If you are working hard to stay away from debt but still find yourself tied to a monthly payment, you are not alone.
But personal finance author and radio host Dave Ramsey often reminds his followers that carrying debt of any kind is an unnecessary risk — especially when your income isn’t guaranteed from month to month.
In fact, one recent advice-seeker asked Ramsey about managing a fluctuating income while balancing savings and an auto loan, according to an email sent to TheStreet from Ramsey Solutions.
“Dear Dave,” wrote a man named Mike. “I’ve never had a credit card in my life. I do have a $600 monthly car payment right now, and it’s my only debt. I owe $10,000 on the vehicle.”
“Currently, I have a six-month emergency fund saved, plus $25,000 in a regular savings account,” he added. “I’m in sales, so my pay often fluctuates from month to month. Should I pay off the car from savings, or hang on to that money just in case things in my job take a downturn?”
Ramsey offered some advice about how Mike should approach his immediate financial structure, including the risk associated with variable income.
“I’m proud of you for never caving in to the temptation of credit cards,” he wrote. “That sets you apart from the vast majority of folks in America today.”
“But I’m not letting you off the hook on the car payments.”
Dave Ramsey explains the true cost of car loans
Ramsey was quick to acknowledge the man’s solid financial foundation while pointing out the danger of keeping the loan.
“I don’t care what anyone else says, debt is never a good thing,” he wrote. “And it’s absolutely the last thing you want in your life when your job compensation structure is unpredictable.”
He urged the advice-seeker to visualize how much more freedom his monthly budget would have without the burden of a loan.
“Now, it sounds to me like you’re in pretty good shape financially, except for the car payments,” he continued. “It may be the only debt you have, but it’s still like a ball and chain around your neck when it comes to your money.”
The Ramsey Show host then focused on the mathematical and emotional benefits of becoming completely debt-free.
“I want you to take a moment, and think about all the great things you could do if you didn’t have that monthly payment flying out the door,” he wrote. “I mean, an extra $600 in your pocket every month would be pretty cool, right?”
Ramsey encourages eliminating risk and choosing freedom
The personal finance coach had a straightforward action plan for using existing savings to clear the remaining balance.“If I were in your shoes, I’d take $10,000 out of savings today, and pay off that car,” he asked. “You’d be completely debt-free in a heartbeat, plus you could rebuild your savings in no time with the money you’ll free up.”
He also reassured the reader that taking this step would not leave him financially exposed.
“On top of all that, you’d still have your emergency fund of six months of expenses sitting there untouched,” he added.
That’s when Ramsey drove home his core philosophy regarding borrowing money and peace of mind.
“Debt always equals risk, Mike. Always,” he wrote. “Write a check today, man, and pay off that car. You’ll be surprised at how much lighter and more comfortable you feel with no debt—or the potential consequences of debt — weighing you down!”
3 real-world approaches to paying off the car
I decided to calculate what might happen over a two-year window by looking at three very basic, but different, approaches you might take to paying off the car, should you find yourself in Mike’s circumstance.
Each scenario assumes you have a $10,000 balance at a 6% interest rate with 18 months left on the loan, resulting in that $600 monthly payment. By comparing these paths, we can clearly see the hidden costs of holding onto debt versus the power of freeing up your cash flow.
Scenario 1: Paying off car loan immediately
If you write a check to eliminate the loan today, you instantly save about $480 in remaining interest charges.
Your savings account drops from $25,000 to $15,000, but your six-month emergency fund remains completely safe and untouched. Because you no longer have a $600 monthly car payment, you can immediately redirect that cash back into your savings.
Over the next 24 months, pocketing that extra money allows you to completely rebuild your savings back to its original strength, leaving you with no debt and maxed-out financial security.
Financial tally:You spend exactly $10,000 to kill the debt, save $480 in interest, and accumulate $14,400 in freed-up cash flow by month 24.
Scenario 2: Keeping cash in savings while paying off car
If you decide to hold onto the $25,000 out of fear of a job downturn, you will finish out the 18 months of payments as scheduled. Over this time, you will hand over that extra $480 in interest to the lender.
Even if your savings account earns a decent interest rate, the math rarely works in your favor after factoring in taxes on that interest.
While you maintain a larger cash cushion initially, you spend a year and a half sending $600 out the door every month, leaving your monthly budget highly vulnerable to any sudden drops in your sales commissions.
Financial tally: You spend a total of $10,480 over 18 months, losing $480 to interest while your monthly budget remains squeezed until the loan naturally expires.
Scenario 3: Investing instead of paying car loan immediately
If you decide to leave the car loan alone and put that $10,000 into a conservative investment, you are essentially gambling that your investment returns will beat the 6% guaranteed cost of the debt.
A conservative investment, like a high-yield savings account or short-term bonds, typically yields around 4% to 5%, which is a very reasonable and safe expectation but fails to outpace the 6% cost of the loan.
While trying for a higher return in the stock market historically averages 7% to 10% over long periods, expecting that gain over a short two-year window is highly unreliable due to unpredictable market downturns. Over a short two-year window, market fluctuations could easily leave you with less than you started with, all while you are still stuck making those heavy monthly payments.
Choosing to invest while carrying a high monthly obligation increases your overall financial risk without providing a guaranteed reward.
Financial tally: You spend $10,480 on the car loan. In this scenario, your investment must grow by more than $480 after taxes over 24 months just to break even with the cost of your debt.However, you could hold onto that investment over a longer term than just the 24 months and give it more of a chance to earn value.
Note: This piece of financial journalism is for educational purposes only and not for formal tax or investment advice.
Related: Dave Ramsey warns Americans on 401(k)s, IRAs (he’s not wrong)
