Tag Archives: budget

Should You Pay Off the Car Loan Early?

My son recently bought a car of his own so he can use it when he goes to Rutgers University. The journey began earlier in the summer when he starts hunting for his perfect car. But I brought him down to earth by explaining the process especially applying for an auto loan.

So he started applying for a pre-approval loan through several banks and he was rejected because of his lack of credit history. One bank approved a loan under pre-condition with high interest rate. He was shocked of how difficult it was to buy a car.

I stepped in and helped him to get the loan from the car manufacturer using co-signing. We were able to get the loan with low interest rate. We were quite happy with the loan condition because of low monthly payment and there is no penalty for paying off early. The car dealership finance manager asked if we plan to pay the loan off early. That is a very good question of which I’ve thought of when I had two car loans prior to this.

There are pros and cons when it comes to paying off loan early. The obvious pro is that you get to be debt free early. This is especially true for someone who hates to carry a debt. But that does not mean that you will be totally debt free because everyone carries other debts (i.e. mortgages, credit cards etc.). Another benefit of paying off the car early is that you get to own the car early and you are not required to have a comprehensive full insurance coverage, which is an added saving.

Other Obligations

Let’s address the elephant in the room. The car payment is big chunk of anyone’s budget. Besides our daily obligations such as grocery bill and fixed cost, car payments can be a big portion ofour our monthly expenses because of the condition of the loan. Unlike a mortgage which could be 15 to 30 years loan, auto loan is usually 5 or 6 years loan. That means that monthly payment could be high depending on how much you are borrowing.

You can opt to pay more every month so you can pay off the loan early. A mortgage will reduce its monthly payment when you pay more upfront. BuyAuto loan is fixed every month regardless how much you pay more. The only benefit is that it will reduce the period of repayment by several months. So paying more every month will not likely to make a dent on your monthly obligations.

Affordability

Before going through this point, everyone should ask the question why would they need to have a new car on their driveways. Cars today rarely break down. The quality of the cars have improved dramatically that most will last 10 years before breaking down. Are you ready to absorb another cost when the benefits of owning a car rarely outweighs the costs?

If you can afford to pay for the car then the answer to paying off early makes sense. It is highly recommended that you make a proper budget to ensure you can afford the car payment. Once you are aware that you can afford an extra payment, paying more on the principal will help. However, as I alluded to above it will hardly make a difference in the long run unless you pay extra every month.

The Return

My son was able to get a good rate on the car loan. After paying off the loan in 72 months, it will only cost him $1,500 for the entire loan. If he pays off the loan early, it may lower the cost by a few hundred of dollars. However, he could repurpose the money for something more beneficial. For example, if he invest the $7,200 (assuming that he pays $300 every month for the next 2 years) with an average monthly return of 12%, he would have made a profit of about $2,000 by the end of second year. Obviously this is being optimistic but history shows that it is possible to obtain 10% return annually based on conservative stocks. Keeping the money in investment will continue to grow year on year.

However, if you have a high interest auto loan then it may makes sense to pay off the loan early. This should only be done if you can actually afford to forgo the money otherwise that you can use it for something else. Another option to minimize the cost of the loan is by taking a personal loan from a bank with lower interest rates.

Everyone’s financial situation is different. Paying off the auto loan early may make sense if you have a large outstanding debt or if you have the means to do so. It is important to consider if paying off would benefit in the long run. The best way to manage any auto loan is simply not to have it. If you can continue to use your existing car for a few more years there is no reason to obtain a shiny new car with a large price tag.

Personal Budget vs Reality

Budget Finance Cash Fund Saving Accounting Concept

All of us heard about financial responsibility starts with a budget. We need to look at our take home pay and plan ahead for any expenses. While it is a good idea because it allows us to plan how much we can save. However, in reality how may of us can actually stick to the budget?

Having working full time for almost 30 years, I can tell you that I could never stick to my budget because it never works. There are always the unexpected expenses that threw the budget out the window. Expenses such as the car needs repair, the washing machine needs replacement or buying presents for birthday parties tend to appear unexpectedly. Having a budget is definitely a plus but it should be treated it as a guide more than a bible.

I was a financial analyst helping with the budgeting for a large accounting firm (heard of Arthur Andersen?) 15 years ago. Having spent 2 years in planning and budgeting for the Assurance practice in New York, I came to the conclusion that budgeting is a waste of time. Not only the team I worked for constantly reforecast the financials every month because we missed the budget, the actuals that were recorded in the financial statements never came close to the approved budget. Personal finance is very similar. The actuals at the end of every month is usually off from what what we intend to spend. There are several reasons why budgeting never works.

Time Consuming

To prepare a proper budget we need to gather all the expenses from prior years and plan what we want to spend based on prior history. Once you have the budget, we need to start tracking actuals spending to minute details in order to have an accurate picture of true expenses. The question is how many of us actually have the time to log everything in? There are apps or online tools that could help with the budgeting. Unfortunately, all of them require a considerable amount of time to maintain.

Always Wrong

As noted earlier, the unexpected expenses tend to appear and invalidate the budget. Because of this we need to spend more time to reforecast our budget so we do not miss our monthly goals. As we progress throughout the year, we soon realize that the numbers are off again and we need to re-budget again. It becomes a never ending cycle.

Not Bound to Anything

The biggest problem with budgeting is that it is not bound to anything or no one is measuring the budget but ourselves. Having a budget is great but what happens when we exceed our budget every month? Who is going to penalize us for going over the budget? No one. At the end of every month no one will be held accountable. Hence, the value in budgeting diminishes quickly.

So that begs the next question. How do we become financially responsible and plan for our future? The best answers I can give are use your best guess and plan only several months ahead. Additionally, always consider saving for the future a priority and everything else secondary.

Investing and Saving

This is a priority and something that we must to do first. We need to put as much as possible (or to the best of our ability) in investment vehicle such as 401(k) and IRAs. If you participate in your employer’s 401(k) plan, the money is automatically withdrawn from your paycheck and you never see it. If you have extra disposable income, consider invest it in Roth IRA or traditional IRA. Finally, putting those money in stocks that pay dividends will also allow you to generate passive income.

Fixed Expenses

Every month we are required to pay for fixed expenses. Some of these expenses include mortgage or rent, utilities and education expenses. You should be able to figure out these expenses relatively easy. Personally, I only put my mortgage expense as the only expense in this category because the amount is always the same every month. Utilities such as gas, water and telephone tend to vary by month – so I place them under other expenses.

Food Expenses

The second type of expense that takes a large chunk of my monthly expense is food. Prior to the pandemic I had to have a separate category called “eating out”. Nowadays, I just have grocery. The amount I pay every month is different so instead of using a set amount, I use an estimated total. Notice that I do not set a number because this category is “fungible” and it does go up or down because it depends on what type of food my family wants to eat at any given day.

Gifts and Unexpected Expenses

Holidays such as Christmas and birthdays also have a big impact on my annual expenses. I usually try to limit how much I am willing to spend on gifts. Other unexpected expenses that can’t be planned ahead are things (such as cars or appliances) that need to be fixed or increase in utility bills due to the weather.

Taxes

Finally, I put taxes as the last item because they should not be in our mind as they are paid automatically from our paycheck. If you file your W4 with your employer correctly, you should not have to worry about paying taxes when you file your annual income tax. However, do prepare for any eventualities particularly if you have capital gain from sale of your stocks. Other taxes that could appear unexpectedly are increase in property taxes or if you are required to pay certain taxes when you withdrew money from your 401(k).

I believe budgeting is a great tool if you have time to do it correctly. However, you should use it as a guide and allow some breathing room when it comes to actual expenses. The most important thing that you should always remember to do is grow your money by saving as much as possible in certain investments vehicles. Don’t aim to buy that shiny new cars which is usually a large expense; aim to expand your portfolio as it will pay you in the long run.