Friday, March 14, 2008

Pay auto/car Loan or Invest in a CD or other investment. When do you break even

The previous post of mine on auto loan had lots of discussion and ifs and buts. I decided to make it pretty simple this time. Here is the case. You have $10000 with you today, that you can use to pay off a car loan of equivalent amount which is at a interest rate of 5.5% or you can pay the monthly installment on the car loan and invest the current $1000 you have in a CD or shares..


Current car loan = $10000
Interest rate = 5.5%
Term = 2 years or 24 months

From Bank Rate Calculator the equal monthly installment is $440.96

Let us say Best CD rate available is 5% (which is impossible at this time). So the case under study is that you have $10000 in hand today and you have $440.96 from your monthly income available to you to pay the car loan

Pay the car loan

In this case you paid off the car loan and you put the $440.96 in a Savings account like ING Direct. Let us say in an ideal scenario you are making 4% on your savings account (ING doesn't offer this interest at this time). So putting $440.96 in a Savings account for 2 years, at the end of 2 years, (from dinkytown)

Total = $11,505
Taxes = 28% of (11505-10000) = $421.4
After taxes total savings = $1083.6
After paying taxes, money you have with you = $11083.60

Put in a CD

From Bankrate $10000 at 5% for two years will yield a total of $11,052.

Total = $11,052
Taxes = 28% of (11,052-10000) = $294.56
After taxes, net with you = $757.44
After paying taxes, money you have = $10,757.44

Paying the car versus CD

Difference you lose by not paying the car loan and investing in a CD = $11083.6-$10757.44 = $326.16

Incentives for not paying the car loan is the fact that you are only liable to $441 a month, if you lose the job or if you are on bench in consulting, then you have $10000 with you and you are only liable to $441 a month. So, that makes it easier for your mental peace

If you do not put in a CD and invest in shares or something, then what percent interest rate on your $10000 investment justifies your not paying off the car loan? lets calculate that. This means that your $10000 has to become $11,505 in 2 years. Using the formula for compound interest, that would be 7.26% assuming interest compounded annually. That is a very low interest rate compared to gains on Shares. But then, you never know about Shares. You might as well lose your money.

So, that's the calculation folks. Know your facts, analyze your situation and make a good decision :)

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