I have no other debt, my FICO score is good, and I'd like my credit record to be super clean. I pay off my credit card every month. I've been advised by a friend that paying off this car loan would be a good idea. Your thoughts? --LW via email
A: I agree with your friend. Paying off the car loan is a good idea.
People who are careful with money, as you clearly are, sometimes consider a savings account almost sacrosanct, and don't want to tap it for anything but an emergency. But as your situation shows, this doesn't always make financial sense.
The basic rule of thumb for figuring out whether to keep your money in an investment or use it to pay off a loan is compare the interest on the loan with the interest you can earn on the investment.
If the loan costs you more than you're earning on the investment, it's sensible to pay off the loan.
(Bear in mind that comparing the cost of a loan with an investment return is valid only when you're talking about a predictable investment return. The cost of the loan is a sure thing. To make a bona fide apples-to-apples comparison, the return on the investment must also be a sure thing -- i.e., a guaranteed fixed rate of return. Or to put it another way, it's unwise to borrow, even at a low interest rate, to invest in a stock that's certain to triple in value within the year, or to put money on a horse that pays 20 to 1 and can't lose.)
You're earning 1.4% on your savings account, before taxes. The car loan costs you 5.75% after taxes. The interest isn't deductible unless this is a business car, notes Barry C. Picker, a Brooklyn NY tax accountant.
Paying off the loan makes sense. In addition to reducing the total cost of the loan, an immediate repayment will put an extra $208 a month into your pocket -- and in a perfect world, says Picker, you'll deposit it in your bank account.
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