Loan payments impact on credit score

First, call your car loan company and ask if there is any problem or negative reporting if you stop making payments for a few months. It should be OK if you are in fact paid forward.

Beyond that, I'd need to know what your car loans look like. That would be the original purchase prices, the original loan values, when that was, the rates of interest, and current balances. I would suspect that if you had the cars for a while, and you have now paid a year in advance, that there shouldn't be too much left to pay. It might make more financial sense to pay off these loans and avoid some of the interest. That might set your house deal back a few months, but it will help you in the net worth column over the long run.

-john-

Thanks for the info, John! I will call my loan companies on Monday to see if skipping some regular payments will be okay.

Both cars were purchased in June 2007:

Car 1 - Purchase price $24,000 Original loan value $24,000 (no money down) Interest rate - 1.9%, 60 month loan Current balance - $17,000

Car 2 - Purchase price $16,000 Original loan value $11,200 Interest rate - 11.64%, 72 month loan Current balance - $3,500

The only other debt that we carry is about $4000 on a no-interest credit card, which we pay $250 a month towards.

As for scraping up money for the down payment, I would qualify to pull $10,000 from my traditional IRA and we also have about $9,000 in contributions in our Roth IRAs, but I would rather not touch those if I don't have to. I do, however, really want to avoid PMI in the first place...

Thanks again for any advice! :)

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You have way too much invested in cars. A normal car loan is

3 years. Any longer means that you are buying a car that is more expensive than what you can afford. And going out 72 months is pure and simple financial foolishness.

You had a chance to save money for a house, but you invested in cars. In 5 years, these cars will be wore out and ready for the junk heap, yet you will still have payments to make. Had you bought reasonable cars and put this car money towards your house fund, you would be ready to buy a house today, and be on your way to owning an asset that actually goes up in value over time, and you would have caught it at a time when interest rates are near their historical lows and prices are very low. Those two cars may have cost you $200K in additional house purchase price and interest fees over the next 30 years.

Since what is is what is, I'd do unnatural acts (ie, beans and rice for food) to scrape up the $3500 and get car #2 paid off. That gets rid of mafia-rate loan shark interest that you are paying.

I'd consider selling car #1, and replace it with a 5 year old Toyota Corolla with 125,000 miles on it. You can pick them up very reasonable, and they will run another 125,000 with little trouble. That will clear up $17K in debt.

Yet another sign that you are spending more than you earn, mostly due to the huge car payments compared to your incomes. Again, do whatever you have to in order to get this paid off. Sell the dog, deliver pizzas, do some E-bay, or whatever it takes. You should be able to put $1000 a month towards this and get it wiped out in 4 months. Then don't ever do that again.

This credit card debt is a real red light. It tells me that you cannot afford to live on what you earn today. It also tells me that you have absolutely no chance to live on what you earn after you add a house payment to your budget. You have to get these bills taken care of before you even begin to think about a house. Getting a house when you have a ton of credit card debt and two car loans would be like getting in the express lane for financial disaster. What happens if one of you gets sick and cannot work, or you get downsized and cannot find a job for 6 months. Do you want to lose everything just because a normal life event happens?

No, no, no. Never, ever pull money out of retirement to buy "things". You will need that money when you turn 65. If you spend it now, you will end up having to fight the stray cats and dogs for the leftover food in the dumpsters. Not only that, but there are huge fees and penalties for pulling money out of an IRA (in most cases). If you pull out $10K, you may have $5K in fees, taxes, and penalties.

-john-

John A. Weeks III wrote: [...]

Hmm, the family I grew up in was pretty frugal, and I distinctly remember my dad having a five-year loan back in the 1970's. Seems pretty normal to me from everything I've heard.

You contradict yourself later. Any well-made car purchased today can be quite serviceable for eight to ten years or more. Whether you buy a car with loan proceeds or savings does not have any impact on its useful life.

One doesn't lose "everything" as a result of a normal life event, only a catastrophic one.

[...]

Let's see, even if I was in the 25% federal tax bracket, 8% state bracket, and 12.5% combined federal and state penalty, that would still be significantly less than 50% of a withdrawal. Plus, up to $10,000 can be taken from an IRA penalty-free to make a down payment on a first home, that is something that was written into the tax law precisely to encourage this use of an IRA -- which is what the OP was referring to, I surmise.

Frankly, the stray dogs and cats don't stand a chance... ;-)

-Mark Bole

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Car loans are not a wealth building strategy. If you interview

100 rich people, not one of them will tell you that they got rich by taking out more and more car loans. The bottom line question is if your family achieved critical mass? That is, enough wealth in savings to quit work and live off of the interest from the savings?

There is no contradiction. Rather, you missed the point. Buy a new car, use it for 5 years, then check the value of that car. The value is going to be very low. In fact, the value will drop 10% to

15% just driving it off of the dealer's lot. The net result is that buying a car is a terrible use of money when it comes to building wealth. Cars quickly go to zero value, and in this case, they will have almost no resale value before the loan is paid off. In my book, it is silly to make big payments on an item that has no book value.

If they had bought a house instead, then they would have had something of value when they were done paying for it. Again, in my book, shelter is a requirement, cars are toys, so take care of the shelter first, then buy toys if you have leftover money.

OK, then riddle me this...these folks are spending 110% of what they earn. They have to go to credit cards each month to make things work. Since they didn't say what they do, lets assume that one is a computer consultant and the other is a physical trainer. Those are good enough guesses. Lets say they take a weekend and go skiing. He breaks both legs and ends up in traction for 3 months. That means the revenue from the computer consulting stops. And their expenses go up due to the unusual circumstances. How long will it be before they max out the credit cards (which they already needed before the accident), and end up not being able to make their payments? Lets now say that the guy ends up like one of my former co-workers and the bones don't heal quite right, and he ends up having to do a few operations and is in a cast for 9 months. Now a year goes by without that income. How long before they start losing cars, and if they had a house, how long before that goes away?

The bottom line is that the reason we see so many foreclosures today is that so many people are living right on the edge. If anything bad happens to them, they lose pretty much everything. And with our current economic situation, bad things are happening at ever increasing rates.

-john-

Hi again, John! :)

Perhaps we have too much invested in them, but we do plan on keeping them until maintenance costs significantly exceed remaining value. The

72 month loan was ridiculous, and the interest rate insane, but that is why I am paying off the car ASAP (most of it has already been paid off in less than one year).

I already have quite a bit of money available spread out between my money market savings, CDs, and some stocks (which I'm carefully selling off to preserve the capital for the house down payment). I could easily pay off both cars right now, it's just that I'd have nothing left for the house down payment :).

What is wrong with keeping something on a 0% interest card and making regular payments on it? Wouldn't that $4000 be better invested, saved, or used towards something else in the meantime? Aside from the interest-bearing car loans, I pay no interest on anything. All of our routine credit card expenditures are fully paid every month.

I am already accustomed to paying $1000 in rent each month, so I don't feel that a reasonable mortgage with a 20% down payment on the house is going to cost me much more than that a month, and at least we'll be building equity and have the tax benefits of home ownership.

I do enjoy nice things, but we definitely have money left over at the end of each paycheck to go towards savings and such, including maxing out our IRAs each year.

I understand that retirement savings should not be touched unless absolutely necessary. The contributions to Roth IRAs may be taken out at any time without penalty. Up to $10,000 may also be taken out of a traditional IRA for a first-time home purchase without penalty. That still doesn't make it a good idea, but if I needed a bit of extra money to avoid PMI, I would probably do that. I am 29, and my husband is even younger than that. I doubt most people our age already have as much as we do in our IRAs to begin with. I know by the time we retire, we'll need a LOT more in our retirement accounts, but I think we're doing pretty good so far.

We will probably be looking at buying a house in the $200-250k range, which means coming up with $40-50k down payment to avoid the PMI and to have lower payments in general. I guess we could always push back our moving plans by about 6 months; that would be enough income to make up the down payment without pulling from our IRAs. I'm really eager to move, but perhaps being patient will pay off in the long run, unless the housing market swings back by then. I was hoping to move by December of this year...

I do appreciate any feedback, and I realize how my previous post painted a bad picture of my financial situation (hopefully it's not that bleak though!).

Thanks again!

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[...]

I agree with your message about the importance of living within one's means. IMHO there was just a tad too much hyperbole mixed in to get the message across effectively (which is what my reply focused on), but then maybe a little shock treatment is called for in the case of some individuals. A subsequent post by the OP tells me they aren't quite in as bad shape as originally portrayed.

-Mark Bole

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It should be paid off tomorrow.

Paying off that absurd 11% loan is more important than saving money towards that house downpayment.

If you can't come up with 20% down *and* pay off these car loans and that $4000 outstanding on your zero-interest-rate credit card all at the same time - then you don't have enough to buy the house you want.

I wouldn't be in a rush to pay off that 1.9% car loan - you've already got the sunk costs which bought you down to that rate (ie. you paid more for the car in exchange for that low rate). Paying it off early just means you'll have wasted that rate buy-down, and you can earn more than that 1.9% on your cash in the meantime.

But pay off that 11% loan *today*.

Perhaps, but not usually. Those zero-percent credit card deals often have triggers (ie. a single late payment, etc) or structures (ie. new charges on the card accrue double-digit interest and payments go only towards the zero-percent balance) which more than offset the savings due to either risk or hidden costs. You want this thing paid off before you consider buying a house,

They're very bad ideas. If you can't afford the down payment without cutting into your retirement savings, you can't afford the house.

You may be able to structure the deal with a primary mortgage for 80%, plus a HELOC for the difference between that and the amount you actually have available for the down payment. But bear in mind that doing so means that if the housing market keeps creeping lower, you may end up underwater. It's worthwhile avoiding the PMI, but it's not worthwhile buying more house than you really can afford, no matter how nice it sounds to own a home.

Then don't screw that up by mortgaging your future to own a house now. You're young. The most valuable assets you have are your earning potential and *time*. But if you pull money out of your retirement accounts - the time that that money needs to grow to fund your retirement is getting whacked.

It would probably make a rough analysis of your situation more accurate if we knew your whole balance sheet and cash-flow situation (incomes, rents, assets, debts, etc). Knowing only about those cars and the credit card and your intentions to pull money from your retirement accounts for a down payment paints a picture, at least to me, of someone trying to overreach. That perception may be wrong, but the way to fix it is to give us more information.

Then there's no question in my mind that that's the right thing to do. Homebuying and wealth-building are *slow* processes. If you're so eager to do things that you can't wait 6 months, something's wrong. Take those 6 months. Pay off the credit card and the 11% car loan. Heck, take 6 more months and build up a nice cash cushion. Every home buyer out there can tell you that after you buy that house, you inevitably spend a bunch more money getting yourself set up in the first few months - don't make the common mistake of putting that additional spending on a credit card too. Houses are not going to skyrocket in price. If you think you might be able to afford that house in 6 months, you can bet that you'll still be able to afford it in 12, with a much bigger margin of day-to-day cashflow safety.

Major keys to wealth are patience and discipline. Ask Warren Buffett. Be patient. Those who are capable of delaying gratification have much much better chances of building wealth.

That car loan really is frightening. Did one of you or your spouse have seriously bad credit when that was made? You may need to examine your credit ratings and make sure you can even get the mortgage you think you can get.

You need to weigh 2-3 factors for buying the house.

1) have you signed anything for the house? If yes, then that timeline trumps my other 2 suggestions. 2) The bank will look at debt to income ratio, I would suggest paying off the cars, especially the one at 11.64% interest rate. The money you free up can then be used to accumulate down payment. 3) consider a loan with less than 20% down. 80-5-15, where you put 15% down, have a first mortgage for 80% LTV and a second mortgage for 5% LTV.

I would free up cash flow by paying down debts, then use the debt payoff to bump up the credit score. If you paid down on the 1.9% loan before paying off the 11.64% loan, you need to take a step or two back and ask what are you trying to accomplish? I would pay off the loan with the higher interest rate first, then reasses priorities. A house will not appreciate at 11.64%, neither will a savings account, so make financial decisions which make sense is my advice.

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Mikki, you may want to determine if your loans are simple interest loans. A lot of car loans used to use some other interest calculation which gives you no benefit for paying off early. I think these other types of loans have been outlawed in a number of states, but I'm sure they still exist in some places.

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Just as a data point. In 2004 my wife and I put money down (lot hold) in a neighborhood. I don't remember the month, but I think we put money down in November. After some discussion we told them we wanted to close in June (because that is when car and student loans were paid off), they said no, and we pulled our money out and walked away. Cost of house was $275k.

In June of 2005 we put money down (lot hold) in same neighborhood on same floorplan with same builder- just deeper into neighborhood. Cost of house had increased to $352k. 77k increase in about 6-12 months. That was when RE market was still hot (in southern Ohio). A few factors changed -the place we live now was not part of original sub division plans, so I am sure the plot of land cost more for developer when they were "mid stream" in rest of neighborhood, and our current location is a wooded lot where as first lot was not wooded, AFAIK.

Sometimes waiting costs you money. In our case we liked going into house debt free and on our terms. In this market if you walked away like we did, they will bend over to keep you. In the market of 2004 that lot was resold within 2 weeks.

Negotiation will work if you are building.

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Wow! A lot of useful information and tips from everyone! Thanks for all the input, as always!

- I paid off car #2 today! Well, rather I submitted the e-payment which will be processed on Wednesday, but in any case, it's settled. I don't know how I ended up with that high of an interest rate. When I bought car #1, a few weeks before car #2, the dealership showed my my reported credit score, which was around 780. Maybe purchasing car #1 killed the credit score? In any case, lesson learned about the interest rate. I definitely should have been putting all my resources towards paying off that car. The sad part is that I was prepared to pay the full amount for the car when we were buying it, but the finance liaison at the dealership talked me out of it ("Why wipe out a lot of your savings when you could just pay a little each month!"). I just thought the interest rate was high because it was a used car vs. new.

- Just for some background about what I do, I'm a pharmacist. My husband makes significantly less than I do, working in retail sales, but he enjoys what he does and we are happy. We just have two cats right now, and are considering having a child in the next 5-10 years. I know we are not financially ready for that yet!

- John brought up a very good point about what will happen if for some reason I am unable to work. There is no way my husband could even pay our current rent. My employer offers a small disability/death benefit, but perhaps I should consider a more substantial policy? And of course keeping enough in our savings account to cover for such matters on a temporary basis...

- We have personal reasons for wanting to relocate, so another option may be to relocate but to rent in our new location. With the current housing market, a seller may be willing to enter a lease-with-option- to-buy arrangement that would buy us some time to accumulate more money down. If we don't find something like that, we could just rent another apartment until we can find a house we like and have sufficient down payment saved up. Would the act of relocating and just being in an apartment for a year hurt our credit score? We have been at our current location for over two years...

Thanks again! :)

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Ah, the finance manager. He makes more money for the dealership than the car salesmen. My guess is that the interest rate was high because he thought he could get it. The interest rate is as negotiable as the price of the car.

-- Doug

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Don't worry about your credit score. All a credit score does is tell a financial rip-off artist how profitable you are to them. You really want to be building wealth for yourself and your family, not paying for boats and cruises for some financial salesperson.

Go where you want, relocate where you choose. Your happiness is job #1 in life (right after job #0, which is survival).

I would always suggest renting for a while once you move to a new area. It takes a while to understand the character of new area, and learn where your favorite spots are. It might cost a few dollars a month more to get a month to month lease, or get a 6 month with option to renew, but that is a small amount compared to making a mistake by rushing in to buy the wrong house.

Good luck in whatever choice you make.

-john-

That was during a unique and extraordinary period. Over the long run, houses go up at about 1-1.5% above inflation, NOT at 20% in 6 months. Houses that go up 20% in 6 months can come *down* almost that fast, especially when purchased by folks who leverage very hard to buy them and have no cash cushion. Those are the some of the same people being forced to dump them right now.

The odds are overwhelmingly against what you described. It happens that the markets behaved that way a handful of times over the last century. Not a great bet, or at least certainly not a *conservative* one and not one I'd ever recommend to the OP to engage in. And it sounds like you did the smart thing, too - by not buying that place until you really were ready.

BWS - see

This is a Robert Shiller graph, Shiller of the 'Case - Shiller' index. The chart is inflation adjusted, and shows no increase to speak of from

1890 to the mid 1990s. Go right to the boom peak and we're at a bit under .7%/yr increase. May I ask where you get data to support your conclusion? Funny, I showed a peak in 1981 with no return to that level right in to 2005, even as Shiller showed his spike. My chart, with links to all data is at Joe

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Agreed.

For some, a car *is* the shelter of last resort.

I agree with your message about living within one's means.

I don't agree that new cars are ready for the junk heap in five years, or that taking money out of an IRA automatically costs 50%, especially if used for a down payment on a first home.

A non-trivial number of people have a lot of debt and still manage to go out and enjoy the sunshine every few days... they haven't lost everything.

From a financial planning viewpoint, I argue that under the right circumstances, it can be wise to take negative mortgage amortization, reduce a 401k matching contribution, buy a used car on credit, and so on. It really depends on individual circumstances and tolerance for risk.

-Mark Bole

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Either way, Case-Shiller makes an even *stronger* case for my point - that real estate, or at least the raw appreciation of it - does not make folks rich.

Of course, real estate is a very hard thing to use such broad and long-range numbers for - individual properties are unique, not commodities - which may make for fantastic opportunities for folks who really know the markets and how to operate in them. And I have no doubt that there are folks who really can work those markets. Unfortunately, the recent housing price silliness led a lot of folks to think they were real estate geniuses, just as the tech bubble misled a lot of folks into thinking they were stock market geniuses.

Then you should keep some notes, and let me know how all these credit card moguls are doing when they hit 65. I am willing to bet that most of them are still in debt at 65, few can afford to retire, and nearly every one of them needs take welfare (in the form of social security checks).

I'll agree it is wise if you are selling these things and make big fat commissions. But if you are a normal everyday person, doing things that are in this list will prevent you from achieving critical mass, and doom you to a retirement where you are living day to day on welfare fighting the cats and dogs for scraps from the dumpster.

A person only has one shot at life. That shot is time based. If you miss the chance or waste the time, you will be in a world of hurt when age 65 rolls around.

-john-