What to attack first when getting out of debt? (Ramsey baby step 2)

April 6, 2014 11:25 AM

I get it: never lease a car. Well, we have two. Following Dave Ramsey's money makeover, we've got more than our 1,000 emergency fund, so how do we start attacking our debts? He says start with the smallest and just start knocking them out. So...how does a car lease factor in there?

We're willing to change up our transportation, but "just get rid of the cars" won't work in our car-dependent city. Should we save up for a couple of dependable used cars? But that's not attacking our debt, really. These are our first experiences with auto leases, so I guess we don't really understand the ending of the lease.

Swapalease? Leasetrader?

posted by Admiral Sock to Work & Money (24 answers total)

I'm going to focus on the lease question specifically, not whether or not worrying about the lease in light of other debts should be your priority.

Getting out of a lease can be costly. If you wanted to "turn in the keys" you would essentially need to write a big fat check to the financier. To find out how much, call them up and ask what the payoff is.

Your next option is to trade in the leased car for a financed one and to roll the negative equity into the new car payments. Having some familiarity with, but never having read Ramsey, I can tell you that he'd probably say that this is a big no-no (rolling negative equity).

Your final option is Swapalease or Leasetrader. Keep in mind that some lease companies will NOT allow you to transfer the lease into someone else's name. In that case you can still do a lease swap, but you will be on the hook for payments if the new party defaults.

Every situation is different, but if I were in your shoes and not desperate for cash, I would ride out at lease one of the existing leases and then try saving for a decent used vehicle that you can (ideally) pay cash for, or finance for a very short term.

One thing to keep in mind with leases that a lot of people forget is that you can 'turn them in' at the end or you can trade them in. Big difference between the two. Many people just turn it in at the end of the lease and pick up a new one. However, if you've got a popular model you can often trade it in and wind up with a little bit of equity toward a new car purchase/lease/etc.
posted by tgrundke at 11:35 AM on April 6, 2014 [2 favorites]

One other thing about leasing: everyone has an opinion on it. Like with any financial product, it can serve its purpose or it can strangle you.

Your best financial bet is almost always to buy a quality used car, pay cash if possible (unless you've got a ridiculous finance offer that equals free money), and ride it into the ground.

Lots of people don't do that (myself included) because we like cars, or our needs change frequently, or we drive an incredible number of miles, or we own a business and can take the lease as a business write-off. Leases shouldn't be vilified, but if in your case your goal is to pay down debt and to stay out of it, it's probably not the best financial decision for you.
posted by tgrundke at 11:38 AM on April 6, 2014 [2 favorites]

Leasing is not the end of the world. It's simply the least expensive way, on a monthly-payment basis, to own a new car that's nicer than you could afford if you bought it. I would count the lease as a monthly expense you just have to deal with for the next however many months and concentrate your money towards (a) paying down debts and (b) saving up for a replacement car when the lease is up (which will likely be older and not as nice as what you are leasing).
posted by deanc at 11:45 AM on April 6, 2014 [18 favorites]

What deanc says. Put up with the lease payments until the leases are up and then buy used for cash if possible.
posted by DarlingBri at 12:05 PM on April 6, 2014 [4 favorites]

There can be quicker satisfaction in seeing the smaller debts get crossed off the list which I assume is why Ramsey suggests this. But I think it makes more financial sense to focus on the debts which are costing you the most in interest/penalties. Once they are out of the way there is more of your income to apply to the other obligations and to savings.
posted by cat_link at 12:15 PM on April 6, 2014 [4 favorites]

You mention attacking your debts by starting with the smallest. That's not necessarily the best idea. It's suggested because psychologically, it's good to clear something off the books. But if your smallest debt does not carry the highest interest rate you're incurring, then it's a bad idea.

You'll clear the decks fastest and at the lowest cost if you rank your debts in order of interest rate. Make the minimum payments on all of them except the one with the highest interest rate. Put all your monthly available money on the one with the highest interest rate. When that's paid off, start paying down the next one, etc.

About the cars: The right way to think about them is the cost per mile of all auto-related expenses. So, lease payments, gasoline, repairs, insurance, registration. Add together all of them for the past 12 months, divide by miles driven. You're going to get a number like 45 cents per mile, plus or minus depending on the model. That's what it's costing you to drive. Not the monthly lease payment. Not the fillup at the pump. Going forward, track that number (annually is often enough) and you'll be able to make better decisions about replacement and whether you should buy new, buy used, or lease. (If you own a car, finance payments don't count in this calculation — what counts is the annual depreciation in value, regardless of whether you pay cash or finance the cost. When you are leasing, your payments are basically equivalent to depreciation plus a profit for the lessor.)
posted by beagle at 12:15 PM on April 6, 2014 [4 favorites]

The nice thing about a car lease is that you know exactly how much you're going to have to pay - every month, and for the whole of the lease.

Treat it like any other loan. Calculate how much you will pay in total for the car over the length of the lease (ex: $200 month x 30 months = $6000), and sock money away until you have that much in a single savings account. Once that's done, use that bank account to pay your lease every month, and use whatever money you would have paid for your car lease to attack your next largest piece of debt.
posted by NotMyselfRightNow at 12:24 PM on April 6, 2014 [2 favorites]

You mention attacking your debts by starting with the smallest. That's not necessarily the best idea. It's suggested because psychologically, it's good to clear something off the books. But if your smallest debt does not carry the highest interest rate you're incurring, then it's a bad idea

Mathematically, that is correct. But even more than just the psychological benefit, there is an advantage in clearing up the small debts first: doing so reduces your total minimum monthly expenditure, almost always by more than paying the same amount towards a single larger debt. Lowering that total minimum expenditure gives people a little more breathing room to absorb small expenses without needing to add more debt.

Whether or not that and the psychological reasons are enough to pursue this path versus the mathematically better option is for you to decide. It's worth running the numbers (there are plenty of snowball payment calculators out there) to play around with different scenarios and see which makes sense in your situation.

Regarding the leases, I'd think of them as bills rather than debts for the purposes of this exercise. Unless there is a good, financially viable way out of the leases, you may just have to ride it out and then pick a car option that is in keeping with your new financial approach.
posted by Dip Flash at 12:42 PM on April 6, 2014 [2 favorites]

I don't know enough about leases to say whether it makes financial sense to get out of them, given the penalties you would incur. But I do have a lot of experience with sharing cars, and suggest that once you have the economics worked out, downsize to just one shared vehicle. (I'm assuming, given that you're following Ramsey, that you are eager to get out of debt.) It can be a pain but is a huge cost savings. Keep in mind that there's always the option of cabs or car rentals if there are occasions when you REALLY need two cars, and that occasional expense is usually much less than that of owning a second car.
posted by metasarah at 12:42 PM on April 6, 2014 [1 favorite]

Ignore beagle's debt advice. It's well-meaning but misguided. Yes, you'll save a bit by attacking high-interest debt first, but Ramsey's right about the importance of getting psychological wins. Start with the small debts first. (But prioritize any debt that feels especially onerous, such as loans from family.) It'll also increase your cash flow most quickly.

As for the car leases? Well, I don't have any experience with those. You may want to just ignore them for now. But in the future, follow Ramsey's advice about gradually upgrading your used cars.
posted by jdroth at 12:44 PM on April 6, 2014 [3 favorites]

>I guess we don't really understand the ending of the lease.

Get so that your really understand the natural and accelerated ending of the lease. Then you can make an informed decision about the costs associated.

Edmunds.com has a bunch of well-written articles on the topic at
http://www.edmunds.com/car-leasing/

I'm going to guess (because I don't know your numbers) that the cheapest thing to do is to continue leasing the vehicles until one of them runs out, and to use the other vehicle as sole transportation for the two of you until its lease expires. Then you'll buy a decent used car and continue to use it as sole transportation until you can afford to buy, outright, another decent used car. That's the guess of an imaginary internet person.
posted by the Real Dan at 12:53 PM on April 6, 2014

Does your city have car-sharing? Do you need both cars every day? If the answers are "yes" and "no," then maybe your second car should be a subscription to a car sharing service.
posted by musofire at 12:56 PM on April 6, 2014

In your situation, I would view the leases as sunk costs. Continue on the lease and when each one expires buy a solid used car that is within your means.

You're making positive steps. Keep your focus on that. You can give yourself analysis paralysis trying to optimize every penny and balancing that against the psychological win. If the Ramsey plan resonates with you, then go ahead and follow it exactly as it's written. You can have the mental relaxation of knowing that the plan will work if you follow it.
posted by 26.2 at 12:57 PM on April 6, 2014 [1 favorite]

Response by poster: >What are your monthly lease payments, and what are the duration of the leases, and how far into the leases are you?

2012 Civic - ~200/month - 12k miles/year, began Jan 2013 (15 months in), 14,000 miles ; just got an advertisement about wanting to "buy" the car

2013 CRV - ~360/month - 12k miles /year, began Jan 2013 (15 months in), 16,000 miles

[moved from a carless lifestyle in a very urban environment to freeway culture, so both started at the same time]

>Does your city have car-sharing?

No. We had Zipcar subscription and no owned cars in urban city and it was awesome. Would LOVE to do that, but it's not available.
posted by Admiral Sock at 12:59 PM on April 6, 2014

So, the idea of attacking the smaller debts first is not only psychological, but it's also to knock out an unnecessary monthly payment to free up cash in your monthly budget and give you some more savings, wiggle room, or power to pay off the bigger debts. That's why they call it a snowball, as the further you go, the more cash on hand you'll have each month. Got a $1000 debt on a low-interest credit card? It may not be at the highest interest rate, but that's still $25-$50/month extra free and clear once that debt is gone. Pay off a couple of those, and you can really start attacking the big debts (car, school, home) since you're not putting so much money towards minimum payments each month.

You don't say how long those leases are (are they... 36 month? 48? 60?) and what the over-mileage penalties are, but chances are that it'll be a lot of work to turn that monthly payment into something genuinely smaller (ie, without penalty payments, or a lot of hassle for something very similar). You don't mention credit card debt, but in the vast majority of cases, the strategy would be to pay the credit card debt off first to completely kill those monthly payments, save some money while the leases run out, and then get a couple of mediocre-but-reliable decade old cars that you can drive into the ground for 5 years for a much smaller monthly payment, or none at all, while getting the rest of your finances taken care of.

That said, frugality is not necessarily about buying a used car. It's about buying a car that holds value once you drive it off the lot, is within your budget, and that you wouldn't mind driving for years and years. Put enough money down on the car so that you always owe less than the car's value (so you can easily get out of it if your finances change), pay the costs down as quick as possible, and then, if all goes well, you can then spend years and years without monthly payments.
posted by eschatfische at 1:00 PM on April 6, 2014 [2 favorites]

A lease is not debt. A lease is analogous to debt. Debt is borrowing money now in exchange for paying more later, whereas a lease is borrowing the use of something in exchange for money, and crucially, in which interest isn't a factor. It's not really rational to be against any and all borrowing as a matter of principle. In the response I'm making here, I'm assuming you need two cars, which may or may not be true, but I don't know if it really is or not.

Unless you're spending too much money on the leases, like if they're costing you so much that you can't pay your current bills, I don't see any reason to try to get out of them. You should get out of debt, and you should feel good about moving in that direction, but unless there's some specific monetary need to get out of these leases, it's almost certainly not worth the early termination fees that are no doubt in the contract you signed.

Buying a decent used car requires several thousand dollars up-front, and once it's yours, you have to maintain the damn thing. What if your car needs a new transmission six months after you buy it? Sure, it may not be likely if you buy a good make with reasonable wear, but it's possible, and perhaps worse, unpredictable. Leasing is great because all that uncertainty is transformed into a simple monthly payment. If you don't have a lot of liquid capital, managing financial uncertainty is super valuable.

Ultimately, the answer here is going to depend entirely on your specific situation, in terms of how much you need the cars, how much you're both earning, what you spend on other things, what your lifestyle is like, how quickly you want to pay down your other debts, etc. If you take the money you're paying monthly for the leases, you can calculate how much money you'd save in interest payments by using that to pay down your other debts instead of leasing, but we couldn't tell you whether that would or wouldn't be worth your while in a larger sense unless we had more details.

So my advice would be to not treat the leases as debt, since they're really not anyway, and focus on devoting financial resources to paying off real debt.
posted by clockzero at 1:42 PM on April 6, 2014 [3 favorites]

we've got more than our 1,000 emergency fund

How much more? $1000 is just one missed paycheck from being thrown out on the street. I would be inclined to try to build that up a bit before tackling debt too aggressively.
posted by JackFlash at 2:30 PM on April 6, 2014 [5 favorites]

Agree with JackFlash on the emergency fund. One mistake I see a lot of people make is to pay down debt at the expense of savings for both investment and emergencies. If we're talking 17% credit card debt - then yes, paying it down makes sense. But if we're talking 2.9% student loans or the like, then I think it's more important to save some pennies first.
posted by tgrundke at 2:48 PM on April 6, 2014 [2 favorites]

For the purposes of debt repayment, ignore the leases. That money is gone. Think of it more like rent. You may want to start a savings account so that you can sock away a bit of money to purchase a car when your lease is up.

So with the cars off the list, what does the rest of your debt situation look like? I would suggest paying off any store cards you have, over due utilities, family members first. Then tackle larger loans like credit cards and student loans. The "debt snowball" (I think that's Ramsey) works by paying the minimum payment to everything then adding as much as you can towards the smallest debt until its paid off. Then take all that money and add it to the minimum for the next smallest etc... The idea being that by the time you get to the big ones (visa/MC/student loans) you have hundreds more to pay each month over the minimum.

The leases don't factor into this as paying them off early doesn't free up more cash, you are still going to need a car and there are huge penalties for getting out of a lease. The interest rate on them is also irrelevant as, again, paying more doesn't save you interest. It was a fixed amount at the time of purchase. You are going to pay the same either faster (with penalties) or slower. So keep them current but attack your other debt. If you get to the end of your debt before the end of your lease SAVE, SAVE, SAVE as you will need to turn in your cars or buy them out.

Many people don't want to buy out their leases but if you are significantly over miles as it seems you might be on the CRV, buying out usually means that the mileage overage fees are waived.
posted by saradarlin at 3:17 PM on April 6, 2014 [4 favorites]

It is possible to sell your car and have the buyer take over the lease. Depending on the state you can transfer the lease or the buyer can pay the lease off themselves and take possession of the car. It's not like you're stuck in the lease with no recourse. The easiest way to do this might be to sell one car, replace it with a cheap used one you bought outright, then sell the second car and replace THAT one too.
posted by Anonymous at 4:18 PM on April 6, 2014

A lease is not debt. It's a liability, to be sure, but there are many kinds of liability, and debt is only one of them. Ramsey's basic scheme is great for the average consumer, but it's not terribly sophisticated in terms of its analysis of various species of accounting items. For instances, accountants categorize debt, accounts payable, shareholder equity, and retained earnings as liabilities, but they are very different things.

So I'm not sure whether you should consider your car leases as part of the debt that Ramsey wants you to eliminate, and I'm not sure that Ramsey has himself developed his program to the point that he can parse things on that level of detail. It's definitely something you want to get rid of if you can, but I'd work on that after I got rid of things like credit card debt.

Oh, and $1000 isn't an emergency fund. It's padding your liquidity, i.e., meaning you aren't living entirely hand to mouth, but nothing more. A true emergency fund will have at least a month's spend in it. Six if you can swing it, but certainly no less than one.
posted by valkyryn at 5:59 PM on April 6, 2014

ANY car is going to cost you a MINIMUM of $200/ month, whether you save it up ahead of time so you can pay cash or pay it in a lease or finance it or you buy a beater and make repairs. They all cost about $2-3K per year to run, that's just the cost of owning a car. When the lease ends maybe buy the cars, maybe don't but right now you live in freeway land and have two brand new cars for under $600 a month and no unexpected maintenance costs: that's a deal.

Cars are like housing, sometimes it makes sense to rent, sometimes it doesn't.
posted by fshgrl at 9:05 PM on April 6, 2014 [2 favorites]

Were I you, I'd ride out the leases while taking very good care of the cars, as you are unlikely to save any decent amount of money by getting out of the leases early (and are actually likely to lose some.)

Just before each lease end, compare:

- Cost of buying the car post-lease
- Cost of selling the car privately, paying off the lease, and using the remainder towards a replacement car (only valid if you can sell it for more than the cost of buying the car post-lease)
- Cost of turning the car in and buying a replacement (only valid if you cannot sell it for more than the post-lease but, or if you don't want the hassle)

If you had a good lease for cheap monthly payments, congrats! You probably can't sell and use the remainder (option two) but you didn't overpay for your lease. Turn it in and buy a replacement (presumably cheaper than your post-lease buyout.)

If you paid too much for your lease, your post-lease buy should be cheaper than getting a replacement car. Congratulations! Do option one or three.
posted by davejay at 9:49 PM on April 6, 2014 [1 favorite]

Yes, you'll save a bit by attacking high-interest debt first, but Ramsey's right about the importance of getting psychological wins.

You can get a psychological win out of engineering your way out of debt at the lowest overall cost, as well, and looking at your spreadsheet to see the total debt going down. If you retire smaller but lower interest debts first, those psychological wins are costing you cash that could be paying off higher-interest debt. And unless you are extremely strapped for cash every month and have to make really hard choices, eliminating the minimum payments associated with smaller debts is a red herring. The overall difference in minimum payments is going to be minimal, and overall, you want to be paying more than the minimums or you'll never get out from under.
posted by beagle at 7:18 AM on April 7, 2014 [1 favorite]