Occasionally I publish answers to selected readers’ money questions. I welcome your opinion in the comments. Send questions to [email protected]
Q: I am in the process of purchasing my first car. I make a little over $30,000 and have student loan payments, but I save by living with my parents. After law school, I was in some credit card debt. I decided to consolidate into a personal loan from my credit union at 9.24% (a much lower rate). I have it down to $3,900 and pay $250 per month. I am considering buying a used car that costs about $18,000, and I have about $5,000 saved up. Should I use that saved money to pay off the credit union loan or as a down payment on the car? – Nancy
A: I recommend you use $3,900 of your $5,000 savings to pay off the 9.24% personal loan even if that means you don’t make much of a down payment on the car.
Of the remaining money, I would use $500 as a bank account buffer and the start of an emergency fund, assuming you don’t have a separate one already. You have a good safety net living at home with your parents, but the sooner you get in the habit of creating and maintain rainy day savings, the better.
This only leaves you with $600 for a down payment, which isn’t great, but it’s better than nothing.
With your decent credit score (722), your credit union has offered you a 3.5% APR on the car loan, far better than the 9.24% on the unsecured personal loan. It was smart to get the auto financing quote from your credit union, but don’t forget to see if the dealer can beat the rate…maybe not, but it doesn’t hurt to ask.
Also, if you repay that personal loan and buy a car, you’ll have a lower total monthly payment, allowing you extra room in your budget that you can spend or save. For example: If you finance $18,000 at 3.5% for four years, you’ll have a payment of about $402. If you finance $13,000 (after a $5,000 down payment), your monthly payment is $290. Combine that with your $250 loan payment and you’re paying $540 a month—$138 more—until the personal loan is paid off.
It doesn’t always work out this way, but in this case what’s best for your monthly budget (a single, lower payment), is also better for your long-term bottom line (paying less total interest).
I’m glad to hear you’re buying a used car, as a new car’s rapid depreciation would put you upside down on a loan right off the lot, especially without a down payment.
With student loans and a modest starting income, I recommend being cautious with the total amount of debt you take on. (This is what happened to me…I graduated with some debt, did not earn a lot, and piled more on so I could live like I wanted to.) Before you take out the car loan, perhaps make a plan for where you want to be financially when the car is paid off. How much will you be earning? What will your budget look like? And how will you use the money that was going to the car payment?