What to Pay Down First to Accelerate Retirement

[CoolRich59]

I apologize in advance if this turns into a looong post:

I've been having a friendly disagreement with my wife and two of my kids on what is the best way to pay down loans to accelerate my retirement date.

We currently have three loans (2 auto and the mortgage on our home).

The first auto loan has the smallest payment ($390), has the shortest remaining term (appx 2 years), and an interest rate of 1.9%.

The second auto's payment is $520, has 4 years left, and also has an interest rate of 1.9%

The mortgage payment is (of course) significantly higher than both of these, has appx 12 years to go, and has an interest rate of 3.125%.

Paying off the first car loan seems to be the obvious choice. But, when I called and asked if any add'l payment would go to principal, I got an evasive answer. So, I dug up the loan contract and worked my way through the fine print.

It seems that any add'l $$ goes towards the next three payments and does not accelerate the loan at all. (For example, if I sent $1,170 on Jan 1, the loan company would apply $390 to January's payment, $390 to February's payment, and $390 to March's payment; my next payment would then be due April 1 - the loan maturity date would not move. (What a deal - for the loan company ) So, we are just going to keep the status quo with the first car loan.

The wife and one of my kids vote for paying down car loan #2 (I checked with them too, and 100% of each extra dollar goes to pay down principal). Their thinking is that we can pay off the car loan faster and then apply those payment amount to the mortgage.

However, my and my other son's thinking is that we will get more benefit by dedicating any extra $$ to the mortgage because of its higher interest rate and because the extra $$ will be accelerating the payoff date now, rather than keeping the mortgage payments "static" until we pay off the car loans and shift those $$ from the auto loans to the mortgage.

There may be a simple formula or calculator for working this out. If so, I apologize for wasting everyone's time. (And if there is a formula or calculator, please point me in the right direction!)

Thanks in advance for any input!

 

[wmc1000]

CoolRich59 - One thing that makes a difference in these comparisons is whether you itemize or take the standard deduction. If you itemize then the cost of your mortgage loan interest is deductible and the "Effective Rate" is less than 3.125%. Normally I would advocate towards the highest rate loan first but in this case the net rate for the mortgage might be so close to the auto loan rates where interest is non-deductible it may make sense to pay auto loan 2 off first.

 

[euro]

Hard to call without more info. Do you itemize taxes? What bracket are you in? would you be able to drop/lower insurance once the car notes are paid off?

 

[ERD50]

I apologize in advance if this turns into a looong post:

I've been having a friendly disagreement with my wife and two of my kids on what is the best way to pay down loans to accelerate my retirement date.
...

Thanks in advance for any input!

I'll make it simple, and short.

I feel there is a flaw in your first statement, that paying down these loans will accelerate your retirement date. I don't believe it will. So that makes it easy.

At those interest rates, I wouldn't do anything. Just keep paying the bill before it is due to avoid penalties/fees. Now go take a nap, or whatever activity/non-activity you choose.

-ERD50

 

[CoolRich59]

Thanks to you both for some great comments.

Hard to call without more info. Do you itemize taxes?

Yes, we do.

What bracket are you in?

Umm, no idea. That's my better half's realm

would you be able to drop/lower insurance once the car notes are paid off?

That's a definite 'yes'. Loan #1 has full coverage and a $500 deductible. I tried to get the loan company to let me increase it to $1,000 to reduce my insurance premium, but they said "No".

This vehicle also has 100k miles on it, so once the loan is paid off, I will be dropping collision and just going with liability coverage and increasing the deductible.

 

[gayl]

IMHO:
1. Pay off car #2 for peace of mind then --
2. Put invest that amount to increase nest egg / establish legacy account

 

[CoolRich59]

I'll make it simple, and short.

I feel there is a flaw in your first statement, that paying down these loans will accelerate your retirement date. I don't believe it will. So that makes it easy.

At those interest rates, I wouldn't do anything. Just keep paying the bill before it is due to avoid penalties/fees. Now go take a nap, or whatever activity/non-activity you choose.

-ERD50

Could you please expand on why you think that?

 

[ERD50]

Could you please expand on why you think that?

Then I can't keep it short!

OK, it's pretty simple - long term, your money will probably make more than the 1.9% and 3.125% rates on those loans. To pay them off, you need to pull money from your long term portfolio (or divert money from portfolio contributions).

Sure, your portfolio might do worse than those rates. And it might do better, or the same (to cover all my bases!). But it is unlikely to do so much better OR worse to have any real effect on your retirement date.

My choice is to let it ride, and focus on other areas (spending, asset allocation, low cost broad-based index fund investments, etc).

You posted that the insurance costs might change if you dropped the car loan - OK, that might be a good reason to pay it off in full.


BTW - we are practically neighbors (I had to check your profile to see that North Barrington was the one in Illinois). I see you have opera listed as an interest, and I seem to recall there are some Opera following groups in NB - do you belong to one? I love classical music, have yet to fully appreciate Opera, but I really should try to learn more.

-ERD50

 

[RunningBum]

Could you please expand on why you think that?

Not directed at me, but I'd bet you can do just as well or better by investing the money rather than paying off very low interest loans.

 

[CoolRich59]

Then I can't keep it short!

OK, it's pretty simple - long term, your money will probably make more than the 1.9% and 3.125% rates on those loans. To pay them off, you need to pull money from your long term portfolio (or divert money from portfolio contributions).

Sure, your portfolio might do worse than those rates. And it might do better, or the same (to cover all my bases!). But it is unlikely to do so much better OR worse to have any real effect on your retirement date.

My choice is to let it ride, and focus on other areas (spending, asset allocation, low cost broad-based index fund investments, etc).

You posted that the insurance costs might change if you dropped the car loan - OK, that might be a good reason to pay it off in full.

Thank you all so much for your replies. I'm at the office and reading them to my wife over the phone (I'm not being very productive today. Well, productive for me; not so much for my employer. )

Our investments have been pretty consistently making about 8% and so yours and RunningBum's points are well taken.

While 8% is not a guarantee, if I redirect the $$ from increased auto or mortgage payments into our retirement and investment accounts, any return over 3.125% is a net gain over the "return" I see from increased principal payments on those loans.

BTW - we are practically neighbors (I had to check your profile to see that North Barrington was the one in Illinois). I see you have opera listed as an interest, and I seem to recall there are some Opera following groups in NB - do you belong to one? I love classical music, have yet to fully appreciate Opera, but I really should try to learn more.

-ERD50

I thought I heard you typing!

I love opera and was a subscriber to the Lyric for 10+ years. I am a traditionalist and prefer the great standards (Mozart, Verdi, Puccini, etc.). If you decide to explore opera, those would be my recommendation (e.g., Puccini's 'Tosca', or Mozart's 'The Marriage of Figaro').

Lyric does have an opera group in the Barrington area, but I'm not much of a joiner and never attended any of their events.

 

[donheff]

At those interest rates, I wouldn't do anything. Just keep paying the bill before it is due to avoid penalties/fees. Now go take a nap, or whatever activity/non-activity you choose.

-ERD50

This and save the money you would have dedicated to the early payments.

 

[Markola]

Regardless of how you get there, you have the right idea to get out of debt. The thing that did it for me was reading the book "Total Money Makeover" by Dave Ramsey. Before that I thought, "Eh, some debt is ok". Not anymore. His investment advice is wrong and is to be ignored but his get-out-of-debt arguments and process are motivational and clear. Good luck.

 

[Texas Proud]

I'll make it simple, and short.

I feel there is a flaw in your first statement, that paying down these loans will accelerate your retirement date. I don't believe it will. So that makes it easy.

At those interest rates, I wouldn't do anything. Just keep paying the bill before it is due to avoid penalties/fees. Now go take a nap, or whatever activity/non-activity you choose.

-ERD50

I knew someone would put down my thoughts.....

And I would say that all extra cash should be invested.... these are all low interest rates and should not be accelerated....

Learn to live with cheap debt...

 

[Ronstar]

Given the loan rates, I don't think I would pay any of them off - invest the money instead.

 

[GalaxyBoy]

You might find this article on the Bogleheads wiki informative

https://www.bogleheads.org/wiki/Paying_down_loans_versus_investing

It's not the easiest read. Take it slow and in pieces; I had to read it several times.

 

[Senator]

It seems that any add'l $$ goes towards the next three payments and does not accelerate the loan at all. (For example, if I sent $1,170 on Jan 1, the loan company would apply $390 to January's payment, $390 to February's payment, and $390 to March's payment; my next payment would then be due April 1 - the loan maturity date would not move. (What a deal - for the loan company ) So, we are just going to keep the status quo with the first car loan.

Make sure they apply this extra payment to "Principle only". Then you will get the amount reduced and the maturity date shortened.

Pay off the lowest balance first, unless you have a crazy high interest rate loan.

 

[CoolRich59]

Thanks everyone. I really appreciate you all taking the time to reply.

Based on your input, yesterday I cancelled the scheduled extra payments to one of the car loans and to the mortgage and "reset" them to the regular monthly payments.

I was going to redirect those $$ from our checking account into one of our investment accounts when I had a related idea. I checked with my employer and learned that I could "split" the direct deposit of my paycheck.

So, now those $$ that went to the extra loan payments will be deposited directly into the investment account. And, as we find ways to cut spending, we will increase the amount that gets directed into that account.

More importantly, I've been cutting and pasting info from this forum and emailing it to my kids. While I regret not doing more to prepare for retirement earlier, I'm determined to "convert" my kids so that they can start applying these lessons now while they are in their 20s.

 

[ERD50]

Regardless of how you get there, you have the right idea to get out of debt. The thing that did it for me was reading the book "Total Money Makeover" by Dave Ramsey. Before that I thought, "Eh, some debt is ok". Not anymore. His investment advice is wrong and is to be ignored but his get-out-of-debt arguments and process are motivational and clear. Good luck.

I feel most of Dave Ramsey's debt advice "is wrong and is to be ignored". Maybe more misguided than 'wrong'.

He is so debt adverse that he leads people to make bad financial decisions. I listened to one of his radio shows, where he congratulated some family on a string of bad financial decisions, all so they could chant that 'debt free' mantra of his. These people sold a bunch of stuff at fire-sale prices to pay off their debt. Made no sense, they needed that money, and could have made better use of it.

He is also so adverse to credit cards, when a credit card provides cash rewards, float, money management, convenience, safety, etc.

Sure, some people will misuse a credit card. Some people misuse chain saws. We don't say they are 'bad', but a tool which when used properly, brings good things to the user.

OK, if you are a credit card-a-holic, maybe you need the AA approach of abstinence. But best would be to learn how to use the tool, and Dave Ramsey steers ALL people away from that.

-ERD50

 

[JoeWras]

I feel most of Dave Ramsey's debt advice "is wrong and is to be ignored". Maybe more misguided than 'wrong'.

He is so debt adverse that he leads people to make bad financial decisions. I listened to one of his radio shows, where he congratulated some family on a string of bad financial decisions, all so they could chant that 'debt free' mantra of his. These people sold a bunch of stuff at fire-sale prices to pay off their debt. Made no sense, they needed that money, and could have made better use of it.

He is also so adverse to credit cards, when a credit card provides cash rewards, float, money management, convenience, safety, etc.

Sure, some people will misuse a credit card. Some people misuse chain saws. We don't say they are 'bad', but a tool which when used properly, brings good things to the user.

OK, if you are a credit card-a-holic, maybe you need the AA approach of abstinence. But best would be to learn how to use the tool, and Dave Ramsey steers ALL people away from that.

-ERD50

ERD50, I understand where you are coming from. From a sanitized math point, debt works -- especially at these low rates. To the OP: your rates are so low, I agree, don't sweat it.

However, I think Ramsey stops more than just the credit card-a-holic behavior. It is more than just down in the gutter credit-a-hism. It can also mean you are a "problem credit consumer."

My friend admits he falls into this category. Every time he makes progress on some "good credit," he feels the need to extend it. He made progress on his house. Good! So then he buys a lake house. That debt now replaces the mortgage. Next is the boat. Then the truck to tow the boat. Etc.

Now over 50, he's like, "WT heck happened?" Never any credit card abuse, but always something causing him to not save.

This, of course, is bigger than credit. It is part of LBYM. So, it is easy to "do the math," but for some people, they get a little amnesia about the math and slip into some bad habits where the math is no longer working for them.

For this reason, I think it is worthwhile for people to consider going debt free. But I totally respect your position and understand it. Please understand, conversely, that debt free works really good for some of us.

 

[ERD50]

....

For this reason, I think it is worthwhile for people to consider going debt free. But I totally respect your position and understand it. Please understand, conversely, that debt free works really good for some of us.

Yes, my problem with DR is the broad brush (not even 'broad', but 'all encompassing'!). He paints the CC cos as 'evil', 'snakes', etc. He mocks people who collect the rewards ("they are playing with snakes - why?", "they could make more money cutting lawns" !?).

He uses convoluted, meaningless claims to attempt to make his point "I know lots of millionaires, and not one said the way they got rich is through these rewards" Of course not, that's just silly. And meaningless. So why say it? It is disingenuous, and that is not worthy of my respect. People deserve better.

I got into a Ramsey discussion on another forum. The more the guy (a Ramsey fan) posted, the more I disliked Ramsey. He really twists things to make it fit his view (and retain his intended audience is my guess). Truth and accuracy and relevance don't matter, it's mostly about creating a straw-man enemy, so Dave can be the 'hero' and attack the enemy.

I pretty much don't care if a credit card company is 'evil' (to a point), as long as I get my float, 2-3-4% cash rewards, I'll live up to my side of the contract, and they can live up to theirs. And it's all good.

-ERD50

 

[RunningBum]

...

Now over 50, he's like, "WT heck happened?" Never any credit card abuse, but always something causing him to not save.

This, of course, is bigger than credit. It is part of LBYM. So, it is easy to "do the math," but for some people, they get a little amnesia about the math and slip into some bad habits where the math is no longer working for them.

For this reason, I think it is worthwhile for people to consider going debt free. But I totally respect your position and understand it. Please understand, conversely, that debt free works really good for some of us.

It's all LBYM. As ERD says, credit is just a tool. But even if your friend didn't go into debt at all, but still spent every single cent on those extras with no savings whatsoever, he would still have a huge problem. That's what makes me say credit is not THE evil.

For plenty of people in the "outside world", perhaps viewing credit as evil is a good deterrent, and keeps them from living too large. For most of us in here at e-r.com, credit can be a way to get an extra bonus or leverage assets to optimize our finances.

What I'm getting at is the difference in approach between someone who can't make ends meet versus someone who is trying to retire as early as possible. The former should be extremely wary of credit. The latter can look for ways to make the most of it.

People who follow Dave Ramsey seem to have trouble making that differentiation. I rarely pay attention to Ramsey so I don't know if he does, or if he really sticks with the very broad brush and absolutes.

 

[JoeWras]

I am not a Ramsey follower, I only hear second hand his recommendations.

I will say that not all people have the discipline most do here. Many also do not have the intelligence. Sometimes, simplifying is required.

 

[ERD50]

I am not a Ramsey follower, I only hear second hand his recommendations.

I will say that not all people have the discipline most do here. Many also do not have the intelligence. Sometimes, simplifying is required.

I don't disagree, but these posts are in the context of the OP, who does not appear to have any of these sorts of "can't control debt" problems. So "all debt is bad" just doesn't apply.


I think I'll take a taste of the home-brew beer I put on tap yesterday, even though it's before noon.

Not a good thing to do for someone with a drinking problem, but just fine if you don't paint with too broad a brush. It's not one-size-fits-all.

-ERD50

 

[CoolRich59]

I pretty much don't care if a credit card company is 'evil' (to a point), as long as I get my float, 2-3-4% cash rewards, I'll live up to my side of the contract, and they can live up to theirs. And it's all good.

-ERD50

Completely agree. I occasionally play the credit card churn game.

Chase or Amex wants to give me loads of points and benefits if I meet the spend requirement? So, long as I'm sure I'll have no problem meeting the spend (while paying off the entire balance every month), I'll play.

But as soon as I meet the spend, the card gets cancelled or gets put in a drawer and I go back to my primary card.

If the credit card companies thought they weren't getting value from these promotions, they'd stop offering them. And, to an extent they have. I can't remember the last time one of them offered 100k bonus.

 

[mystang52]

Paying off the first car loan seems to be the obvious choice. But, when I called and asked if any add'l payment would go to principal, I got an evasive answer. So, I dug up the loan contract and worked my way through the fine print.

It seems that any add'l $$ goes towards the next three payments and does not accelerate the loan at all. (For example, if I sent $1,170 on Jan 1, the loan company would apply $390 to January's payment, $390 to February's payment, and $390 to March's payment; my next payment would then be due April 1 - the loan maturity date would not move. (What a deal - for the loan company ) So, we are just going to keep the status quo with the first car loan.

I'm going to be non-committal whether what follows is the right thing to do, but let me play devil's advocate: If you sent $1170, the next payment due is April 1. So what happens if you send another, say, February 1? If they cash the check, either principle gets reduced, or your next payment is then due July 1. Repeat this process, and you either get a principle reduction or yet another advanced due date. Inevitably that "due date" will be beyond the expiration of the loan, except it would already have been fully paid off in advance. So, you're still getting benefit of cash flow of that now-no-longer-due loan payment.