|
  Dear
Dr. Don,
I will soon be receiving a large sum of cash. I have a car loan
at 6 percent interest. I owe about $25,000 on the car.
Should I take out a share loan at my credit union or pay it off?
I have no other debts. That will still leave me with $25,000 cash.
Or should I buy CDs and keep paying the car? Thank you!
-- Angela Accelerates
 Dear
Angela,
Since the interest expense on a car loan hasn't
been a tax-deductible expense since 1986, you can directly compare
the expected after-tax return on the investment to the auto loan
rate. If you expect to earn less than 6 percent after-tax
on your investment, then you should repay the auto loan.
That's the easy part. The hard
part is taking the money that you would have used for car payments
and investing that sum over time. If you don't have the discipline
to do that, and the money you were using to make car payments gets
used for current consumption items, then you've spent $25,000 in
cash today to free up some spending money in your monthly budget.
You're worse off because you saved the interest expense but spent
the principal balance.
If you know you don't have the
discipline to invest an amount equal to the monthly car payment
over time, don't spend the cash now to repay the loan. Even if you
expect to earn less than 6 percent after-tax on your investments,
you'll still be better off keeping the auto loan and investing the
lump sum.
The decision to refinance the auto
loan with a share loan at your credit union is a pretty straightforward
refinancing decision. Review your loan document or talk to your
lender to make sure the auto loan doesn't have a prepayment penalty,
and that the allocation of interest over the life of the loan isn't
determined by the Rule of 78s. Then use Bankrate's
mortgage refinancing calculator to see whether refinancing
the auto loan makes sense. Just enter zeros in the spaces for points
and other mortgage costs and input any auto loan cost as "other
costs" in the worksheet.
|
