Saturday, June 16, 2007

Dave Ramsey, Car Payments, and a Gut-Punch



Car payments are the mantra of the middle class. As long as you keep a car payment, you're going to be mediocre in your finances. It's just stupid. Avoid that. Pay cash. Save up and pay for whatever you do.
— Dave Ramsey, Radio Show 2007-06-08


Wow. Talk about making me feel this big.

Look over in the right-hand column, and the Debt Paydown amount you see is due entirely to our only non-mortgage debt: it's what's left of the loan on our 2006 Honda Accord.

To date, my plan has looked like this: Since my car loan's at a rate of 3.95%, and my Emergency Fund grows at a rate of 5.05% (~4.025% after taxes), I've made minimum payments on the Honda and pumped extra cash into my E-fund. Rate-wise, this is about as break-even a deal as you can get. And having the plump (for us) E-fund has felt better than being in car debt has felt bad. (Variation on a great Ben Stein quote, by the way.)

But what's becoming less and less "break-even" is how I feel when I hear stuff like the quote posted above. It pretty much feels like a punch in my gut. Because I know that it is absolutely, one hundred percent, dead-on true.

The question becomes: What do I do about this? My E-fund is nearly complete. To drain it now, erase the car debt, and start again on the Financial Security Blanket that is my Emergency Fund seems as tremendously unappealing as, say, being on the receiving end of a wedgie doled out by Shaquille O'Neal. I'm only five-foot seven. I weigh about a buck-sixty. That would do me some serious bodily harm.

Conversely, the longer that loan hangs out there in the right-side column, the longer I'll have to see it for what it is: a symbol of either (1) my inability to save money as quickly as I should have in preceding years, or (2) my still-present penchant for spending above my means — at least where our car is concerned.

Or ... both.

I guess I'll reason my way through this, one way or the other. Just please somebody let me know if you see Shaquille heading this direction.

At five-foot-seven, there are still a lot of good places I can hide.

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— Posted by Michael @ 9:52 AM








24 Comments:
 

Tough call. Especially when you look at the numbers and see the growth rate of your emergency fund compared to the interest on the car.

Think of it this way...if you eliminate the car payment by mostly emptying your savings (looks like you will still have about $1500 left), you will be able to rebuild that savings account at a rate of at least an additional $334 per month (your current car payment plus however much extra you are putting on it now). Ya it will take a while - but how often do you take big bites out of your emergency fund.

The true numbers geeks will tell you to keep the loan. But that after-tax spread is .075%. We're talking less than $100 per year. I'd dump the car payment for the peace of mind of being out of debt. In a heartbeat.

And Dave would tell you...if you miss the debt, you can always get yourself back in. :)

 

Dave Ramsey is a clown. A car, while it is a depreciating asset, is a necessity in life today. If you wait to save up until you pay cash, you have missed out on the utility of a car until you pay for it. That's what interest is--the extra "rent" on using someone else's mony until you have enough to pay for it yourself. It allows you to enjoy a better standard of living at a small price (for a car, a loan rate of 4-6%). If you don't recognize the value you're getting, then you are an uneducated simpleton, just like the majority of Ramsey's audience.

 

Blovio apparently enjoys driving around spending more on a depreciating asset than it's actually worth since he doesn't have the patience to save up or the self-confidence to drive something that actually reflects his true financial status. I am sure the folks at the stop sign are impressed, and Blovio is welcome to keep making car payments the rest of his life while enjoying mediocrity. At least he will LOOK good doing it.

 

Lisa, I never said I had a great car. I have *a* car--probably wouldn't impress even you. But I did buy it before I had all the money saved for it. And guess what, it gets me to my job and gives me the convenience of running errands and taking family trips and all kinds of things I couldn't do if I were still saving up for it!

Perhaps you're lusting after a car you can't afford, missie?

 

Oh, I would be itching to pay that loan off immediately. I think what I would try to do is hold off, just for a little while.

Given what you've written about the way the EF is allocated, you might consider paying the loan down and increasing the emergency fund until your emergency fund is at least $5000 greater than your loan balance. Then leave the $2500 in your account and the $2500 in your wife's account, and take as much from the Emigrant Direct account as is needed to wipe out the car loan.

At that point, you still have $5000 in emergency funds, and you can rebuild the $10,000 ED account even faster by including your former car payment amount.

Of course, if it were me, once it got to the point where I'd have $2000 left over after paying off the loan, that loan would be history. But then I hate being in debt more than I hate having a wimpy emergency fund. And... Not being in debt means that you can have a smaller emergency fund, since you don't need to include the money for 3-6 months of those debt payments.

 

Leave things as they are. Your emergency fund is for emergencies, not debt payment.

Assume for a moment that you followed Dave's advise to the T. If you were going out today to plonk cash down on a new car would you invade your emergency stash to do it? Of course not. You would save up in a different fund for the purchase. You could not do this so you took on debt instead. Contrary to what Dave says (and I do respect him) depending on a person's place in his financial life this is perfectly normal as long as you aren't buying way over your head.

There are times when running the numbers and acting on them is the way to go but this isn't one of them.

Look at it this way: You have your savings and you have the car debt. An emergency happens. You live through it, you still have the car and you simply have to replunish the savings. Plan B: You drain your savings, pay off the car and the emergency happens. Now you have two choices. Sell the car or take on more debt to get you through. You are out the savings and the car or your deeper in debt without any cash reserves. This would be taking many steps backwards.

My point is, you are not at a place in your life where you can pay cash for a car but it is something you should strive for. Until then, keep the savings for emergencies and pay the car off as quickly as you can without touching the emergency fund. You will sleep better at night.

Ron

 

@ Lisa:
I think what I've decided after reading all this, and pondering it some more, is that I should just forget about the interest rates on the loan versus the rates on my savings. There's not enough difference here to be considered anything other than a wash, as you reiterated. So that part of my conundrum is out. Forget the rates.

But now we're moving to that whole "peace of mind thing," which is key.

@ Blovio:
If Dave's a clown, he's a mighty successful and influential one. I understand your points about interest and "missed utility," but the fact of the matter is that I'm paying ~4% interest on a car loan that I took out because I was unprepared for what Life sent my way. And also because I wasn't willing to try to track down a used Accord that would've been similar in age and condition (good luck) to the one I had -- one that I could've paid cash for.

I think that's absolutely what Dave would've advised me to do, had I called his show back in December of '05. Which, for someone who's truly sworn off debt, would be the right thing to do. I see nothing "clownish" about that scenario. I just couldn't go through with it.

 

I find Mr. Ramsey's advice is all too often of a one size fits all variety.
As one who is wrestling about when to replace a '95 Cherokee...and as one who has just undug myself out of a post-divorce financial hole...his mandate that one must wait until cash is built up before buying the next vehicle isn't a workable solution for me. That Cherokee will be long dead and i will be walking under Ramsey's plan.
Also, I live in a large city where the average mileage driven is ~22,000 miles per year. A typical 2 year old car has 40 grand worth of hard urban freeway/traffic jam miles under its belt already, so Ramsey's "buy less car" idea can bring in some surprise maintenance overhead fairly quickly.
I think its almost best to buy brand new and then keep the vehicle 7-8 years (maintaining it along the way of course).

Anonymous Anonymous
, at 11:00 AM, June 18, 2007  
 

I agree Dave Ramsey is a clown. Yes, some Americans spend too much. may be way too much. they use credit cards too much. They always borrow and never save. But there are situations when saving makes no sense. Such as mortgage or car loans.

 

Blovio's calling Dave a clown??? Did I read that right? Look, let him (Blovio) keep paying more money for a depreciating asset.

As for you, the non-clown that you are, I would take your e-fund down to about $5k and put the rest on the car. $5k is plenty to ward off most emergencies until you knock the car out. Then you can start adding your car payment (plus a little maybe) to that e-fund each month to get it built back up. And please, block Blovio out. I can smell the guy's oversized, funny-looking red shoes from here.

 

This would be my approach in this situation.

If my emergency fund needs to be at $15k, I will make sure I reach that goal first. From today, goal of 15k is not too far away, while making min. payment on car payment.

Once the emergency fund is fully funded, use Dave R.'s debt snowball method to add whatever you were adding to your e-fund into car payment in addition to the current min. payment.

You build an emergency fund for a reason. For an EMERGENCY. If you know when that emergency will happen, then you would not call it an emergency.

I think 3.X% of car interest payment is low enough to do what I am suggesting above. If the interest rate was like 15%, then strategy will change.

Just a thought. But think about why you have an emergency fund in a first place.

Good luck.

 

I don't personally care for debt, but I don't like Dave Ramsey's one size fits all debt. Would I take out a car loan? It depends on too many variables to consider.

I haven't had a car loan, but DH has for $5k. Without it he could not have gotten to graduate school/work, etc. So would he do it again? Yes, but he lived 23 years without a car, lived at home through college, saved to move to the US, etc. So I don't think he was a spendthrift, but buying a car after moving to the US was just tough. After all his expenses.

So would I have told him to try and manage without? No, he did pretty good working, studying, saving to come to the US.

In your case, I wouldn't empty the EF, but that's me. I'd just pay off the loan faster. It's a great rate that I wouldn't even be paying it faster, but for your peace of mind if you like do so.

Is it nice to have a car without payments? Yes. But it's nice to have a car to go to work with period and if getting a loan even for $5k to get there makes you capable of living it's a wise investment.

 

Dave Ramsey is not a clown, but he's also often wrong. And in this case I think he's overly critical of car loans. Sometimes a loan makes the most financial sense-- and when your interest rate on the loan is just 3.95%, that is one of those times. Savings accounts earn more, creating, as you said, a virtual break-even scenario.

If it is a breakeven scenario, consider the other factors:

1) You need an emergency fund, for your comfort and security. This is more important than getting rid of your low-rate debt.

2) Since the savings are essentially the same, I nearly ALWAYS will prefer the choice that keeps me in a better cash position-- that way if I change my mind in the future, I can reverse course and throw all the diverted funds back at the debt. If you do things the other way and need cash down the road, you can't take it back out of your car.

Essentially, waiting to pay off the car keeps your options open, while paying it off early closes off one of them-- having a better cash position. The cost of keeping these options in your situation is zero, so why would you choose to eliminate one?

 

Brad's last comment nailed it on the head. Status quo maintains all your options. If you were disabled tomorrow and had to survive 6 months on your savings until disability insurance payments kicked in, you could do it, right? If your EF is gone, then what would you do? Cash advances on your credit cards? Home equity loan? Keep your options open and snowball payments on the car loan as suggested. My husband would say stop looking backwards at what you should have done...(your angst about not finding a used Honda). He's always a 1/2-filled glass, look-to-the-future kind of guy...

Belated Happy Father's Day, Michael. Shaq sends his regards as well... ;)

 

Wow. What fabulous comments on this post; thanks to everyone for the input.

I have decided to push my E-fund to its completion. Once that's achieved, I'll begin throwing extra funds at the car loan.

Brad's comment caused me to seriously revisit the reasons I set my goals up this way in the first place: If the comfy cash position doesn't cost anything, and it means more options are open, then why not keep it?

I absolutely respect Dave's advice, and his stance on auto loans. But in this case, I'm sticking to my original plan.

 

Sell the car, pay off the loan, and buy a lesser car with the money left over. No more debt. You can keep your savings. And you can start saving up for the next car.

 

I apologize for calling Dave ramsey a clown. I meant to say, "That reason guy is a clown."

 

I think it's like this, if you have an EF, shouldn't you have build into it a car payment? It's like a mortgage payment, you have to pay it unless you are dead.

Yes you can own a house, but in some areas property taxes and insurance cost as much as people in pay in mortgages. I pay like $700/month in property taxes + Ins which is more than a lot of people! Um, even without a mortgage I need to have a cash cushion cause my house is not paid for when I have those ongoing expenses.

Cash is king. Sure debt free is nice, but having assets to pay to maintain your assets is nicer still.

 

I agree with Lisa and Chris Thomas.

Pay down the Car debt and leave at least 5 or 6K in your savings. You will be debt free. So when you ever become laid off you do not have to stress about paying rent/mort and a car. You only have to focus the household bills. You are still young. So you can refuel that e-fund right back to where it was very soon after the car is paid.

 

Hello all. My situation is that to reduce my payment length (6 yrs.) I want to pay an extra $200 monthly in addition to my regular monthly car payment, but my lender won't permit me to pay more then 5% extra per month. Any assistance would be greatly appreciated. Thanks.
Joy

 

Joy,

Can you refinance your auto loan away from that lender? Any chance at all?

 

I find the comments that it's just impossible to pay cash for your first car to be hilarious. It's not impossible.

I drove a total junker and took lots of public transport for the first several years of my post-education life. Saved $8K and bought a used Cavalier. I've been putting a pretend car payment into a savings account ever since, and so when my current car finally dies, I'll have lots of money saved to pay cash for my next car. Once you get in the cycle of paying cash and saving your 'car payment' into a savings account you can continue to pay cash. You just have to be willing to lower your taste in cars.

Anonymous Anonymous
, at 1:47 PM, October 09, 2007  
 

We are doing the Dave Ramsey baby steps (my husband and I). We are very unpopular. People think we are crazy, I guess. Here is our situation. We have 2 Hondas, 12 years old. We have no debt except an $80,000 mortgage. We do not use credit cards. We have a $12,000 emergency fund piled up and just sittin' there. We are saving for a car right now. We are saving $1,000 a month for a future car purchase. It's entirely possible. Keep pressing forward. You can definitely do it. Only pay cash for car repairs. Save up, swim upstream, be weird. It is so worth it in the end, my friend.

Anonymous Anonymous
, at 8:21 AM, April 05, 2008  
 

Dave Ramsey is awesome! After reading his books and listening to him, I have my house completely paid off, my rental home completely paid off (great to have that extra money coming in) and two cars that I paid for cash in. I have over $20,000 in my emergency fund, a "car fund" savings account where I pay MYSELF a car payment (yes, people actually DO that) and about $48,000 in stocks so far. EVERYTHING is paid off so I'm doing is saving a lot now and just paying utilities. Feels great...and I'm not even 35.

:)

Anonymous Anonymous
, at 3:38 PM, May 18, 2008  
** Comments Closed on this Post **

Thoughts on my personal finances, goals, experiences, motivations, and accomplishments (or lack thereof).

My financial life began turning around when I took responsibility for it.
— Dave Ramsey


100%

Start (2005-12): ~$21,900
Currently: $0
[About Our Debt Paydown]

100%

Savings Goal: $15,000
Currently: ~$15,115
[About Our Liquid Savings Goal]