The Money Mustache Community
Around the Internet => Antimustachian Wall of Shame and Comedy => Topic started by: Jake P on April 06, 2013, 09:35:37 AM
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I have a coworker who is struggling with debt and has been coming to me for advice since my Wife and I recently payed off about 15k of bad debt in less than a year. She just yesterday sold her mini van for 4k and is going to use that money to pay off her credit card, then is planning on financing a newer car. She thinks that she is going to be better off because her monthly payments will now be about the same (depending on what new vehicle she ends up buying) but now she will be driving a much nicer vehicle. Basically she paid off 4k in credit card debt and is now looking to finance about 10K on a car.... She is convinced that she is working her way out of debt...
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Assuming she's buying and not leasing, what's the interest rate on the new (to her, or in general?) car?
Even at two and a half times the principal balance, the interest rate might be such that she pays less in interest over the lifetime of the loan than she would with the credit card. If she has learned her lesson and doesn't rack up toxic debt again, and if she has a low-interest car loan, she might come out of this ahead - and with a car that should last her over a decade.
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I hope so. I couldn't find the logic in it. I know she said that for her bank to give her a decent interest rate, she would have to buy an '05 or newer vehicle.
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10,000 > 4,000
That is a mathematical fact.
She will be in more debt, not less.
Thinking in terms of monthly payments is what gets people in to debt problems. Think in absolute terms.
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Or think in terms of balance sheet / net worth rather than cash flow.
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While at first glance it looks like a stupid idea, it's not the worst of which I've ever heard.
IF she has sworn off the credit cards,
and IF she actually needed a new car that can be purchased for 10K (a 4K minivan has some years/miles on it),
and IF the interest rate on the car is less than the interest rate on the credit card bill (that last one's likely true),
then it might turn out to be a moderately decent idea.
And, really, ALL these things must fall in line to make this into a moderately decent idea.
On the other hand, which is probably more likely,
IF she decides to put only part of the money towards the credit card debt and enjoy a little splurge of some type,
or IF the 4K wasn't enough to pay off the credit card bill,
or IF she runs up the credit card bill again,
or IF she goes to the car lot and allows herself to be "upsold" to a more expensive vehicle,
or IF she gets a high interest rate on the car loan,
then she might find herself even deeper in debt.
As things go, ANY ONE of these things could be enough to topple this house of cards she's created.
The bottom line: You can never borrow your way out of debt.
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Please tell me she is at least buying private party rather than going to a dealership. Overpaying for her new car will only compound the problem...
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I've got to say, she has suprised me. She sold her van, payed off her credit card and is currently bumming rides / borrowing family vehicles while she tries to sock away a few grand to buy a reliable beater.
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No her debt didn't change
4k car - 4k credit card debt = 0 dollars
10k car -10k car loan = 0 dollars.
Now there are some transactions fees and the like that need to be factored in. If her credit card payment are car payments are the same, think about where she will be in 3-4 years. The car will be payed off and be worth like 5k (her old car would be worth like 2k). On the other hand she is likely still going to paying off that credit card debt.
The real problem is that you can only do tricks like this once. She is likely to pay off the credit card debt and 18 months later be back to having 4k of debt. For most people debt is only half the problem.
10,000 > 4,000
That is a mathematical fact.
She will be in more debt, not less.
Thinking in terms of monthly payments is what gets people in to debt problems. Think in absolute terms.
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I've got to say, she has suprised me. She sold her van, payed off her credit card and is currently bumming rides / borrowing family vehicles while she tries to sock away a few grand to buy a reliable beater.
^5