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Here are the loan details :

  • Car Loan : 2.8% APR with a balance of $11,300
  • Student Loan : 3.0% APR with a balance of $7,300

I have enough cash to pay off both loans today. Should I pull the trigger on that?

I already have a 12 months emergency fund (the fund above is from extra cash on top of this emergency fund), maxed 401K to company match (5%) and max Roth IRA.

  • I would prefer paying off a major portion, if not fully, of the loan now. The earlier your debt is cleared, more easier the future would be. – DumbCoder Jul 22 '13 at 14:49
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    It is costing you $600 a year to ensure that you have $20,000 in cash available in an emergency or for whatever other reason you might want. Sure, interest rates are very low now so your money isn't earning much, but if inflation kicks in, you could very well earn more than the interest you are paying if you have the cash. Since 3.0% is very low, I would hedge my bets and make sure I have the money. As the saying goes, cash is king. No debt is great, but having liquid cash is better. A compromise position is to simply pay off a little more each month rather than continue to build up savings. – Dunk Jul 22 '13 at 17:51
  • P.S. Also, 5% in your retirement account isn't very much if your goal is to have even a remotely comparable retirement lifestyle as you have while working. – Dunk Jul 22 '13 at 17:56
  • @Dunk I understand what you're saying. Paying everything off is perhaps more psychological than financial. It's like a monkey off my back so to speak. – Kingamoon Jul 23 '13 at 1:52
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    Generally speaking, I agree with Dunk. In addition, the official inflation number is just short of 2% and could be as high as 5% (see shadowstats.com/alternate_data/inflation-charts). If inflation is 5%, then you're getting paid 2% to have those 3% loans. A more accurate measure of inflation would be to figure inflation on the things you actually buy regularly and not necessarily the things included in the CPI. If the things you buy are inflating faster than the rate of the loan, it would be smart to have the loan as long as that were true. – Randy Jul 26 '13 at 2:27
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If I were you I would pay off these loans today. Here are the reasons why I would do this:

Car Loan

For car loans in particular, it's much better to not pay interest on a loan since cars lose value over time. So the longer you hold the debt, the more you end up paying in interest as the car continues to lose value. This is really the opposite of what you want to do in order to build wealth, which is to acquire assets that gain value over time.

I would also recommend that once you pay the loan, that you set aside the payment you used to make on the loan as savings for your next car. That way, you will be able to pay cash for your next car, avoiding thousands of dollars of interest. You will also be able to negotiate a better price by paying cash. Just by doing this you will be able to either afford to buy a nicer car with the same amount of money, or to put the extra money toward something else.

Student Loan

For the student loan, 3% is a very low rate historically. However, the reason I would still pay these off is that the "return" you are getting by doing so is completely risk free. You can't often get this type of return from a risk-free investment instrument, and putting money in the stock market carries risk. So to me, this is an "easy" way to get a guaranteed return on your money. The only reason I might not pay this down immediately is if you have any other debt at a rate higher than 3%.

General Reasons to Get out of Debt

Overall, one of the basic functions of lifetime financial planning is to convert income into assets that produce cash flow. This is the reason that you save for retirement and a house, so that when your income ends when you're older these assets will produce cash, or in the case of the house, that you will no longer have to make rent payments. Similarly, paying off these debts creates cash flow, as you no longer have to make these payments. It also reduces your overall financial risk, as you'd need less money to live on if you lost your job or had a similar emergency (you can probably reduce your emergency fund a bit too). Discharging these loans will also improve your debt-to-income ratio if you are thinking of buying a house soon.

I wonder whether as someone who's responsible with money, the prospect of cutting two large checks feels like "big spending" to you, even though it's really a prudent thing to do and will save you money. However, if you do pay these off, I don't think you'll regret it.

  • Would you still recommend paying that off if one is planning to buy a house with 5%+ mortgage in the very near future? – Vitalik Nov 1 '14 at 17:59
  • @Vitalik I would still pay off the car loan at very least, since cars go down in value pretty quickly, whereas a house generally holds its real value after inflation.. So given the choice, I'd rather be in debt for a house than a car. – JAGAnalyst Feb 3 '15 at 17:37
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Congratulations on doing all the right things in your financial life.

To me, the answer to your question is a no-brainer: pay off the loans immediately.

However, I am sure that some people will post answers arguing exactly the opposite. I would also recommend using the extra cash that you will have each month (since the payments on the loans will disappear) to increase your 401k contributions even though they will not attract additional company match, and once again, you will certainly get answers telling you why doing so is a very bad idea.

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    I'll add comment here,not to contradict you, but to ask OP, is he saving for something? A house? Cash earning .1% is pretty wasteful if you owe 3% loans. I see nothing wrong with bumping 401(k) to 10%, seeing cash flow, and starting to pay the loans faster or at once. – JTP - Apologise to Monica Jul 22 '13 at 15:42
  • My short to medium term goal is to add a room to my house. Other than that, I'm just aiming at retirement and paying off my house. – Kingamoon Jul 22 '13 at 17:37
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If you end up keeping the student loan, it will be a tax deduction. Probably not much but at least it's something.

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    This depends on where the OP lives. Most countries don't allow you to deduct student loan interest. – ChrisInEdmonton Sep 12 '13 at 18:30
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    @ChrisInEdmonton Looks like the OP is in the U.S., based on mention of U.S.-specific investment accounts. – Chris W. Rea Sep 12 '13 at 18:57
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    Op said "401(k)" and "Roth." You are right, Chris, but OP is certainly a USer. – JTP - Apologise to Monica Sep 12 '13 at 18:57
  • In the US a federal student loan might be handled differently a private student loan. There are other risks with private student loans, and those be paid off as quickly as possible. – MrChrister Nov 20 '13 at 15:01

protected by C. Ross Nov 23 '13 at 13:36

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