It’s a well-known fact that the vast majority of us finance types can do amazing things with other people’s money while consistently shitting the bed with our own. I was inspired to write a post addressing this topic today because I was trying to decide what to do with my car loan this weekend.
Some context: the loan has a 36 month term (of which I’ve paid 14), and an interest rate of 12.99% - hold the monkey shit, I had no credit and this is the lovely steaming turd of an interest rate Wells Fargo was kind enough to concoct for me, and I have enough saved up to pay off the loan balance in full should I feel like it.
So my options are effectively:
- Keep doing what I’m doing and make the monthly payments until the loan is paid off
- Refinance the loan to try and get an interest rate in the single digits
- An extension of 1&2 – pay more each month to reduce the effective interest rate I’m paying
- Pay off the loan in full
I actually modeled out these three options and used a 2% cost of capital (basically the CPI). The interesting thing I found was that it actually makes more sense to just keep doing #1 – the issue here being opportunity cost. If I paid off the loan balance in full, I would forgo the cumulative savings benefit of starting at T=0 vs T=1. Truth be told, the difference between both options is negligible, and I’ve basically budgeted the car payment as a fixed cost going forward, so I’m perfectly content to keep doing what I’m doing.
So this got me thinking – when do I actually apply what I’ve learned in school to my personal finances? Would I be an attractive “LBO candidate” to a credit card company considering my stable and predictable cash flows? What potential synergies can I expect to realize through a “merger” with my significant other? All goofy finance analogies aside, what has your experience been? Do you treat your personal budget with the same meticulous care you would that DCF you’ve been building for your MD? Food for thought…
Jeez, for 12,99% I hope it was a cheap car you bought :P. Those kind of expenditures tend to be vulnerable to mental accounting bias.
"what is your personal wacc?"
whatever interest rate my checking account is giving me lol.
:-/
I don't discount my finances in my budget. I've got a sick spreadsheet that tells me what I'm bringing in versus my spending but that's about it. I don't make enough money at this point for this kind of DCF analysis to produce any valuable insights.
I just save as much money as I can right now and put it towards my loan (~6.5%). Until it is entirely paid off (7 months from now at this rate) I will continue to save and pay as much as I can afford. My "financial" justification is plays off of the risk-reward relationship. Essentially, loan payments generates a "risk-free" return equal to the interest rate on my debt. I may be able to earn a greater return elsewhere, but not nearly at the same level of risk. Being a total wimp when it comes to my finances, I choose the first option.
Another lesson learned in my finance education was that price =/= value. We often categorize our thinking into the dollar amounts that we can get out of certain situations, but value is what those investments mean to us. I may be able to generate a higher return somewhere else, but it's worth it to me to forego this return so I don't have this debt obligation.
Do you have a steady job? If so taking a 13% loan seems crazy to me. On top of that, not paying it off seems nuts, unless it would leave you with little to no cash reserves. Other than getting matching in a 401(k) every excess dollar you have should be paying that loan off.
Personally, I'm not great with my money, mostly because I'm conservative with it and my wife wants to be SUPER conservative. We're good at saving, but not great at earning an optimal return.
Based on my conservatism, I typically go for the low-risk option, similar to bonks. I'm actually thinking about paying off my 4% student loans right now. I have the cash and would rather reduce my debt and have an extra couple hundred of cash flow a month than put more $ into the market right now.
Really not that hard I think but correct me if I am wrong - are you getting at least a 13% cash return on the money you have borrowed at 13%? If not you should probably pay it off.
I don't think you are discounting yourself enough.
This is what I was thinking. If WACC = or
Mmmm, no way in hell I would keep at 13% car loan around when I have the cash to pay it off.
~50%
When I got the loan, I hadn't started my banking role yet (May 2011). So I had little to no credit history and my Dad had to cosign with me.
Also re: paying off the loan right now, I have several big expenditures coming up, so I'd rather use the cash I have to deal with those than the loan. That being said, frgna, you have a point as well.
whats the marginal utility
Being serious here - what kind of car are we talking about here? Because the really responsible thing to do as a first year analyst is buy a $5,000 car that runs dependably with high MPG (like I did)...
Just to be thorough what are your 'out' options at this point? I assume not too good but want to cover all bases. I.e. if you want to sell the car and just pay cash for a cheaper one. Not sure what that'd do to the credit though, I assume it's a breach and therefore probably not too good.
At the least, do option 2/3...how necessary are the big outlays coming up? Please don't say it's a watch...
I'm with you there - I got a used Nissan Altima that I should be able to run into the ground. Works fine for my purposes. And by no means am I in dire straits here - like I said in the OP it was more a "oh I got the notice that I could pay off my loan balance in full since it's been a year" and let's apply some analysis and consider the options.
Outlays are related to other loans, a few items for the apartment that me and the roommates are chipping in on, as well as a few wants (no watches haha).
The other question people might be asking is "shouldn't my bonus factor into this somehow?" The answer is yes, it would have, had I not moved, and had my previous firm not had some less than ideal compensation structures in place - although that's a topic for another day :)
Assuming you're not funding other personal expenditures by raising equity (!), then you should utilize your cost of raising debt financing as your personal cost of capital, not the 2%.
I like to take it a step further however and factor in things such as liquidity discount (I have a high preference for liquidity) and market risk - Assuming you had an investment that could earn you 15%/yr, you might be tempted to make the spread vs your loan payment. However paying off the loan is the far safer investment as your "return" is effectively guaranteed.
Keep paying the loan for about 6 months and pay it off. You NEED to build some credit.
He's already prime, there's a little improvement at 750 but it's not like he's got bad credit at all.
my fault, I thought he didn't have any credit. ^^^Retract
Funny how this turned into a thread about my car loan rather than people's personal finances in general! Well, I welcome the advice, but I obviously intended for the thread to be a more open-ended discussion about if/when people applied some sort of financial analysis to their personal finances.
txjustin - I have had other means of building credit (rent payments, credit cards paid in full every month, etc.) and my current credit score is around 730. Like I said before, I got a shitty rate on the used car because I had no credit history at the time.
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