Karen, a young Jedi Pilgrim, sent me an email asking if it was wise to pay off a $9,000 high-cost student loan by selling her car. She mentioned that she was fine with using use public transportation for a while if that’s what it took.
I was really impressed by the thought process, commitment and out-of-the-box thinking demonstrated by this young Pilgrim. And I loved the idea of going to great lengths to slay the debt dragon. I wanted to learn more.
After trading a few emails, Karen’s situation became clearer:
A. She wrote that if she sells her wheels she’ll be able to extinguish all her debt in a year or two. If she doesn’t sell the car, it will take her a good 5 to 6 years to get these loans off her back.
B. If she does sell the car, she won’t lose much money. (I guess she got a fantastic deal on her purchase.)
C. If she sells, she’ll have enough to completely pay off the highest cost loan. She’ll save that money PLUS the $350 she was paying on the car loan and the insurance. Sweet.
D. She later explained that she’ll buy a cheaper used car buy borrowing $7,000 at 3% a few months after she sells her existing auto. Since she’s planning on using this used vehicle for a new business, she’d be able to write off a portion of this expense.
Knowing all this, you might have different advice for Karen but here’s what I said:
1. I like the idea of selling the car to pay off the loan. But the benefits of executing the plan as she’s formulated it are limited. She has high-cost loans of $9,000 now. After she sells the current car and buys the new (used) one, she’ll have $7,000 in lower cost debt. This will save her less than $1,000 a year. That’s good of course. But it’s probably not a game changer. And when Karen first emailed me, I got the idea that she would get out of debt by making this move. After I asked a few more questions, I learned that this was not so.
2. While Karen may have already tried this, she should consider refinancing her student debt in other ways – because in essence, this is what she’s doing. Again, I don’t know her family situation, but it’s possible that she could find family or friends who might be willing to refi her loans at 3% or close to it. If true, that would save her the trouble of selling her car and having to replace it with a used car. Also, this would keep her in a newer and possibly more reliable vehicle.
3. She mentioned in her email that she will be launching a new business shortly. While I love this idea too, I just want Karen to really think it through and make sure the venture is worth the risk. She didn’t ask me about this, but I think it’s worth sticking my nose in. It’s important for our friend to make sure she can afford this move. It sounds to me as though she may not have a huge cash flow right now. If that’s true, she’s got be careful about starting her business. Cash flow is the root cause of most business failures and I don’t want to see that happen to Karen.
In short, selling a car to pay off a loan can be brilliant but you’ve got to look at the real “before and after” picture. That is the most important take-away.
If Karen was in a situation whereby she could live her life and keep her job without having a car, her plan would be a no-brainer. I’d advise her to do just that and keep working until she had the money saved to buy a car without taking a loan.
That doesn’t seem to be the case, and that’s fine. Karen is refinancing her student loans and this is a good move. As long as she first looks at other alternatives to see if she can achieve the same result with less work, her plan is sound.
Do you agree with what I’ve suggested above? What would you say to Karen if she asked you?
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