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Should consumers pay down auto loans before saving for rainy days?

[Jun 27, 2011.]


Over the weekend, Fox Business carried some useful advice about personal finances. A reader had asked whether she should build up her savings in order to provide an emergency fund, or whether she'd be better off paying down her auto loan and other debt. What a good question!

Cheap auto loans

The point the reader was making was that, although there are plenty of cheap auto loans (and other credit) out there right now, the interest rates that have to be paid on them are still almost always higher than the rates you can get from even so-called high-yield savings accounts. So wouldn't it be smarter to pay down auto loans early (or sign up for less debt if you're looking for a new one) rather than putting money aside for a rainy day?

You can see her point, but the short answer is no! Why? Well, mostly because she was comparing apples and pears. People have auto loans in order to own the cars they need to get to work, ferry the kids around, do the family shopping ... you know, live. Emergency funds exist in order to provide a cushion for when things go wrong. And nowadays, with unemployment hovering around the 9 percent mark, the thing that's probably most likely to go wrong is losing your job.

Keeping your head above water

On Friday, The Chicago Tribune reported on new research that suggests than just 24 percent of Americans have enough money saved to see them through six months without income. And, given that 6.2 million people in this country have been jobless for more than six months, that's a scary figure. Here's some detail:

  • 24 percent have no savings at all

  • 22 percent have some, but only enough to survive fewer than 90 days

  • 46 percent could cover outgoings for more than three months (including those 24 percent who have six months covered)

  • That leaves just 8 percent who can be almost totally relaxed

The Tribune reckons that single-earner families should have a six-month emergency-funds cushion, while those with two or more breadwinners may be able to get away with less. However, it does recognize that those are impossible dreams for many:
... how do you build an emergency fund when you're supposed to be socking away for retirement, paying down debt and trying to save for your child's college education while also putting food on the table and making sure the lights are kept on?

Auto loans, debt and cushions

If you're one of those people who stand about as much chance of building a worthwhile cushion as winning a lottery (and for many, the chances are precisely the same), then you may still be able to do something to prepare for unexpected financial knocks:

  1. Try to avoid high-interest credit such as payday loans, although one of those can be cheaper than an unauthorized overdraft providing you pay it back promptly.

  2. Pay down accounts that charge the highest interest (often store and credit cards) first.

  3. Work on your credit score so that you qualify for the best rates possible.

  4. Do your best to build up a small cushion (maybe $500 or so) that might be enough to pay for unexpected car or washing machine repairs, a small medical expense or a family emergency. That may save you having to run up expensive debt on your cards or when you take out an emergency loan.

  5. Shop around for credit so that you don't pay more than you have to. That applies across the board from mortgages, through credit cards, to auto loans.

For the last of those, you can begin by finding competitive quotes for auto loans on this site.


About Author:

Peter Andrew has been writing about -- and for -- business for more than two decades. For the last couple of years, he has found himself increasingly specializing in the U.S. financial sector.

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