By the end of this lesson, you'll have learned if you should accept the car loan.
Class of 2020 car loan terms - $36,000 at 0.75% APR, repaid over 60 months
Take the car loan, open a Roth IRA and fund it for 2018 + 2019, buy a decent used car (optional), save the remaining cash for your Ensign TSP & an emergency fund.
The past two summers I’ve sailed aboard EAGLE and while underway, I delivered financial training to the 3/c and cadre. Many of them asked if I could provide guidance on the car loan, and if they should take it at all. This "Level" is all about how a CFP® professional (me) would recommend using the loan. I’ll also cover how I used my car loan when I was at CGA. (I’m now an officer in the Reserves and stationed in Seattle.)
I’ll break this up into four parts:
Should I take the car loan and if so, what do I do with it?
The loan terms from USAA are excellent: $36,000 at 0.75% interest, payable over 60 months, which begins a few months after graduation. (Technically it’s called a “career starter loan,” but since everyone just calls it a car loan I’ll refer to it as that.) Many cadets asked me if they should take it even if they don’t plan to buy a car, or if they have a hand-me-down car from a family member. For most people, I think it makes sense to take the loan due to the low-cost of borrowing and opportunity to front-load your savings.
Here’s my general recommendation on how to use the loan money:
But Rob, why would I willingly go into $36k of debt when I don’t need the money?
Fair question. Even if you simply park the $36,000 in a Discover, Ally, or Capital One 360 Money Market account, you’ll earn ~2.10% interest. That’s not an amazing return, but it beats anything USAA or NFCU offers, and you’ll be making money. (Do realize that the interest is taxable, so in reality, you’re earning about 1.60% after-tax, still coming out ahead of the 0.75% interest rate.) This isn’t my first recommendation on what to do with the loan, rather I’m just showing you that you can come out ahead even by parking the money in a high-yield savings account and literally doing nothing. (Reminder that high yield savings accounts often have a $150-$200 bonus for opening an account and depositing $15k-$25k.)
If you opt not to take the loan, you'll have ~$620 per month more in disposable income in the 5 years after graduation, which you could also invest. Another advantage of using the loan to front-load your savings/Roth IRA is that it becomes a forced-savings vehicle. If you play your financial cards right, you should be able to repay the loan and still come close to maxing out your retirement accounts. Through proper budgeting and sharing a house/apartment with classmates this is certainly feasible!
Who should not take the car loan?