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Slash debt by draining savings?

Question: My wife and I bought a new car a year ago with a 6% interest rate and have about $14,000 of the loan left to pay over the next four years. We have approximately $15,000 liquid in a savings account and are hoping to start saving for future expenses, namely, a house.

Does it make more financial sense to quickly pay off the auto loan with our savings so we can start focusing on our other savings goals? Or is it advantageous to continue to pay the $350/month payment over the coming years to build our credit history while saving what we can above and beyond that? Thanks for the wonderful show! Tony, Los Angeles, CA

Answer: How about a financial compromise? I would be nervous in this current volatile economic environment to drain my account down to $1,000 in savings.

I know that paying down debt is the equivalent of saving more and that you'll replenish the till. But it's still nice to have an adequate cushion against a sudden setback so that you don't have to borrow on the credit card.

What if you cut the auto loan by a third or even half? And then what i you you hiked the monthly payout in coming months, say, to $400 or $500 so that you shortened the life of the loan considerably? You can go to a website like dinkytown.net and play with the numbers. The calculators will help you decide what combination of debt payoff and savings plan works best for you.

You'll be well on your way toward building up a downpayment for a home by the time the debt is extinguished. In the meantime, you'll stil have a good safety net or emeggency fund to tap (and hopefully you won't need to).

About the author

Chris Farrell is the economics editor of Marketplace Money.

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