To us Americans, a Car is a symbol of freedom. It takes us to work and to fun. It takes us places. A Car defines who we are. We spend more wakeup hours in our Car than we spend in our house. House is important but it comes down the list of our priorities. I am not the only one who thinks like this. A recent article in USA Today confirms the thesis I presented above.
TransUnion Study On Consumer Defaults
It mentions a recent study by Credit Rating Agency TransUnion. The agency studied payment behavior of over 30 Million consumers who had at least one Car Loan, One Mortgage and one Credit Card Debt in 2011. Results of their analysis showed that Consumers discharged their financial obligations in following order of priority.
Highest was the percentage of consumers who defaulted on a Mortgage but remained current on their Credit cards and Car Loan Payments. Very small proportion of consumers defaulted on their Car loans while staying current on Credit cards and Mortgage i.e. 9.5 % only.
Ezra Becker’s Witty Remarks
Emotional attachment to Cars aside, Ezra Becker(Vice President of research and consulting at TransUnion) explains a more rational and Economic reason for consumer’s tendency to prioritize Car payments over mortgage payments.
Mr. Becker points toward a relatively strong Used Car Market and compares it with a very weak housing market.
In his point of view, Consumers see their Car as a valuable asset which can be converted to cash in a strong used Car market. The House , however , is a “Negative Value” asset. Consumers are making a sane economic choice by protecting a “Positive Value” asset. That is a Car.
Mr. Becker Puts it very nicely when he says
“If push comes to shove, you can live in your Car, But you can’t drive your house to work.”
U.S. consumers see more value in their cars
- Employment Factor
- Re-Possession Factor
- Equity Factor
The TransUnion study says something about how Americans view the economy these days. Short of Buying a motor home, where you can live and drive at the same time, U.S. consumers see more value in their cars and trucks, and less value in their homes, and are making decided choices about which to pay for first.
Read this for a detailed guide on how to get out of debt.
Start by comparing the details of your two loans. Which costs you more money each month? And which causes you more anxiety? It’s important to consider both your financial and emotional perspective..
Look up the interest rates and remaining balances on both your loans. You’ll find these on your last monthly statement, and you can always call the bank itself if you can’t find this information.
With this information in hand, let’s explore your options.
“Debt snowball” — pay off the lowest balance first
One popular option is to pay off the debt with the lowest balance first.
Just apply any spare cash toward this debt and once it’s gone, you’re one step closer to debt freedom. For most people, your lowest-balance Loan will be your Car Loan, unless you’re nearly finished paying off your mortgage.
After you pay off your first debt, you can use the money you would have allocated for those monthly payments toward your outstanding balance.
Let’s say, for example, that your monthly Car payment is $200, but you can afford an extra $100 a month. If you pay $300 a month toward your Car Loan, you’ll pay it off almost twice as fast. And once that’s gone, you’ll have an extra $300 a year to go toward shrinking your mortgage.
This allows you to be debt free much sooner. However, it also means that your current monthly payments should remain constant until all your loans are fully paid off. If it will clear your debt and let you fully own your Car and home, though, it’s worth it.
“Debt avalanche” — pay off the highest-interest-rate debt first
If you’re trying to diminish the total sum owed, you should use your extra cash to pay off your debt with the highest interest rate first.
For example, if your mortgage has a high interest rate, it might behoove you to pay off this Loan first, even if your Auto Loan has a smaller balance. If you do so, it will take you longer to clear both debts, but you will pay less money overall.
The “debt avalanche” method can be tough to commit to. Unlike the “snowball,” you don’t get the instant gratification win of a fully paid-off Loan. But if you have the patience for it, this method will save you more money in the long run.
Did you know that you can deduct a portion (or all) of the interest on your mortgage from your taxes? For many people, this can be a hefty and helpful influx of cash.
Let’s say your family lives in a state with no income tax and is in the 15% federal tax bracket. If you just bought a home for $190,000 at a 4.5% interest rate, you’d get a tax deduction for $1,558 in your first year. That’s not pocket change.
Interest on Auto loans for personal-use cars, on the other hand, is not tax deductible. As such, if your mortgage payments are saving you hundreds to thousands of dollars a year, you may want to prioritize paying off your Auto Loan first.
Investment alternatives — spend your spare cash elsewhere
If your mortgage interest rate is less than 7% (the average rate of return for the stock market), it might make more sense to invest your any extra money instead.
Let’s say your mortgage interest rate is a super-low 3%. If you invest your extra savings to earn an average of 7% in the stock market, you’ll likely come out with a healthier savings than if you’d put all that cash toward your payments.
Of course, you can lose money in the stock market as well, but in the long term, you’ll end up with more money in your pocket.
Make sure to find a brokerage you can trust to invest your savings in. If you don’t, you may as well have used that cash to pay off your loans early.