LEVEL FOUR / I'M AN ACADEMY CADET!
Lesson 1: Car Loan, Yes or No?
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.
TL;DR version
Take the car loan, open a Roth IRA and fund it for 2021 + 2022, 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 Alameda.)
i’ll break this up into four parts
Should I take the car loan and if so, what do I do with it?
Setting up a Roth IRA as a cadet
Maxing your Ensign TSP account
Buying a car
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:
Put $6,000 into a Roth IRA as your 2021 contribution (available up till 4/15/2022)
Put $6,000 into a Roth IRA as your 2022 contribution (available from 1/1/2022 to 4/15/2023)
Buy a reliable used car (if you want one) for $10-$15k max
Set aside $15,000 to use as your 2022 TSP contribution & Roth IRA contribution
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 ~0.40% interest. That’s not an amazing return, but it beats anything USAA or NFCU offers. This isn’t my first recommendation on what to do with the loan, rather I’m just showing you that you can park the money in a high-yield savings account and then deploy it to your Roth IRA or TSP as an Ensign. (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?
If you think there is a high probability you will get kicked out between now and graduation, or you think you might be medically disenrolled, don’t take the loan. If you lose your cadet status, you either have to repay the loan immediately or face a much higher interest rate.
If you absolutely HATE the idea of being in debt and you can’t sleep at night because you owe someone else money, don’t take the loan. Most folks aren’t this anxious, but I have come across a few people over the years who literally cannot stand the idea of being in debt. Sadly they can’t bear to take out a mortgage, car loan, or even use a credit card. If this is you, don’t take out the loan.
If you know yourself well enough and that having a large sum of money in your account will encourage you to spend frivolously (gambling, partying, vacations, etc.) then don’t take the loan.
reminders
Don’t leave a large sum of money in your USAA account for any length of time! Their interest rates are very, very bad: 0.01% for checking and 0.15% for savings as of Jan 2019. Instead, simply link your Discover or Ally account online and transfer the money.
Ironically, having the loan will likely improve your credit score. This is because it adds to your mix of accounts. More on credit scores here.