Here’s a question from Nancy, a reader:
I’m in the process of purchasing my first car. I make $30,000 and have student loans, but I save by living with my parents. After law school, I consolidated some credit cards into a personal loan from my credit union at 9.24 percent (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 $18,000, and I have saved $5,000. Should I use that money to pay off the loan or as a down payment on the car?
I recommend you use $3,900 of your $5,000 savings to pay off the 9.24 percent 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 to give you the start of an emergency fund for unexpected expenses. 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 a lot, but the reality is — if you have good credit — that may be all you need to secure a loan.
If you have past credit problems or don’t yet have a credit history, however, you will have to put more money down toward the car. In this case, you’ll want to figure out just how much of a down payment you’ll need before paying the rest toward your refinanced credit card debt.
Save on interest and your monthly payment
With your decent credit score (722), your credit union has offered you a 3.5 percent APR on the car loan, far better than the 9.24 percent on the unsecured personal loan. It was smart to get the auto financing quote ahead of time, 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 percent 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).
Keep your car costs as low as possible
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.)