I have about $20,000 in savings. I owe $9,500 on my 2018 vehicle. Would it be wise to pay off the vehicle because the savings account is not making me any money and the car loan is 5.25% interest? The $20,000 is for cash flow. I do own a mobile home, no mortgage.
— Well Endowed
Debt payoff and savings goals often compete for attention, especially when you have limited resources to dedicate to either goal.
Many experts recommend using money toward whichever goal will have the greatest payoff in the long run, as a way to optimize your net worth. For example, if your savings account balance grows with 0.01% interest, but you pay 5.25% interest on your car loan, mathematically you lose money each month you let the loan accrue interest (even though you have the same cash sitting in your savings account).
Similarly, if you pay 5.25% interest on the loan but you could earn 8% interest by investing the money, experts tend to recommend investing instead of paying off the loan ahead of schedule.
The most important question to ask yourself is: What purpose does the $20,000 serve for you?
When you say it’s for “cash flow,” does that mean you rely on the money for everyday expenses? Or to float you between paychecks? Or is it a cushion you rarely touch but feel more comfortable with day-to-day spending knowing it’s there?
In any of these cases, cutting that savings in half might have a serious impact on your day-to-day relationship with money. It could force more restricted spending, make it hard to cover your bills or raise your stress level around money.
If, instead, the money in your savings account is just sitting there without a clear purpose — and your financial commitments, spending and other goals are otherwise covered — eliminating a debt could be a good use for it.
You might also decide you’re fine with making the monthly payments on the vehicle loan with interest, and you can use the $20,000 for something else, like home improvements, a medical procedure, traveling or an event. You’re not obligated to eliminate debt before spending on something that improves your quality of life.
The key is that you have a purpose for your savings, so you’re not sitting on money that could be serving you in some way — whether that’s paying off debt, growing with interest, giving you peace of mind or buying some luxury you’ve been wanting.
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Dana Miranda is a Certified Educator in Personal Finance® and contributor to The Penny Hoarder. Send your tricky money questions to AskPenny@thepennyhoarder.com.