Lynn Brenner's Family Finance

Should I Tap My Savings Account to Pay Off a Loan?

Q:  I have $28,000 in the bank earning 1.4%, and I also have a car loan on which I pay 5.75% interest. The remaining balance on the loan is $8,751, in forty-two more payments of $208.37 per month. But if  I pay the loan off right now, I'd only have to pay $7,775.  So I could save $976.

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.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

CAN I CLAIM A TAX LOSS IF MY BANK FAILS?

Q: If your bank fails and you have a Certificate of Deposit that exceeds the amount covered by the Federal Deposit Insurance Corp., what's the tax treatment for any money you lose as a result? Can you treat it as a capital loss on your federal income tax return? -- BC, via e-mail 

 

A: Yes.  

 

There is a specific provision in tax law for this situation, says Barry C. Picker, a Brooklyn New York tax accountant and financial planner.

You could claim the loss as a non-business bad debt. Or you could claim it as a miscellaneous itemized deduction to the extent that it exceeds 2 percent of your adjusted gross income. "In most cases, the non-business bad debt would be the best option because there's no threshold to cross," he says. "It would be a short-term capital loss on schedule D, and it would offset any capital gains you have, dollar for dollar."

In other words, a $12,000 capital loss would wipe out the tax on a $12,000 capital gain.

If you have no capital gains, you can use up to $3,000 of a capital loss to reduce your ordinary taxable income this year, and carry forward any balance to use against next year's income. 

 

But don't be too sure you won't have any 2008 capital gains! To meet redemptions as shareholders cashed out of the plummeting market, many mutual funds sold holdings on which they made a profit - and they pass those taxable gains to their shareholders. The upshot: Even if your mutual funds were crushed last year, they may present you with a tax bill.

On the bright side, of course this doesn't apply to funds you hold in a tax-deferred retirement account. You can’t claim capital losses in a tax-deferred account, but you don’t pay taxes on capital gains there either.