Deciding whether to pay off your car or house first is a common financial dilemma With limited funds, it can be tough to determine which debt to tackle first to maximize savings
There are good arguments on both sides Let’s dive into the pros and cons of paying off your auto loan versus mortgage early so you can make an informed decision,
Factors Favoring Paying Off Your Car First
Here are some reasons it may make more sense to pay off your car before aggressively paying down your mortgage:
1. Auto Loans Typically Have Higher Interest Rates
Most interest rates on auto loans are higher than rates on mortgages. The average interest rate on a new car loan is around 5%, while the average rate on a 30-year fixed mortgage is below 4%.
Paying off high-interest debt saves you more money in interest charges. By tackling the debt with the highest rates first, you minimize interest expenses.
If the interest rate on your car loan is higher than the rate on your mortgage, you might want to pay off your car loan first. Putting an extra dollar toward the principal saves more money in interest than putting that same dollar toward the house.
2. Cars Depreciate Rapidly
Cars lose value quickly. According to CarFax, a new vehicle can lose 10% of its value within the first month and around 20% by the end of the first year. The depreciation accelerates from there.
With a mortgage, you build equity over time as you pay down the loan. Your home will likely retain its value or even appreciate. So you have an asset that offsets your debt.
When you buy a car, it’s almost certain that your loan balance will go over the car’s value at some point. You end up owing more on the car than it’s worth. It is less likely that you will go into debt if you pay off the loan quickly.
3. Car Loans Are Shorter Term
The standard car loan term is 4-6 years. Mortgages are typically 15-30 years.
Paying off a shorter term debt frees up cash flow sooner. Eliminating a $300 monthly car payment more quickly gives you more money to tackle the mortgage.
4. Interest on Car Loans Isn’t Tax Deductible
If you list your deductions, you can write off mortgage interest on your taxes. Car loan interest isn’t tax deductible.
Paying off non-deductible debt first means you pay less interest without losing the tax benefits. It maximizes your deductions while minimizing interest.
5. No Prepayment Penalties
Mortgages sometimes have prepayment penalties that make it expensive to pay off your home loan early. Car loans don’t have prepayment penalties.
You can pay off your auto loan as fast as you want without penalty. Doing so with a mortgage may incur extra fees.
Factors Favoring Paying Off Your Mortgage First
On the other hand, here are some reasons it may be better to prioritize paying down your mortgage first:
1. Mortgages Usually Have Lower Interest Rates
As mentioned above, mortgage rates are generally lower than auto loan rates. The average 30-year fixed mortgage rate is almost always below 5% while the average car loan rate is around 5-6%.
Paying off low-interest debt first may not make sense mathematically. The money put toward lower rate debt saves less in interest than tackling higher rate debt.
From a pure dollars and cents perspective, paying off debt with the highest interest rate saves the most money. Even a small rate difference of half a percent or less compounds over the long run on a large mortgage balance.
2. Mortgages Are Longer Term
The standard mortgage term is 15-30 years. Auto loans are typically 4-6 years.
Over a longer repayment period, the mortgage costs significantly more in interest than a car loan. Paying down principal early on in the mortgage has more time to compound savings.
An extra $100 a month toward a 30-year $200,000 mortgage saves over $20,000 in interest versus putting that money toward a 5-year $30,000 auto loan, which may only save $1,000-$2,000 in interest.
3. You Build Home Equity
Paying down your mortgage builds equity in an appreciating asset – your home. As your loan balance decreases and home value increases, you gain equity.
With a car, you’ll never get back what you put into it. But mortgage principal payments may be recouped later when you sell the home.
Building home equity more quickly gives you financial flexibility. You can tap it later via a line of credit, cash-out refinance, or reverse mortgage.
4. Mortgage Interest is Tax Deductible
You can deduct mortgage interest if you itemize on your tax return. This deduction reduces your effective interest rate.
For instance, at a 25% tax rate, a 4% mortgage only costs 3% after tax savings. You lose this deduction by paying off the mortgage early.
Since auto loan interest isn’t deductible, you want to pay that off first to reduce total interest paid. Paying mortgage principal faster means more lost tax deductions.
5. Lower Minimum Payments
Minimum monthly mortgage payments are lower than auto loan payments because of the longer term and lower rate.
Freed up cash flow from eliminating the higher car payment can be applied to the mortgage. Paying off the car first makes the mortgage more affordable.
Other Considerations
Beyond interest rates and loan terms, here are a few other factors to weigh when deciding whether to pay off your car or house first:
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Total interest paid – Calculate and compare total interest for each loan under different payment scenarios. Focus on minimizing total interest costs.
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Cash flow – Paying off the car first frees up more in monthly payments sooner. Evaluate the cash flow impact.
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Budget – Make sure you can afford the higher monthly payment if you pay off the car first. Don’t overextend yourself.
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Fees – Check if mortgage prepayment penalties make accelerating payoff expensive. Factor in any fees.
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Goals – Decide which is more important: being debt free sooner, building home equity faster, or maximizing wealth.
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Investment opportunities – The stock market may provide better returns than extra mortgage payments. Don’t miss out on investing.
Whether it’s better to pay off your car or house first depends on your specific situation. Run the numbers based on your loans, rates, tax situation, goals and cash flow.
There’s no one right answer. Paying off high-interest, non-deductible debt first often makes sense mathematically. But mortgage payoff may be preferable to build home equity faster while rates are low.
Think through both sides – then do what feels right for your finances. Either option puts you ahead by tackling debt aggressively. The key is having a plan and paying off debt systematically.
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While a house is probably the most expensive thing you will ever budget for, a car can also require a significant amount of cash. Finding the right car or home for your needs must be balanced with your budget.
Car loan vs. mortgage: Impact on loan terms and rates
Car loan terms are much shorter than those of mortgages, the standard maximum being 84 months with rare exception. While the average length is 67 – 69 months, it’s suggested you stick to vehicles you can pay off within 48 months. Meanwhile mortgage terms can be shorter than ten years, though this is rare. Most mortgage loans are 15 or 30 years.
Interest rates for the two loans also differ. Interest rates for cars are often significantly higher, ranging from 10% to 17% depending on a variety of factors, mainly your credit score and whether the car is new or used. When it comes to mortgages, you can expect rates below 10%. Over the last 6 years, the average rates ranged from as low as 2.2% to as high as 7.57% on 15- and 30- year mortgages. These interest rates also consider a number of factors beyond your credit score, such as loan type and home location.
Use My Savings To Pay Off My Car?
FAQ
Should I pay off my mortgage or my car first?
By paying off your car loan, you lower your overall debt, which can improve your DTI ratio and make you a more attractive applicant for a mortgage that will likely get you better loan terms and lower interest rates.
Which debts should you pay off first?
The avalanche method focuses on paying off higher-interest debt first. Getting rid of the debt that costs you the most in interest will save you money in the long run.
What is the 50 30 20 rule for car payments?
The 50/30/20 rule is a budgeting guideline that suggests allocating 50% of your after-tax income to needs, 30% to wants, and 20% to savings and debt repayment.
How much is a $30,000 car payment for 60 months?
Depending on the interest rate, a $30,000 car loan with 60 months will cost between $500 and $700 a month. For example, at a 5. 8% interest rate, the monthly payment would be around $520, according to Edmunds.