Hello reader. The following is not financial advice and should not be construed as such. Please seek professional guidance on all financial matters. I’m not a financial advisor–I’m just a guy online that likes talking about financial topics and sharing my opinion.
Folks, there’s a lot of chatter online right now about how borrowers “win” during high inflation.
On paper, this makes sense. After all, a loan at 2% has a negative real return when inflation is running at 6% or higher.
What I’ve found over the years is that often something can make sense on paper–but in the real world it’s a lot more gray.
So let’s dive in and see what we unpack with the debate around paying off a car loan during a time of high inflation.
My Story – Why I paid off my car loan at 1.75%
When I bought my first car with a loan–I was 23 and fresh out of college. I needed something to get around since I had sold my old car when I was in college to raise money to pay for rent.
I bought my 2007 Acura TL (which I still own today) in 2015 and borrowed about 11 grand or so to buy it.
The rate was insanely low even back then. I was able to get a promotional rate of somewhere around 1.75% over a 6 year repayment term.
Obviously, that’s an amazing rate by any standards and I paid hardly any interest on the car.
However–in 2020 I ended up paying off the car about 1 year early–even though I was “passing up” an opportunity to put that money to work during the crazy stock market crash in March / April.
Looking back, I’m actually glad I did that–and let me explain why.
When I still had the loan on the books, I had debt payments around $220 or so per month.
At the time, my top priority was (and still is) to use cash to put myself in the best position from a cashflow standpoint as possible.
I was able to turn approximately $2,000 into an extra cashflow position of $200 per month–giving myself more space between my income and bills every month.
If I had invested that same $2,000 into a broad-based total stock market index fund–I would have generated the cash flow that the index provides (roughly 1.8% or so as a dividend).
Per month, my cashflow position would have been a meager $3 per month.
Now, you can make the argument that the growth is a lot more over time that just the dividend payout–and you’d be right. But folks often discount the positives that come with increasing your cashflow position now.
For example, with that extra $200 per month, I could afford a bigger loan on a home right now, or to move into a nicer apartment right now, or increase my savings rate right now.
In my humble opinion–there is real value in the security and options that greater cashflow can afford you when you use cash to lower your monthly liabilities.
Even in a high inflation environment–less monthly obligations = more freedom.
With less demands on monthly cashflow–folks often make career changes, make the decision to stay home with the kids instead of working a second job, or take that extra vacation they’ve always dreamed of.
For me, I was happy to secure an increase in my monthly cashflow position–even if it was only for that extra year.
I used this same logic to pay off some student loan debt (around $50,000) instead of invest it when the market crashed in April of 2020. Again–cashflow!
I’d make the same decision 100 more times–but it’s a personal preference. That’s why they call it “personal” finance–it’s up to you!
Cash Flow vs. Growth Potential of Paying off the Car
So, now the choice is yours. Do you want to optimize for cash flow, or growth potential?
My thesis as an investor is to decrease my monthly cash burn, and use tax-advantaged accounts to invest for growth in the extremely long term (over 10,20,30 years).
This gives me the freedom of low monthly expenses (no debt) and the extremely long term compounding that comes with long term growth investments.
Now, what will you decide to do?