Pay off debts early?

[by_1008]

I'm trying to determine if it makes sense for us to pay down either of our debts early using savings.

Current debt:
$7,800 @ 3.25% (2011 Outback) - paying $405/month, 21 months remaining
$4,000 @ 5.16% (student loan) - paying $150/month ($100 over the minimum), roughly 30 months at this pace

Savings:
$8,000+ liquid savings/emergency fund
$70k+ retirement

I am currently in school while my wife works (remnants of student loan from her master's degree), so our current net income is on the low end. I am taking out loans (not yet included above) to cover a portion of my current masters degree which I will complete in 1.5 years and expect a significant pay increase (plus we will finally be at 2 full time incomes).

From an interest perspective, paying off her student loan before the car makes more sense. But the saved interest on either of these debts will be fairly minimal in the long run, and not worth worrying too much about. Are there any other advantages to being loan free on the vehicle (ie. lower insurance) that I might be missing?

Thanks for your thoughts

[Professor Ecks]

Well, you're already aware of the potential insurance savings. Not much else will change regarding car expenses unless your usage changes as well.

In regards to the interest savings though, keep in mind that paying off one or other of the debts will not only reduce the interest you pay on that debt, but on the other as well. You can now apply your monthly outflow that was going towards the now paid-off debt to the remaining debt, accelerating the repayment and reducing interest paid.

It's easy to write-off the interest savings as insubstantial, but that sounds to me like the same type of mindset that writes off a daily latte habit as insubstantial. I don't know what sort of risk you're exposed to but if it were me (I have little risk of losing my job or having a medical emergency outside of a freak car accident or something) I would be putting those dollars to work paying off your current loans, especially since you are already talking about taking out MORE loans to cover your education expenses.

[Dicey]

I would walk my car loan to the nearest credit union and re-fi it asap. You should be able to get about 2% with auto pay. I'd be surprised if there was any significant insurance savings if the car is paid off, except that you could lower coverage levels, which isn't the best idea on a late-model vehicle.

The you can accelerate payback of the student loans if you wish. You don't mention housing goals, but if ownership is one of them, I'd start building your down payment fund before killing the student debt. I think that over the next few years mortgage rates will rise. Getting in and locking down a cheap long-term mortgage could be a very smart move.

[La Bibliotecaria Feroz]

I paid off loans with much lower interest rates just because we wanted the feeling of debt-free and not being beholden to anyone. It was also part of our plan with selling off my husband's car (which had a sizeable loan, but also equity).

So I vote in favor of pre-paying, yes. Think of the interest rate as a guaranteed rate of return. You can't get a guaranteed investment with a 5.16% return! Or even 3.25%. In my case, it really paid off because my grandfather read my blog post about it (also the one where I wrote about washing my hair with baking soda because shampoo was too expensive) and was moved to send me $1000 for my then-upcoming move, as he admired the spirit of going debt-free.

[Eric]

I would walk my car loan to the nearest credit union and re-fi it asap. You should be able to get about 2% with auto pay. I'd be surprised if there was any significant insurance savings if the car is paid off, except that you could lower coverage levels, which isn't the best idea on a late-model vehicle.

I would walk my car to the nearest buyer, sell the thing outright, pay off the loan, and then purchase a more economical car with whatever cash was leftover.  Boom! You just eliminated $7800 in debt in one week.  Take the payment amount and roll it into the student loan and be debt free in 7 months.  At least until the next set of student loans kick in, but by that time you'll be a finely tuned loan killing machine.

[by_1008]

It's easy to write-off the interest savings as insubstantial, but that sounds to me like the same type of mindset that writes off a daily latte habit as insubstantial.

Fair point! After speaking with my wife, I think we plan on tackling the student loans first at the higher rate over the next 2-3 months and then rolling the payment over into the Subaru. That way we should be rid of both well before I graduate.