Q: I would like to know if I should pay off my car (BMW 745, $16,600 @5.65%). We do not have credit card debt. If we purchase anything, we pay it off in the same billing cycle. We have a first (4.87%) and second (6%) mortgage, which totals about $83,000. I would like to pay off the car, and use the car payment to pay off the second mortgage, and then work toward the first mortgage. I would like to know if I am on the right track.
A: Anytime you are racing to pay off debt, you are on the right track.
Before you pay off your BMW loan, I have two questions for you.
- Do you have an emergency fund? It’s great that you have no credit card debt, but you need a cash cushion, especially in this economy. Depending on the type of job you hold, you should aim to save at least three to six months of living expenses. If you are a highly compensated individual and you know it will take a long time to find a job, try to save at least a year’s worth of living expenses.
- Do you have a “life happens fund?” This is money you set aside to pay for the things in life that happen and that most people don’t typically plan for, such as major car repairs. Try to save at least $1,000 in this fund. You may shoot for more if you have an older car or you don’t budget well enough to save for other large one-time expenses.
You should answer yes to both these questions before paying off the car. The thing is, you need to have savings in case something happens so that you don’t end up piling debt on the credit cards that you’ve kept free of balances.
I also like your plan of using the money you pay toward the car to aggressively get rid of the second mortgage. Once you have gotten rid of the car debt and second mortgage, you should take that money and go after the first mortgage. And, just imagine the day you can yell, “I’m debt free.” What a feeling.