Should I pay off a 0% interest car loan or put money towards high principal student loans?

Question

Within the past year my wife and I have paid off approximately $40,000 in debt - from her car loan, my two student loans, and other misc debt (new refrigerator, hardwood floor install). I had a car lease expire so I went to purchase a new one and got a 5 year, 0% interest loan, with approximately $20,000 left.

My wife has her doctorate in healthcare and, unfortunately, the student loans racked up and has about $90,000 over the next 26 years.

Based on my estimates we're slated to pay off her student loans within 7 years. We both work full time and I do freelance consulting work on the side. I currently have enough (after taxes) saved from my freelance work to pay off my car or put it towards her student loan.

Which way is better? Should I pay off my car loan and put the $400 per month towards her student loans? Or should I keep paying the car loan and put all our extra money towards her student loans?

Answer 1

First of all, congratulations on paying off $40k in debt in one year.

Mathematically, you'd be better off making the standard car loan payments and putting your extra money toward the student loan.

However, there are a few other things that you might want to consider.

Over the last year, you've knocked out a whole bunch of different debts. Feels pretty good, doesn't it? At your current rate, you could knock out your new car loan in 6 months. Then you'd only have one debt left. If it sounds to you like it would be nice to only have one debt left, then it might be worth the mathematical disadvantage you would get by paying off the car early instead of putting the money toward the last student loan.

The car loan is 0%, but if you are late on a single payment, they will take that opportunity to raise your interest rate to something probably higher than the interest rate of your student loan. For this reason, you may decide it is not worth the hassle, and you'd rather just eliminate the car loan as quickly as possible.

Either choice is fine, in my opinion, as long as you have a purpose behind the choice and you are committed to eliminating both debts as quickly as possible.

As an aside, it is important to remember that even a 0% loan is not really free money, and needs to be paid back. You know this, of course, but sometimes you see a 0% loan advertized and it feels like free money. It's not. You have probably already paid for the loan by forfeiting a rebate. So although, at this point having already taken this loan and paying for it, you will come out ahead by dragging out your car loan for the full term, in the future do not think that you can make money by buying something at 0% interest.

Answer 2

If you're not worried about making the car loan payments, why would you want to pay off a loan that is not charging you any interest? Pay off the interest bearing student loan.

Answer 3

If the car loan has 0% interest for 5 years, then paying off the student loan is cheaper.

No matter when you pay off the car, you will pay the exact same amount (as long as its within 5 years). You could spend $20,000 right now to pay off the car loan or slowly spend $20,000 over the next 5 years. The gross amount paid for the car loan does not change. On the contrary, the longer you wait to pay off the student loans, the more you will end up paying for them.

So why not get the student loans out of the way before they rack up more interest and pay the car loan over time?

---

Update: I forgot to add, as Ben Miller said, congratulations on paying off the $40,000!

Answer 4

The hard and fast rule is to pay off high interest loans first, but each individual's situation is different so there are some things to consider.

Student loan interest is tax deductible up to $2,500. Will your student loan interest exceed $2,500 for the year? If so I would try to pay down the student loan first to bring down the total interest for the year so that you get as much interest back as possible on your tax return. Also, it may be beneficial to pay off the car first to close that account so that you are only left with the 1 loan. Once you have the car loan payment out of the way you can dedicate that amount to paying off the student loan.

I'm in almost the same situation as you. I currently have a mortgage and car payment. In 6 months my grace period will be over, and my student loan payments will start. I have $100k in student loan debt. So I will have a $1,100 mortgage payment, $1,100 student loan payment, and $700 car payment (car loan is 0%). I don't want to have 3 loans active so I will pay off my car loan in a 2-3 months to get that out of the way. Then I will pay down my student loan by paying $700 extra every month.

Answer 5

Although there is no single best answer to your situation, several other people have already suggest it in some form: always pay off your highest after-tax (!) interest loan first!

That being said, you probably also have heard about the differentiation for good debt vs. bad debt. Good debt is considered a mortgage for buying your primary home or, as is the case here, debt for education. As far as I am concerned, those are pretty much the only two types of debt I'd ever tolerate. (There may be exceptions for health/medical reasons.) Everything else is consumer debt and my personal rule is, don't buy it if you don't have the money for it! Meaning, don't take on consumer debt.

One other thing you may consider before accelerating paying off your student debt, the interest paid on it may be tax deductible. So you should look at what the true interest is on your student loan after taxes. If it is in the (very) low single digits, meaning between 1-3%, you may consider using the extra money towards an automatic investment plan into an ETF index fund. But that would be a question you should discuss with your tax accountant or financial adviser. It is also critical in that case that you don't view the money invested as "found" money later on, unless you have paid off all your debt. (This part is the most difficult for most people so be very cautious and conscious if you decide to go this route!)

At any rate, congratulations on making so much progress paying off your debt! Keep it going.

Answer 6

I'm pessimistic about most things, so:

They can't REPO the degree and the knowledge, but they can sure REPO the CAR, so pay off the car.

My suggestion would be to pay off the vehicle, because no matter what the future holds (good or bad) you will need a vehicle to get around.

Although, I recently found out from the comment below that student loans are a recourse debt that won't be forgiven. Not even with bankruptcy. Most collection agencies will take pennies in the dollar for debt, but not with student loans.

Answer 7

NO, you pay off the Highest interest charging accounts first. The zero interest loan should be the Last one you pay off. Basically payoff your student loan and put the extra money to the car loan

Answer 8

As the other answers indicate, if you look only at the clear mathematical formulas regarding your debts and their interest rates, then you'll see that it's better (less expensive) to pay off your student debt first.

However, you must also take into account the value of your car, as it is an asset. The older your car gets, the less it's worth. The more your car gets used and worn out, the less it's worth. Cars depreciate at about 15% per year on average. However, you're continuing to pay the same amount of money to keep a decreasingly valuable asset.

Now, you also have to include the fact that you may be required to carry full-coverage car insurance, versus liability insurance. This can represent an increase in spending if you'd prefer to have liability only.

With insurance in the picture, you should also be thinking about the possibility that something could happen to your vehicle that causes it to be worth less than you owe, or just worthless. If such an event happens, then you may have more difficulty acquiring a replacement vehicle.

I, personally, don't find the increase in total interest paid on student loans to offset the other consideration regarding the value of a car. I'm in a similar situation as you (except your values are all about double what mine are). The peace of mind I gain from being able to pay off the car more quickly, and use that money towards loans or whatever I want, is worth the interest I'll earn by not putting that money into the student loans instead. I also prefer the idea of being able to more easily use my vehicle as a trade in, in case I need to get a different vehicle to better suit my family size.