OMG, I Agree with Dave Ramsey… In This Case
So a friend of mine calls me today and tells me that he’s been having a bit of financial trouble – they call me all the time, they just never listen. Anyway, he previously had 6 months worth of expenses saved up in his emergency fund, but was laid off some time back and had almost run through all of his funds. He’s found another job now and working on getting back on his feet, but he wanted to know what I thought would be best in his situation.
He currently has $1500 in his emergency fund, no credit card debt, about $2000 in monthly expenses, and about $5000 left on his car note. His new job affords him a little breathing room in his budget, but his question to me was what I thought about him paying off his car before rebuilding his emergency fund. I said absolutely.
Here’s Why I Agree With Dave
- He’s got $1500 set aside currently with no credit card debt. Barring another job loss, he actually has some options in the event something comes up.
- He’s been paying on this loan for almost 6 years and has no intention of trading it in, so it would free up $400 a month in his budget – that’s a hefty sum to add to his emergency fund.
- Aside from student loans, this is the only debt he has left.
Now, he has a decent rate – 5.75% – but, my opinion on the matter is that, in this case, his best move is to spend they extra money a month to get this debt completely knocked out and then focus on rebuilding the emergency fund. Normally I don’t agree with Ramsey’s numbers, but here I think they make sense.
His final payment is actually December of this year, but it’s the end of December, so let’s say he’s done with car payments as of January 2010. He’s got about $150 extra a month he could apply to either the emergency fund or the car. If he applies it to the emergency fund, that will give him another $1500 in ten months. Not bad. But, if he applies that to the loan he’ll knock out that debt several months earlier and can start applying the $400 PLUS the $150 to the emergency fund.
Using a standard payment calculator, roughly speaking, $150 per month towards the debt would pay it off three months earlier. So, that three months without the car payment, plus his additional $150 a month, comes to $1650. In three months he’ll put more towards the emergency fund than he would just putting $150 a month for the next 10 months until the car is paid off. Technically, he is missing out on interest, but rates are low enough right now that he wouldn’t be earning enough to offset the interest he’ll save by paying the car off three months early.
That means, numerically speaking, it makes more sense to pay the car off earlier and then apply all of the money towards the emergency fund. Do you agree? Disagree? What would you recommend my friend do?
Wanna discuss beyond the comments? Head over to The Open Thread!
Related posts:
- What I Think of Dave Ramsey
- When To Use Your Emergency Fund
- So Who Wants To Work For Free?
- Kristy’s Weekly Roundup
- Why paying the minimum due is a bad idea
I don’t disagree with you. My advice though would be slightly more conservative. Make the normal payments on the car and put extra cash into the emergency fund. Once he has enough cash (less $1,000) to pay off the car then do it. This would give home extra cash in the event of another sudden layoff.
I would agree with you/Dave to pay off the car. It sounds like this new job gives him a little more wiggle room in his budget, so even if he needed the money for an emergency, he could pause and cut back on some of his expenses including the excess amount he’s paying on the car.
I dunno. Been paying on this car note for 6 years at 5.75% and still owes $5k?? Depending upon what he makes per year, I would wager that Dave would tell him to sell the car. But maybe not.
If not, then yes, he should definitely be consumer debt-free before going back to the E-fund.
@ Weakonimist – The problem I see with that solution is that he’s still paying interest on the car at 5.75% and his savings is only earning less that 3%. I see your point from the layoff standpoint, but he’s pretty sure that he’s going to be fine for now. So he’d rather get the debt paid off so he can put more away in the efund. But, if he were in an uncertain job, then yes, I’d suggest the same thing. But, this company has solid financials and no layoffs.
@ Grant – Exactly! I’m not usually one for Ramsey’s teachings, but in this case I think it makes complete sense.
@ Mr. NtJS – Why would he want to get rid of it? The car is in perfect condition because he takes care of it. If he got rid of it he’d be paying on another car note. He plans to keep this car for several more years – with no payments. That’s a great opportunity to save money, invest in retirement, and even store some aside as a down payment for a future car if that’s his wish. No, I don’t think the answer is to get rid of the car. He likes it, but he was upside down from a previous car and the 6 years was the only way to keep his payments affordable. Not the best solution, but he’s looking to pay it off a little early and it’s still in great condition. I think his best bet is to pay it off and keep it for a few years.