Should I pay off my car loan or save that money for down payment for home?

June 23, 2009 7:54 AM

Should I pay off my car loan before getting a mortgage, or use that money for down payment?

I'm currently shopping for a home and saving for a down payment. I have ~ 16K left on my car loan. I can either pay it off quicker, saving money on the interest... or save that money for the downpayment.

What should I do? The interest rate on the car loan is higher than the mortgage I would get.. so theoretically, I would save money by paying it off earlier - BUT the money that would go toward paying off the car loan is the money that will not go towards my downpayment.

Any help would be appreciated.
Thanks!!!

posted by zavulon to home & garden (10 answers total)

I would use it for a down payment. Considering that zero down mortgages don't really exist anymore, and doing a 80/20 loan (2 loans, one for 80% of the mortgage and one for a 20% down payment).

Cars don't appreciate like houses so I think it would be a waste of money to to pa off the car, especially if you think you might possibly trade it in for something else at any point in the next say 5-7 years.

If you go with an FHA loan, you will need at least 3.5% down. most other loans require a minimum of 5% if not more.
posted by deebs at 8:03 AM on June 23, 2009

It's going to come down to debt to income ratio for the mortgage company looking at your application. If the auto loan is your only debt otherwise, I'd save up for a down payment.
posted by jerseygirl at 8:08 AM on June 23, 2009

Would the 16k added to your down payment save you from having to pay PMI? If the 16k won't save you from paying the PMI then it might not make much of a difference if you put down the extra 16k.
Find out how much you'd be pre-approved for for a mortgage - if it's a smaller #, then maybe you'll need to put down the 16k in order to have a smaller mortgage.
Don't forget the thousands of dollars in closing costs, so you might need the 16k for that if you're not gonna put it towards your down payment.
posted by KateHasQuestions at 8:09 AM on June 23, 2009

Go with the house. With the house you should theoretically (I say that because the housing market blows) get the money back if you sell the home later on. With the car you will never see the money again. So the house makes more financial sense.

Only argument I could see for paying off the car would be if you could not afford both payments.
posted by Mastercheddaar at 8:09 AM on June 23, 2009

Yep, the house. Or hold on to that cash so that when you move into your new house and the sewer line backs up, you'll have some cash on reserve and won't have to put it on credit or take out a loan.
posted by amanda at 8:16 AM on June 23, 2009 [1 favorite]

It's not just the interest rate -- you have to take into account the term of the loan too. Your mortgage is (probably) going to be 30 years. Your car loan is (probably) at most 5 years. Do some math (I used this mortgage calculator):

If you paid off your car, you'll have $16,000 more in your home loan. Financed over 30 years at 6.25%, you'll pay $19,468.52 in interest on that $16k.

If you kept the money to use for your house, and let the car loan go to a full five year term, you'll pay:

$5,597.96 at 12.5% interest
$12,177.37 at 25% interest

So, unless you're looking at a super-short mortgage or an unusually long car loan, put the money on your house.
posted by rusty at 8:31 AM on June 23, 2009

I recently bought a house, and when I was shopping for places that were more expensive than what I wound up buying, the mortgage company was really pushing me to pay off the car (I have around $5K left) to get my monthly debt-to-income ratio low enough to get approved. Since I chose a cheaper home, it's not as big a deal, so I can keep paying off the car. I'd ask your mortgage broker what he recommends, but it seems like your best bet is to use the money for the down payment.
posted by sjuhawk31 at 8:32 AM on June 23, 2009

Thanks a lot everybody! You've been very helpful
posted by zavulon at 8:37 AM on June 23, 2009

Both choices are good.

If you can delay buying a house for a few years, you would end up with more money in the long run by paying down your auto loan.

At the same time, the personal reasons to buy a house could easily trump the bottom line.

Be honest with yourself: how important is it to you to have a house soon?
posted by dualityofmind at 8:43 AM on June 23, 2009

Cars don't appreciate like houses so I think it would be a waste of money to to pa off the car, especially if you think you might possibly trade it in for something else at any point in the next say 5-7 years.
...
Go with the house. With the house you should theoretically (I say that because the housing market blows) get the money back if you sell the home later on. With the car you will never see the money again. So the house makes more financial sense.

These are good arguments against getting a car loan in the first place, but once you have taken out the loan the fact that the car is depreciating shouldn't affect your decision of whether or not to pay off the loan. Once you have the loan, you have to pay interest on it, and the slower you pay it off the more total interest you will pay. It doesn't really matter whether the loan you are paying off (including by having a bigger down payment) is for a car or a house, in the sense that the point of paying it off early is to save on interest unrelated to the future worth of the car or house.

If you paid off your car, you'll have $16,000 more in your home loan. Financed over 30 years at 6.25%, you'll pay $19,468.52 in interest on that $16k.

If you kept the money to use for your house, and let the car loan go to a full five year term, you'll pay:

$5,597.96 at 12.5% interest
$12,177.37 at 25% interest

One major thing that this analysis misses is that in the paid off car case, the increase in the monthly mortgage payment is going to be significantly less than the monthly car payment. So theoretically you could take the extra money that you would have been using to pay the car loan and apply that to the principal of the mortgage. If that came out to be, say $12k in extra payments over the five year loan, that would closer to the amount you would have saved by having a larger down payment. On the other hand, once the car is paid off in the down payment scenario, you would have even more extra monthly income to put towards the principal. Which one will end up saving more money in the long run depends on a lot of factors so it's not that easy to get a hard number on it. Really the total amount of interest paid will depend a lot more on what percentage of your income you spend on paying down the debt over time rather than which debt you decide to pay off first.

Here are the main risks associated with each option as far as I can tell:

Paying off the car loan:
- You may have a hard time getting approved for a mortgage for the house you want in the time frame you chose if you don't have a large enough down payment.
- If you do get approved for a mortgage with a low down payment, you may have to face more costs in the form of higher interest rates and PMI.
- If for whatever reason you have to sell your house right away and can't get what you paid for it, your lack of equity from the small down payment might mean that you still owe money after you sell the house (this has happened to a lot of people in the current housing crisis).

Using it for a down payment:
- Your car loan debt may negatively affect your credit rating and other factors that the mortgage lender looks at, which could mean that you won't get approved or will not get approved for the best mortgage interest rates.
- Since you still have the car loan, you'll need to cover your mortgage payments and car loan payments at the same time along with your other expenses every month. Depending on your savings, monthly income, and any unexpected problems you might run into before you pay off your car, the extra money each month on your car loan might be a financial burden.
- You might end up using the down payment extra money to get a bigger/more expensive house rather than using it for a bigger down payment for the same house. In that case you would be using the money to take on more debt rather than paying off debt, so you'll pay more interest over time.
posted by burnmp3s at 9:20 AM on June 23, 2009