Should I Pay Off My House in Baby Step 2?
Cindy and her husband owe $20,000 on their home and have $12,000 saved to put against that balance. They have a $27,000 car loan. Cindy wants to sell it. Dave tells them why their plan of attack might be off.
QUESTION: Cindy in San Antonio and her husband owe $20,000 on their home and have $12,000 saved up to put against that balance. They have a $27,000 car loan at $560 a month. Cindy wants to sell it. They make about $90,000 a year. Dave tells them why their plan of attack might be off.
ANSWER: My rule of thumb is to not own automobiles with debt and not to own anything with a motor in it that totals up to more than half your annual income. Your car doesn’t violate the second rule—it just violates the first one. Maybe you could pay off your car and then pay off your house.
You are doing this out of order. Your house should be the last thing you pay off. You are certainly going to pay them both off very soon. Basically $47,000 makes you debt-free. You already have $12,000 and you make $90,000 a year. I see you being debt-free of both things by this time next year and keeping the car if you like it. If you don’t like it sell it, but if you do, then keep it and pay it off first.
We teach people to do the Baby Steps. Baby Step 1 is $1,000 in the bank. Then save no more until you are debt-free except the home. Baby Step 2 is to become debt-free except your home. Baby Step 3 is to have a fully funded emergency fund of three to six months of expenses. Baby Steps 4, 5 and 6 are done at the same time. That means with Baby Step 4, you save 15% of your income into retirement, then with Baby Step 5 you save for the kids’ college if it applies, and Baby Step 6 is where you pay off your house.
What I would do is take $11,000 of your $12,000 and put it on the car. I would pay nothing extra on the house, and everything I can scrape together goes on the car. I wouldn’t go out to eat or do anything until this car is paid for. Pay the car off very quickly. Putting $16,000 on the car when you make $90,000 a year shouldn’t take long at all.
Once you are debt-free of everything except your house, your next goal is to go to the $1,000 account and raise it up to three to six months of expenses. Before you pay off your house, you should have an emergency fund of at least $30,000. Then you should pay off your house. That entire program is going to take you two years, but that’s the order to do it in.
If you are sitting there with a paid-for house and debt on your car and no money in the bank because you are broke, that’s not a good place to be because you did this stuff out of order.
If you want to sell the car and buy a $5,000 car, it will accelerate this process. But I’m all right with you keeping the car if you want to, as long as you pay it off very quickly.