Resource allocation isn’t just something that mega corporations contend with.
Most people have assets and debts. In a finite world where even Elon Musk has to pick and choose what to do with his resources, we all face tough decisions sometimes.
People often wonder about saving vs. investing vs. paying off debt. What happens when you have a solid emergency fund but you're also paying interest on a loan? Which one should you prioritize?
Should I Save My Money or Use It To Pay My Car Loan?
Should I keep my money in savings or pay off my car loan?
That’s what a Clark Howard podcast listener recently asked.
Asked Kim in Georgia: "I have $20,000 in savings and want to know if is best to keep that in savings or pay off my vehicle that is roughly $15,000 and then invest the current monthly payment for retirement."
In this instance, there are a lot of variables that we don’t know. For instance, what’s the interest rate on Kim’s auto loan? How much yield is she earning on her savings? And is she currently on track with her retirement savings?
For example, the average auto loan in Q3 of 2023 was 7.03% for new vehicles and 11.35% for used vehicles. You can still earn 5% on the best high-yield savings accounts — and perhaps even a smidge more on the best CDs.
But even with outstanding credit and using a good credit union as the lender, you’re unlikely to have an auto loan rate lower than what you can get in a savings account.
Of course, Kim could’ve originated her auto loan years ago when rates were much lower. And although it seems like interest rates will start falling as soon as a few months from now, it’s not guaranteed.
The X Factor: The Value of Your Emergency Fund
However the simple math works out, it ignores a larger point: ensuring that Kim's emergency fund remains in a good spot.
Again, we don't know Kim's monthly expenses. But Clark wants everyone to work toward a "rainy day" fund with three to six months' worth of expenses.
“Oops” happen in life, as Clark often says. We just don’t know when they’ll happen — or how much they’ll cost. Just that unexpected expenses are part of life.
So the question is more than simple math comparing the interest rate Kim is paying vs. the interest rate she’s earning on her cash.
“If $20,000 is the ceiling of what you have in savings, I don’t want you to use $15,000 of it to pay off a loan,” Clark says. “Because then your savings are down to $5,000.
“I could see you taking $10,000 of the $20,000 [and keeping] a $10,000 cushion. And you could get your loan way down and then you pay it off much quicker. But I don’t want you to wipe out three-quarters of the cushion that you’ve worked so hard to build.”
Pay Off Your Car Loan and Add the Excess To Retirement Savings
Let’s return to Kim’s idea of eventually taking the car payment money and putting it toward retirement instead.
“Gotta love that. Because you have a rainy day account. But you also need to have money for retirement,” Clark says. “If your employer offers a 401(k), that’s the easiest because the money automatically comes out.
"Or set up a Roth IRA when you are ready to do that and have contributions be automatic every month so that you are in the habit of, as almost like one of your bills, one of your bills is to pay into saving for retirement in a tax-free Roth IRA."
Final Thoughts
Evaluating the decision to pay off debt or save often involves simple math. You’ll want to compare interest rates and figure out which decision is more valuable.
However, you don’t want to completely deplete your emergency fund to wipe out debt. Especially if that debt isn’t of the high-interest credit card variety.
The post I Have $20,000 in Savings and $15,000 on a Car Loan. Should I Pay Off the Loan? appeared first on Clark Howard.