Paying of a higher interest loan first is not always beneficial

[TheGuy]

My boss introduced me to this idea recently and I'm not sure if its correct but here is how I understand it.


Currently I have a car loan with the following outstanding:

Current Contract Balance: R 54,944.54
Current Capital Balance: R 40,126.54
Current Interest Rate: 9 %

Now if I have R 40,000 cash I can pay off the car and save roughly R 15,000 in interest charges.

Alternatively I have a bond with a lower interest rate of 8,15%

If I take that R 40,000 and pay it into my bond then using a bond calculator I save nearly R 300,000 in interest payments over the bond term.

So by taking that into account does it not make sense to only pay the minimum amount into my car and rather pay the extra money into the house?

 

[DerpiesFreud]

My boss introduced me to this idea recently and I'm not sure if its correct but here is how I understand it.


Currently I have a car loan with the following outstanding:

Current Contract Balance: R 54,944.54
Current Capital Balance: R 40,126.54
Current Interest Rate: 9 %

Now if I have R 40,000 cash I can pay off the car and save roughly R 15,000 in interest charges.

Alternatively I have a bond with a lower interest rate of 8,15%

If I take that R 40,000 and pay it into my bond then using a bond calculator I save nearly R 300,000 in interest payments over the bond term.

So by taking that into account does it not make sense to only pay the minimum amount into my car and rather pay the extra money into the house?

yes.
Seems like a simple case of % and magnitude,you need to evaluate both and not just % only
1% of 1 million > 10% of 5,000.

 

[Chevron]

My boss introduced me to this idea recently and I'm not sure if its correct but here is how I understand it.


Currently I have a car loan with the following outstanding:

Current Contract Balance: R 54,944.54
Current Capital Balance: R 40,126.54
Current Interest Rate: 9 %

Now if I have R 40,000 cash I can pay off the car and save roughly R 15,000 in interest charges.

Alternatively I have a bond with a lower interest rate of 8,15%

If I take that R 40,000 and pay it into my bond then using a bond calculator I save nearly R 300,000 in interest payments over the bond term.

So by taking that into account does it not make sense to only pay the minimum amount into my car and rather pay the extra money into the house?

You're forgetting that once the car is paid off you'll have extra cash every month to put to your house.

You save much more taking that into account.

 

[DJ...]

You're forgetting to factor in the time value of money, inflation and opportunity cost loss...

 

[Jehosefat]

My boss introduced me to this idea recently and I'm not sure if its correct but here is how I understand it.


Currently I have a car loan with the following outstanding:

Current Contract Balance: R 54,944.54
Current Capital Balance: R 40,126.54
Current Interest Rate: 9 %

Now if I have R 40,000 cash I can pay off the car and save roughly R 15,000 in interest charges.

Alternatively I have a bond with a lower interest rate of 8,15%

If I take that R 40,000 and pay it into my bond then using a bond calculator I save nearly R 300,000 in interest payments over the bond term.

So by taking that into account does it not make sense to only pay the minimum amount into my car and rather pay the extra money into the house?

IF you pay off the car now and then pay what your monthly car repayments were into your bond I have a suspicion that you would save more than the R300k you save by dumping the R40k into the bond right away. You didn't give enough details for me to actually work out what you would save but give it a look.

 

[ngwe23]

You're forgetting to factor in the time value of money, inflation and opportunity cost loss...

Agree. While R300 000 sounds like a lot of cash now, in a few years time it will be worth less. Also if you pay off the car you will have extra cash which you can use to pay off the house

 

[F1 Fan]

IF you pay off the car now and then pay what your monthly car repayments were into your bond I have a suspicion that you would save more than the R300k you save by dumping the R40k into the bond right away. You didn't give enough details for me to actually work out what you would save but give it a look.

^This. What is your current monthly car repayment? The idea is to have less accounts with debt. So I would pay off the car and put extra cash into the bond every month. R300 000 when the bond is finished is worth a lot less in present value.

 

[DerpiesFreud]

Holy derp
dem variables (%)_(%)

 

[TheGuy]

IF you pay off the car now and then pay what your monthly car repayments were into your bond I have a suspicion that you would save more than the R300k you save by dumping the R40k into the bond right away. You didn't give enough details for me to actually work out what you would save but give it a look.

I think you are right so I got a loan calculator excel sheet that I'm using. So if I pay of the the car now and put the car repayments into the bond every month it seems I'm saving R40 000 more in interest payments.

Does this then mean I must drop my bond rather to the minimum amount and pay everything into the car to pay it of sooner?

 

[Chevron]

Does this then mean I must drop my bond rather to the minimum amount and pay everything into the car to pay it of sooner?

Yes.

 

[Rockhound]

Not enough information but the car is short term debt and might be a for say 4 to 5 years.
But the home loan is long term debt for say 20 to 25 years.
You will be saving the R300,000 over a much longer period of time.
So it really isn't comparing apples with apples.

The most financialy sound advice as previous posters said is to pay of the car and pay the cars installment in to your bond for as long as the car finance would have run or as long as you can.

Even R500 more on your bond over 20 years can make a big difference to the amount saved.

 

[TheGuy]

Not enough information but the car is short term debt and might be a for say 4 to 5 years.
But the home loan is long term debt for say 20 to 25 years.
You will be saving the R300,000 over a much longer period of time.
So it really isn't comparing apples with apples.

The most financialy sound advice as previous posters said is to pay of the car and pay the cars installment in to your bond for as long as the car finance would have run or as long as you can.

Even R500 more on your bond over 20 years can make a big difference to the amount saved.

That is what I would like to do the idea is just to put everything I can into the car until its paid off then put everything I can into the house. I was just wondering if doing car first would be beneficial (which it is) so my boss is wrong.

 

[ele33]

Best is to pay off your debt that has the highest interest rate.

 

[azbob]

Say you have the R40k, would it be better to pay it into the bond while maintaining the same installments or to increase the installments by R4k for the next 10 months or is the difference negligible?

 

[Devill]

You're forgetting to factor in the time value of money, inflation and opportunity cost loss...

+1. I am sure the bond is payable over a much longer time frame than the car.

 

[RexxGrim]

Say you have the R40k, would it be better to pay it into the bond while maintaining the same installments or to increase the installments by R4k for the next 10 months or is the difference negligible?

Paying the 40k once of will save you more interest than 10 addtions payments of 4k each. The size of the saving will also depend on the maturity of the bond. If its early on the saving will be bigger.

Example:

1Mil loan at 8% over 240 months.

At the start:

Extra payment of 40k in period 1 saves R156k interest over the bond period
Extra payments of 4k over period 1-10 save R150k interest over the bond period

Difference R6000

After 10 years

Extra payment of 40k in period 120 saves R49k interest over the bond period
Extra payments of 4k over periods 120- 130 save R46k over the bond period

Difference: R3000

 

[krycor]

But.. don't you incur costs with settling vehicle finance early? I remember they removed that from property.

 

[DJ...]

I believe that was done away with...

 

[Messugga]

I believe that was done away with...

Indeed, you're no longer allowed to be penalised when settling early.