When Cutting Expenses Costs Too Much

If you could give up $75/month worth of income to eliminate $250/month worth of expenses, would you? At first glance this question makes me want to look around trying to find the candid camera or figure out who's punking me. But, after diving deeper, it's not as clear cut a decision as it seems. So, let's jump on in...

Currently, my wife and I have an outstanding balance on one of our vehicles. I know, the cardinal sin in planning for financial success. The only thing that could possibly be worse is having credit card debt, right? Well, maybe. But then again, maybe not. Anyway, we currently owe $10,300 on a vehicle worth north of $31k. And, for the purposes of this exercise, let's just call it a $10k balance. We have $250 set up on auto pay each month that's chipping away at the principal balance nicely due to the 2% rate. In an attempt to somewhat simplify and, more importantly, reduce expenses I thought perhaps we should just pay off the balance in full which we are fortunate enough to be in a position to do. But, being 'overly analytical to a fault' as a previous employer once told me, I decided to definitively determine if the math made sense. The $10k that we would use to satisfy the loan is currently invested in a P2P Lending account that's earning an average of more than 8% over the last two years. Again, for the ease of simple math, we'll say the return is $75/month despite the fact it's actually higher than that. Thus, the initial question.

Math time....

If we write a $10k check, that stings a bit. Especially when you're not buying something fun. But, if we reallocate the $250/month back into savings our break even point is 40 months ($10,000 / $250). A long time, but not terribly long. Wait, we forgot to account for the lost income of $75/month. We'd be giving up $3k ($75 x 40 months) which pushes the break even point even further out. The reality is that, assuming no gain through compounding interest or reinvestment we really wouldn't be even again until roughly 57 months. That's nearly five years! And, to make the math even more complicated, the vehicle would actually be paid off much sooner than that anyway.

So, after running the actual numbers we have determined that it would cost us more to pay off the loan at this time. This seems to fly in the face of every financial guru's advice in the history of ever. It was an eye-opening exercise though as far as proving the necessity of diving deeper into the nuts and bolts of a financial decision rather than simply subscribing to any one model or blindly following the advice of a particular talking head. I'm sure that we will have many similar exercises in the near future to unearth any potentially detrimental moves we're making in our quest towards financial freedom.

What about you? Have you had a situation that makes no financial sense at first glance yet turned out to be drastically different after running the numbers? Or worse, one that seemed to make perfect sense but ended up taking you in the wrong direction financially? Leave a comment below with your own story or thoughts/feedback on ours.

><
Jefferson