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Invest or pay out loan

Discussion in 'Investing Strategies' started by Busteed, 16th Apr, 2008.

  1. Busteed

    Busteed Member

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    guys,

    i have about 20K saved in an online account, initially planning on using it for a IP deposit. i also have about 13K owing on my car, charging interest of about 12%.

    question: am i better off taking the 13K from my savings and pay off the car loan or do i just let it stay in the savings account until it gets big enough for an IP deposit. or is it probably better if i use the whole savings to invest in the share market.

    what better options do i have?

    busteed.
     
  2. nitro-nige

    nitro-nige Well-Known Member

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    Personally I don't like car loan/store card debt.
    So I'd pay out the loan. If you're not making those car payments the $7K you have left will grow pretty quickly allowing you to save for something more financially productive.
     
  3. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    2 questions ...

    1) what are your monthly repayments on the car loan?
    2) what interest rate are you earning on your savings?
     
  4. Busteed

    Busteed Member

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    Hi Sim

    1 - 380/month
    2 - interest on savings is about 7.5%

    i'm reluctant to touch the savings as i'm keeping this as a "savings history" when i buy the IP probably next year.
     
  5. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Current:

    Assets $20,000 savings; Liabilities = -$13,000 car loan; Net = $7,000
    Cashflow = -$4,560pa from car, +$1,500 interest pre-tax, Net = -$3060pa (even less after tax)

    After 1 year:

    Assets: $21,500 savings; Liabilities = -$10,000 car loan (approx); Net = $11,500
    Cashflow = -4,560pa from car, +$1,500 interest pre-tax, Net = -$3060pa pre tax

    ---------

    Alternative plan: pay off car loan.

    Current:

    Assets: $7K, Liabilities: $0, Net = $7K
    Cashflow: +$4560 previously spent on car, +$525 interest pre tax, Net = +$5085pa pre tax

    After 1 year, saving the additional $380pm previously from car payments:

    Assets: $12,260, Liabilities: $0, Net = $12,260
    Cashflow: -$4560 savings, +$920 interest pre tax, Net = -$3640 pre tax

    ... so you can clearly see that provided you are disciplined enough to save the $380pm previously spent on car repayments, after 12 months of saving your net worth is higher than it was if you hadn't paid off the car, and while your cashflow seems worse off at first glance - that figure actually includes the $380pm which you can put towards loan repayments when the time comes, so your cashflow is in reality greatly improved too.

    Don't forget that loan servicability isn't just about savings history (although that is important), it is mostly about spare cashflow - and paying off your car will help your cashflow enormously.

    Personal loans and credit cards are the two biggest items which will stop banks loaning you money. Getting rid of that car loan will help your servicability in the eyes of the bank.

    By my calculations, you would be far better off without that car loan!
     
  6. samaka

    samaka Well-Known Member

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    Get rid of the car loan ASAP. You're paying interest on an item going down in value!

    The only time that is acceptable is if it's tax deductible and you've got actually got income to offset - which isn't the case here.
     
  7. crc_error

    crc_error The Rule of 72

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    general rule of thumb pay off bad debt first!

    it will also be harder to get a house loan with a car loan, it will lower your borrowing power quite a bit..
     
  8. AsxBroker

    AsxBroker Well-Known Member

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    Hi Busteed,

    Quick example for you on a marginal tax rate (mtr) of 30% plus 1.5% medicare levy (you may not be on this but you'll figure out how to do the calcs). Say for 10% as an example.

    Rate before tax = interest rate / (1 - mtr)
    Rate before tax = 10% / (1 - 0.315)
    Rate before tax = 10% / 0.685
    Rate before tax = 14.60% (2 dp)

    This means that paying off a debt costing 10% pa with a MTR of 30% is the same as a RISK FREE RETURN of 14.6% pa before tax. With banks paying 7% to 8% anyone holding non-deductible debt and bank accounts would be going backwards by about 6% to 7% per year.

    I don't want anyone to go backwards and I'm sure many other forum readers don't either.

    Do your sums and make your choice.

    Cheers,

    Dan

    PS Before making an investment decision speak to your FPA registered Financial Planner.
     
    Last edited by a moderator: 18th Apr, 2008
  9. Busteed

    Busteed Member

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    I hear ya all. however i was talking to a mortgage broker sometime this year and he was of the opinion that its better to keep the deposit for now then when i apply for an investment loan i can use the big savings as a leverage to get a bank approval; then when my loan gets approved - that's the only time that i pay off the car loan to free some cash for serviceability.

    if i pay off the loan now then i probably will missed out buying my first IP by end of this year when the market begins to settle down, as by then i will have only save 11K (20K initial savings less 13K loan + car loan savings til end of year of about 4K).
     
  10. AsxBroker

    AsxBroker Well-Known Member

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    Hi Busteed,

    The mortgage broker probably has a vested interest in lending you more money. Hence, why he is saying borrow more money.

    Cheers,

    Dan
     
  11. samaka

    samaka Well-Known Member

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    Maybe look at it this way:

    The car loan is costing you money right now. You have to pay for it every week and that money is going against something which is going down in value.

    You're thinking about continuing to do this on the possibility that you might want to buy something else later. Get rid of that bad debt - and never ever get it again!
     
  12. Busteed

    Busteed Member

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    agree that the car loan is a bad debt but i'm with my broker that if i actually get into real estate by end of year - then the cost (interest expense) i'm paying for the car loan will be minimal compared to the expected gain from real estate exposure (capital gains).

    what then do you propose so i could get into IP? or should i just save pay out the loan, wait for another 2-3 years so i could save up a bigger deposit for an IP?
     
  13. Jacque

    Jacque Team InvestEd

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    I think you've answered your own question :)
    Especially if it's your first property, at least try to have some equity in it by way of savings, even if it's as little as 5%
    Pay off that car loan and start saving!
     
  14. Busteed

    Busteed Member

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    so should i just keep the savings intact for a deposit on an IP later this year? or do i pay off the car loan? sorry i got confused.
     
  15. Saskatoon

    Saskatoon Well-Known Member

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    Hi, see Sim's post above comparing options. Paying off the loan makes sense, but you MUST save the car payments! I agree with Sim' (again).