My husband and I have an upside-down car loan, which means that we owe more on the loan (about $10,000) than the car is worth (only about $7,000). We are paying a pretty substantial amount each month in insurance and car payments (over $300 a month) to keep this car with 8% interest on the loan.

We can afford these expenses however, we don't use the car. My husband now has a work vehicle paid for by his job and the upside-down car sits unused. We feel silly paying so much a month for a car that goes unused.

We have an emergency fund of $5,000, and a lot of available credit on credit cards (currently no credit card debt at all) if an emergency arose.

We are considering dipping to the emergency fund to get rid of this car. We figure it will probably take us around 6 months worst case scenario to pay ourselves back into the emergency fund.

Is it better to dip into the emergency fund to unload this extra debt and expense or bite the bullet and keep the car while trying to save up money outside of our emergency fund to get rid of the vehicle?

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    Aren't all car loans "upside-down"? They certainly are if it's a new car - it's worth at least 20% less than the purchase price the second you drive it off the lot. – R.. Aug 19 '15 at 0:34
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    @R.. Not if you have a substantial trade in our a large down payment. – Eric Aug 19 '15 at 12:03
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    Just a small note: The savings of $300 per month + some insurance savings (say $100 a month?) only adds up to $2400 after 6 months. It's more likely that it would take about a year to replace the money lost. – Chris Aug 19 '15 at 17:39
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    @Chris The question implies they are already generating savings separate from the car costs. – Ganesh Sittampalam Aug 19 '15 at 17:53
up vote 52 down vote accepted

As well as paying 8% interest on your loan (i.e. $800/year), you're also wasting money on the car: depreciation, insurance etc. So it's worth a lot to you to get out of it.

Set against that is the risk of having to borrow the $3000 you'll be taking from your emergency fund at a higher interest rate (say 30%?) for at most 6 months, which would only cost you $300-$400 even if it happens. You'll also be giving up a small amount of interest on the $3000, but at current interest rates that pretty much negligible.

There is a small chance that an emergency would also cause the available credit on your credit cards to disappear, but in the short term that should be pretty unlikely.

So I think the balance is overwhelmingly in favour of getting out of the loan as soon as you can.

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    Also to consider: in an emergency, would you actually be able to borrow $3000? One common "emergency" is unemployment: given your credit history, do you think a bank would loan you $3000 if you were unemployed? – Nate Eldredge Aug 18 '15 at 14:28
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    Does the credit limit on credit cards just evaporate immediately if you lose your job? I wasn't aware of any duty to even inform the issuer. – Ganesh Sittampalam Aug 18 '15 at 14:35
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    Great answer. I agree, get rid of the car now. NOT spending money has the same net effect as making more money. Last thought: sell the car private party -- you'll get more than a dealer or CarMax would offer. – Rocky Aug 18 '15 at 17:31
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    @MSalters That seems like a bold conclusion. Do you have any evidence to support that? People change spending habits all the time. I for one regularly change which credit card I use depending on the best cash-back incentives, and I have never had any of my credit limits lowered because of it. – Nick2253 Aug 18 '15 at 20:49
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    @Relaxed the loan is presumably secured on the car, so you won't be able to sell the car without paying off the loan. – Ganesh Sittampalam Aug 20 '15 at 4:36

With enough money in the emergency fund to get rid of the car and still have a cushion, I would definitely get rid of it, as the car is not needed. Your car is only going down in value, which makes the current setup even less desirable. In essence, you are paying over $300 a month for something that, every month, is worth less and less.

Since you are paying over $300 a month and it will take about $3000 from your emergency fund to get rid of the car, if you start putting that $300+ back in the emergency fund, in a mere 10 months you will have replenished the emergency fund.

I wouldn't give it a second thought. I'd get rid of the extra car and do everything I could in the following months to repay the emergency fund. Even without the interest payments, I'd consider getting rid of an unused car due to the very nature of a car being a depreciating asset that has insurance expenses and annual registration fees on top of that depreciation.

The one exception to the above would be a classic car that was purchased for an investment that is always garaged and doesn't need to be registered for road use. I take it for granted that most people who can afford such investments don't need my advice about when to sell.

I'd lean toward using the $3,000 from the emergency fund although depending on your monthly bills, a $2,000 emergency fund (or even a $5,000 one) may be a bit small. But here are a couple of other options for you:

  1. Zero-interest balance transfers: If you have cards and have a zero balance on them, your credit card companies are keen to see you put a balance on them. Find out if they're offering any "12 months no interest on balance transfers" offers (or if any of their rivals is), since of course the car loan is an outstanding balance you can transfer (you're not asking them for cash). Put the $3,000 on that zero-balance transfer option, get rid of the car, and pay the $300/mo to pay down the balance on the card. 10 months later, two months before the end of the free period, you're at zero again — without dipping into your emergency fund. You'll also now have a history with that card company of paying back, which may lead them to attempt to entice you to go into more debt (which you'll resist, of course) by increasing the limit. (If you don't want a higher limit, just tell them to reduce it again.)

  2. A $3,000 unsecured loan with no pre-payment penalty provided the math works out. The interest may be expensive (unless you find something with a teaser rate for the first X months), but if you find an option, do the math on it to see if it's actually more expensive than carrying the car payments, insurance, etc. on a depreciating asset. It may not be as expensive as the 20% rate or whatever makes it sound (but again, do the math), and if you apply your $300/mo to it, within (say) 11 months you're clear again — with a nice little paid-back loan on your credit report.

Both of these ensure that you still have your emergency fund at your disposal, and both capitalize on the fact that right now, you're probably a good credit risk. If you dip into your emergency fund, and an emergency happens (like loss of a job) and you find yourself short of funds, you may have trouble securing further credit at that point to cover the gap in your emergency fund.

In addition to the two options in your question - pay off the entire loan, depleting your emergency fund; or continue as you are today - there is a third, middle-ground option that might be worth considering.

Since you currently have an emergency fund, zero credit card debt, and you stated "we can afford these expenses", I think I'd be correct to assume that you're currently making regular contributions to either the emergency fund itself, or to another savings account, etc.

Temporarily stop making those contributions, and divert those funds to make larger payments towards the upside-down loan. The additional amount will all be applied to the loan principal, reducing the interest you'll have to pay, but you'll avoid the risk of depleting the emergency fund.

Additionally, the insurance premium may possibly be avoided, as in many places in the world it's possible to de-register the car (for example, in California, USA, you can submit an affidavit of Non-Use) then terminate the insurance on it. However, the car will likely have to be parked off-street (or in a location such as a private road governed by rules that do not include legal registration requirements).

  • With this plan, the OP would still be paying 8% on the 7k value of the car plus insurance. To make it worse, the card will continue to depreciate while the loan is being paid off. – StrongBad Aug 19 '15 at 13:03
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    @Strongbad of course, but it's strictly better than the plan of "change nothing from what we're doing today", and also avoids the risk associated with dipping into the emergency fund. It was that risk that provided the only point of uncertainty leading the OP to ask the question in the first place. – Dan Henderson Aug 19 '15 at 13:11
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    Also, this answer only speaks to the loan itself. The insurance premiums are tied to whether they keep or sell the car, and since selling the car won't eliminate the loan anyway, this answer can be applied to either scenario. – Dan Henderson Aug 19 '15 at 13:17
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    One can de-register the car, assuming that it is parked off-street, and stop paying insurance premiums for a period. – ErikE Aug 20 '15 at 16:08
  • Good to know, thanks, @ErikE! If you think that information would improve this answer, feel free to edit it in. – Dan Henderson Aug 20 '15 at 16:17

Some other factors to consider:

  • Your car may be worth $7K, but can you really get $7K for your car?
  • How much of a hassle will it be to sell the car? How much is that worth to you?
  • If you suddenly need to buy a second car again (ie. your husband gets a different job without a free car), are you willing to settle for a $7K car? Or will you buy a newer car and lose money on depreciation again? You might be happy with your own $7K car, but you might not really want someone else's $7K car.

If none of those factors are significant to you, then the other answers will do just nicely.

An emergency fund of $5000 seems on the low side and I would be worried about spending it down to $2000, that said you want to get out of the car loan. It sounds like you have a little extra disposible income since you think you can rebuild your emergency fund quicker than just the amount you will save from not having a car payment. One option to decrease the hit to your emergency fund is to save aggressively for a month or two to increase your emergency fund by a few hundred dollars and take on some other debt (possibly credit card). You could then pay off the new debt and replenish your emergency fund over a slightly longer period.

While some financial planners dislike the idea of an emergency fund while still having high interest debt, to me I would prefer to have $1000 in credit card debt and $3000 in an emergency fund over $0 in credit card debt and $2000 in an emergency fund. Given your time course of 6 months or so to pay off the debt, you might even qualify for a 0% credit card introductory rate (or balance transfer).

  • I think it's a bad idea to deliberately take on credit card debt instead of reducing savings - you'd be paying a lot of interest for no or little benefit. – Ganesh Sittampalam Aug 19 '15 at 7:35
  • @GaneshSittampalam I had a similar thought as you. On the plus side, the balance would be much lower than the balance on the car, so maybe it evens out? Still, not what I would do. – mikeazo Aug 19 '15 at 11:49
  • @GaneshSittampalam I think $1000 in CC debit and an emergency fund of $3000 is better than $0 in credit card debit and an emergency fund of $2000. Given the plan to pay the debt off in 6 months, the OP might even be able to move all/most of the debt between cards to reduce the interest (not a great long term strategy), but potentially workable for 6 months while the debt is being rapidly paid off. – StrongBad Aug 19 '15 at 12:51

protected by Chris W. Rea Oct 7 '15 at 0:01

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