply don’t have enough room in their budget. By paying off your car loan first, you knock out a big chunk of your monthly debt service, that will make your progress obvious much earlier in the game.
2. A Car Loan is a Fixed Payment
Though most people will see the fixed payment feature of a car loan as a positive, the flipside is that you’ll get no relief on your car loan payment until the loan is paid in full. That should provide the motivation to pay it off as soon as possible.
By contrast, monthly credit card payments drop as the balance owed is paid down. But that can be both good and bad. Sure, the prospect of lower credit card payments will improve your cash flow in the short run. The bad side however is that as your monthly payments decline you may start to get comfortable with them again and decide that paying them off isn’t quite as important as it seemed at the beginning. You might even get lazy and start running them up again.
Once a car loan is paid, it’s gone. With credit cards – well – they don’t call them “revolving” for nothing!
3. Freeing Up Your Budget to Concentrate on Your Credit Cards
In #1 we focused on the fact that a car loan payment is typically much bigger than even the largest credit card payments. But the budgetary freedom you’ll gain from paying it off will free up a lot of cash flow that can be used to pay off your credit cards.
For example, let’s say that you manage to carve an extra $600 per month out of your budget to use toward reducing your debts. If you concentrate the extra cash flow on paying off your car loan first – because the car loan payment is an uncomfortable $400 per month – you will have an extra $1,000 per month to throw at your credit cards once your car loan is paid (the $600 budgeted for debt payoff, plus $400 from the now paid off car loan).
Using $1,000 per month to payoff your credit cards will make the process a lot faster than trying to do it with $600.
Paying off debts with big monthly payments – like a car loan – makes the biggest difference in your cash flow.
4. Paying Off Your Car Removes the Likelihood of Repossession
This is a factor that never gets discussed in the debt payoff priority debate, but it certainly needs to. If you reach the point where paying off debt becomes necessary, it’s most likely because your financial situation has long since begun to experience stress. If you are walking the financial edge in life, the last thing you need to have happen is having your car repossessed.
That’s exactly what will happen if you’re unable to make your monthly car payment. It’s unlikely that you will experience an outcome nearly as dramatic should you fail to make the payments on one or more credit cards. That’s because credit cards are entirely unsecured loans.
No matter what happens with your debts, you will still need to earn a living, which you may not be able to do if you lose your car. By paying it off, you will remove the possibility of that disastrous outcome from happening.
In a real way, your car is a business asset if it is used in connection with earning an income in any way, even if it’s only to commute back and forth to work. That makes it an asset worth protecting.
5. Paying Off Your Car Will Give You More Options When You Need to Replace It
Cars are no respecter’s of your debt payoff plans. They can crap out at any time, and require repairs so expensive that either the car will need to be replaced, or your debt payoff efforts will be thrown for a massive loss. For that reason, you should want to keep your self in the best possible position to be able to replace your car on short notice, should it be necessary.
Having a loan on your car always complicates replacement efforts. This is especially true if you have little equity in the car over and above the loan amount, and even more so if you owe more on the car than it is worth.
By paying off your car loan, you remove this is a potential problem. And if you do have to buy a new car, the absence of a loan will improve your ability to do that immensely.
Keeping your car free and clear of debt is the best possible way to keep your options wide open – whether you plan to keep the car, and especially if you need to replace it.
How about you all? Can you see the logic in paying off your car loan ahead of your credit cards?
Share your experiences by commenting below!
***Photo courtesy of https://www.flickr.com/photos/lendingmemo/11442079145/sizes/n/
