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I'm ahead on 0% interest car loan. I don't have to make a payment until October. I currently owe $3,000 and I could pay it all off. Should I do that or leave that money in my savings account that earns 2% interest?

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    Also, where are you earning 2% interest in a savings account? I'd like to put some money there ... – dg99 Apr 21 '15 at 20:30
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    @n00b Definitely read the fine print there. It's only 2% if you don't establish direct deposit with them (meaning all your paychecks go there), and only 0.1% for the balance over $5000. And even the fine print says that there are more restrictions in the full account agreement. – dg99 Apr 21 '15 at 20:56
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    Keeping the debt is a risk. A small one, admittedly, but still a risk. Whether $30 is enough of a reward for you to consider taking that risk is kind of up to you, but I know I wouldn't bother. – Iain Galloway Apr 22 '15 at 11:30
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    Are you sure you don't have to make a payment until October? A lot of times on loans, if you pay extra, that does not push off future payments. – mikeazo Apr 22 '15 at 12:40
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    @Locutus Just looking at the interest rate without looking at the inflation rate and how the currency is changing its value relative to other currencies isn't really meaningful. India seems to have an inflation rate close to 5% and lost about 6% per year relative to the USD. So the effective interest rate for your 9% on INR might be closer to 3-4%. – CodesInChaos Apr 24 '15 at 12:31

12 Answers 12

88

Between now and October, your $3,000 will earn $30 in your savings account.

If you are late on a payment for your 0% loan, your interest rate will skyrocket. In my opinion, the risk is just not worth the tiny gain you are trying to achieve in the savings account.

If it was me, I would pay off the loan today.


A few more thoughts:

There is a reason that businesses offer 0% consumer loans. They are designed to trick you into thinking that you are getting a better deal than you are. Businesses don't lose money on these loans. The price of the loan is built into the cost of the purchase, whether you are buying expensive furniture, or a car. Typically with a car, you forfeit a rebate by taking the 0% loan, essentially paying all the interest up-front. Now that you have the loan, you might be ahead a few dollars by waiting to pay it off, but only because you've already paid the interest. Don't make the mistake of thinking that you can come out ahead by buying things at 0%. It's really not free money.

In the comments, @JoeTaxpayer mentioned that fear of mistakes can lead to missed rewards. I understand that; however, these 0% loans are full of small print designed to trip you up. A single mistake can negate years and years of these small gains. You don't want to be penny wise and pound foolish.

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    Agreed. And +1 to you. But, I look at money as time. $60 is some number of hour's wages. My checking allows me to set up payments in advance. The full years worth of payments, two minutes of my time. Over a lifetime, the fear of mistakes can add up, and the reward of discipline can also add to a tidy sum. I wouldn't be so quick to toss $60 into the fire. – JTP - Apologise to Monica Apr 21 '15 at 19:49
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    I think what @JoeTaxpayer is saying is "You can't be afraid to fail. It's the only way you succeed - you're not gonna succeed all the time..." Lebron James – Anthony Russell Apr 21 '15 at 19:58
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    I'd hold on to that $3000, take that $30 in interest and on the day I pay off the loan, go buy some wonderful, tasty craft beer and have a barbeque to celebrate a paid-off car. But that's just me. – zanussi Apr 21 '15 at 20:38
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    Keep $3000 in your account, setup an auto-payment/standing instruction to pay off the loan in October, don't touch that money until October. Enjoy the $30 interest earned. Why is this so hard to do? – Masked Man Apr 22 '15 at 12:45
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    What about risks associated with reducing your cash on hand? The OP seems to imply they have much more than $3,000 on hand, but they don't state explicitly. – jpmc26 Apr 23 '15 at 6:01
30

I struggle with 0% interest things in my personal life.

A responsible me that thinks logically says continue to pay it on time and take advantage of the benefit of the interest free loan you got. It will keep your funds liquid in the case of an emergency, build your credit and teach you self control.

Paying it off now has little to no benefit. It does however tie up $3,000 worth of capital you could be using for building interest or leveraging against other purchases.

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    "I struggle with 0% interest things in my personal life." That sums is up exactly for me as well. Math/logic vs. the wonderful feeling of not owing money for something. There should be a support group for people like us. – Phil Sandler Apr 21 '15 at 17:50
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    This is true, but you are forgetting a vital element of the equation: risk. The more debt you have the more exposure you have and the more things you have to keep track of. Say you were critically injured, or the economy tanked, or your business capsized. This is not productive leverage. – superluminary Apr 22 '15 at 12:33
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    @superluminary what are you talking about? If you had some type of emergency then the answer I provided would be the one you would want.... If you broke a leg, got fired or your business went under, what would you prefer? $3,000 in your savings account to use, or an empty bank account because you sunk it into paying off a loan that has 0% APR? – Anthony Russell Apr 22 '15 at 12:36
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    @AnthonyRussell - If, for example, my arms got sliced off in a freak accident and I suddenly had to live off critical injury insurance, I would prefer as clean a slate as possible. Having personally experienced the incredible stress caused by suddenly being unable to service a debt, I would always prefer to mitigate against that risk where practical. £30 seems practical. The £3000 no longer really belongs to the OP, he's just holding it until the bank claims it. It would be unwise to use that £3000 for living expenses. – superluminary Apr 22 '15 at 12:50
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    I suppose we agree to disagree. That said, +1 for the most colorful example I've seen yet haha. – Anthony Russell Apr 22 '15 at 12:52
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Mathematically, the wisest choice is to invest your extra money somewhere else and not pay off your 0% loan early. An extreme example highlights this. Suppose some colossal company offered to loan you a billion dollars at 0 % interest. Would you take it? Or would you say "No thanks, I don't want that much debt."

You would be crazy not to accept. You could put that money in the safest investments available and still pocket millions while making the minimum payments back to them. Your choice here is essentially the same, but unfortunately, on much smaller scale.

That said, math doesn't always trump other factors. You need to factor in your peace of mind, future purchases, the need for future borrowing, your short term income and job security, and whether you think you can reliably make payments on this loan without messing up and triggering fees that wipe out the mathematical advantage of slow paying the loan.

You are fortunate because you really can't make a wrong choice here. Paying off debt is never a bad choice IMO. However, it may not always be the best choice.

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    There is always risk in investments. Even treasury bills. – ChuckCottrill Apr 23 '15 at 3:24
  • @ChuckCottrill Pfft, not at maturity. – Navin Apr 25 '15 at 20:25
  • Interesting hypothetical. But how about this one: I'll loan you $1 billion at 0%, but you have to pay it back tomorrow. If you don't, you'll owe me $2 billion. Would you accept those terms? – Ben Miller - Reinstate Monica Aug 15 '15 at 19:28
  • As long as I can use the overnight lending rate I'll take your $1 billion offer. I'll pay you back the next day and walk away with a few million for my troubles. – Matthew Whited Apr 27 '16 at 19:29
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Pay it off. If you do so, you have the liberty to drop or reduce a portion of your collision auto insurance coverage (keeping uninsured motorist). This could potentially save you a lot more than 20 bucks over the next six months.

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    Great point! Lowering an insurance premium is often over-looked. – Brandon Apr 21 '15 at 21:08
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    This plan is not without risk. Yes, if you pay off the loan you're no longer compelled by the bank to carry full coverage on the car; however you may end up in a bad spot if you then wreck your car with only minimum coverage - no car and no money in the bank. – Andrew Medico Apr 22 '15 at 2:32
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    the cost of dropping full coverage is rarely ever worth it - unless your driving record is atrocious and/or you are in some other extremely high-risk category, the few extra dollars per month to keep full coverage is more than worth the risk of suddenly being out your transportation: that's what insurance is for - you transfer your risk (for a fee) to someone else. If you can afford to suddenly pay, say, $10,000 to replace your car, and it's worth saving $25-50/mo (in my case it's on the very low end of the spectrum) to do it, go for it. If you can't, don't. – warren Apr 22 '15 at 20:22
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Sometimes I think it helps to think of the scenario in reverse. If you had a completely paid off car, would you take out a title loan (even at 0%) for a few months to put the cash in a low-interest savings account? For me, I think the risk of losing the car due to non-payment outweighs the tens of dollars I might earn.

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    What about automated payments? – Erbureth says Reinstate Monica Apr 22 '15 at 10:20
  • This year alone I was charged £400 of interest on an unpaid Corporation Tax bill because an automated payment I scheduled failed to go through, and I forgot to check. Personally, for the sake of $30 (pre-tax?) I don't think I'd bother taking any risks... – Iain Galloway Apr 22 '15 at 11:28
3

The question posted was, "Should I pay off a 0% car loan"?

The poster provided a few details:

I'm ahead on 0% interest car loan. I don't have to make a payment until October. I currently owe $3,000 and I could pay it all off. Should I do that or leave that money in my savings account that earns 2% interest?

The question seems to seek a general rule of thumb for how to behave with smaller debts. And a general rule of thumb could be taken from one of two principles (which seem to be religious camps).

  • Take advantage of "free money" (0% loans) to maximize utility of your money.
  • Reduce debts to be "free" to make other choices, with fewer distractions.

The "free money" camp believes that you can invest (even small amounts) of money risk-free and receive high returns, tax free, for zero effort.

The "reduce debt" camp believes that you should pay off debts so that you have the freedom to live your life unfettered.

Which religion do you prefer? I tend to prefer paying off debts.

The "free money" tent wants you to pay the car off over the next 6 months, earning interest. Suppose you can earn 2% interest (.02/12 per month), paying $500 per month for 6 months. So you earn interest on 3000 the first month, 2500, the second month, 2000 the third month,

(3000+2500+...)*0.02/12=5+4.17+3.33+2.50+1.67+0.83=17.50
17.50*0.75 = $13.13 after taxes (estimate 25% tax rate)

So, are you feeling rich, earning $13.13? How much time did you spending making the 5 additional payments? You could skip coffee once/month and make a bigger difference.

The "reduce debt" tent would have you pay off the car. Suppose you change your deductible on the car (or drop collision) to save money, and you will also same time by avoid 5 bill payments,

save$30/month * 6=$180 (after tax)
save 5*(6-1) = 25 minutes

But do you still have enough money in your emergency fund, how do you feel about having less insurance coverage, and did you notice the time savings?


We really need more information about the poster's situation. The answer should consider the relevant details of the situation to provide an informed response. Here are questions that would enable a response to address the whole situation.

  • Do you have a family?
  • Do you have a fully funded emergency fund?
  • What is your income, and expenses, and do you have a positive cash flow?
  • What are your (other) assets, and debts?
  • Would the money you used to pay it off be better used for another purpose?
  • Are there any reasons why you might need this $3000?
  • What is your current credit history?
  • What other credit tradelines to you have (or plan to have)?
  • Would the loss of this tradeline affect your credit mix at some point?
  • Are there any co-signers?
  • What is your health? (where you might fall ill and miss a payment)
  • Do you work in a dangerous occupation? (where you might be injured)
  • Do you plan to keep the car or want/need to buy another car?
  • How much is the car worth, and would you consider reducing the insurance coverage?

Why are these important? Here are a few reasons why the above might be important.

  • You are married, have two cars and would like to have one car payment, or have kids and need to buy a third car
  • An emergency fund can help you avoid financial shocks, et al
  • You might need the $3000 for an unexpected expense, or an opportunity
  • You might have other debts charging higher rates (mortgage?)
  • You might encounter an opportunity to invest, or buy a rare or collectible item.
  • Do you have delinquent or collection accounts that need to be paid
  • You might have limited credit mix and need an installment account (now or in the future
  • Do you have a co-signer who would be relieved of potential risk?
  • Could you develop an illness, miss a payment, and damage your payment history?
  • Could you get hurt or injured, miss a payment, and damage your payment history?
  • Perhaps you want to keep this car (for your daughter), buy another car, and need to qualify for a loan?
2

The precise answer depends on the terms and conditions of the loan, and whether you can reasonably expect to meet them.

For example, if you keep the loan, make no payments, there is a good chance that - eventually - you will trigger a clause in the contract, and suddenly be charged fees or a significant interest rate. If you don't need to pay anything for a time, odds are you will forget to monitor the loan (after all it is not costing you anything) and suddenly get hit with an unexpected expense.

Most loan contracts are structured - by professionals - to benefit the loan provider. The purpose of a loan provider is to make a profit. They do that by encouraging you to pay more - up front, over the longer term, or both.

Personally, I would never take out a zero-interest loan. It is specifically designed to appear like a gift from the loan provider, while actually (and almost covertly) costing more at some point.

If I was in your position (i.e. if I had taken out such a loan) I'd pay off the loan as fast as possible. If you have more than one loan, however, prioritise by working out which actually costs you more over time. And pay the worst ones first. You'll have to look closely at the terms and conditions - possibly with the help of a professional - to work out which is actually work.

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    Obviously there's no such thing as a free lunch, but a lot of these loans are "paid for" by the merchant rather than the customer, so it's already built into the cost of the car. If it's fixed term and payments are taken on time then I wouldn't see a problem with it. – Matthew Steeples Apr 22 '15 at 11:48
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    Why? That's life. Things come up that you haven't planned for. Some of those things introduce expense. If the expense is sufficient, there can be a cascading effect - unable to buy other needed things, unable to pay existing debt on time, etc etc. The thing is, loan providers plan and allow for some percentage of their customers having things come up that they haven't planned for. Not all customers make allowance in their plans for things to crop up. – Peter Apr 22 '15 at 13:34
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    @Peter Can't be that much of a false economy if it's one of the principle foundation of credit cards. Last 0% purchase I made I got chatting to the rep and they told me that it's commonplace for the merchant to pay something for the cost of the loan. In some cases it's an aid to purchasing (like a discount) because it attracts people that wouldn't have been able to buy it outright. Loan providers on the whole don't want their customers to default, as it's an awful lot of hassle. – Matthew Steeples Apr 22 '15 at 18:38
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    To follow up on it slightly, if you didn't take up 0% finance you could probably have negotiated a discount for paying in cash. – Matthew Steeples Apr 22 '15 at 18:47
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    @MatthewSteeples - I've purchased some vehicles on the "partner code" or "employee pricing" discount: and still qualified for the 0% financing. That cost is the lowest a dealer is going to go in selling a new vehicle. Of course, used vehicles are a different story entirely. – warren Feb 5 '16 at 19:58
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Don't pay off the 0% loan. First, set up an automatic monthly payment to ensure you never miss the payment (which could lower your credit score).

If you are in Canada, depending on your situation:

  • If you are not employed, open a TFSA account.
  • Use the money to buy stocks of good companies that pay a dividend (around 5% yield).
  • If you are afraid of stocks, use the money to buy 1- or 2-year term GICs that pay around 2.5%.

If you are employed and make more than $50k/year:

  • Open a SDRRSP account and contribute the money to it. Depending on your income, you may get up 45% of the money back due to saving on income tax.
  • Use the money in SDRRDP to buy stocks that pay a dividend or GICs.
  • With the money you get from your tax savings, do similar things.
1

Mostly to play devil's advocate, I will recommend something different than everybody else.

If you can pay off the entire $3,000 balance and are torn between saving that money somewhere that will earn a return and paying it off now to be debt-free, why not a little of both?

What if you pay half now and then save the other half and make a big payment at the end.

Essentially that becomes two $1,500 payments: one now, one right before the 0% due date.

To me, the half up-front significantly reduces the risk, but leaves some cash available to grow.

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    Many (if not most) loans with monthly payments would still require monthly payments to be made, even if you paid a large lump sum ahead of time. – user17781 Apr 21 '15 at 22:00
  • True, good point. What I meant was pay the minimum during that time. – Brandon Apr 21 '15 at 23:37
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    Sounds like the worst of both choices. You get less interest, but still have the annoying of remembering to pay or running into fees if your autopayment doesn't work. – CodesInChaos Apr 24 '15 at 12:41
  • It also gives you the best of both choices. – Brandon Apr 24 '15 at 15:03
1

Ultimately the question is more about your personality and level of discipline than about money.

The rational thing to do is hang on to your cash, invest it somewhere else, and pay off the 0% loan as late as possible without incurring penalties or interest. Logically it's a no-brainer. Problem is, we're humans, so there's a risk you'll slip up somewhere along the way and not pay off the loan in time. How much do you trust yourself?

1

Here's my take:

1) Having a car loan and paying it on time helps build credit. Not as much as having credit cards (and keeping them paid or carrying balance just enough to be reported and then paying it), but it counts.

2) Can't you set in your bank, not the lender, something to pay the car automagically for you? Then you will be paying it on time without having to think on it.

3) As others said, do read the fine print.

0

My theory, if you must be in debit, own it at the least expense possible. The interest you will pay by the end, combined with the future value of money. Example: The Future value of $3000 at an effective interest rate of 5% after 3 years =$3472.88 Present value of $3000 at 5% over 3 years =$2591.51

you will need more money in the future to pay for the same item

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