Sometimes we hit financial roadblocks and have to pick the lesser of two evils.
What if you have to choose between making your auto loan payments or your credit card payments? Which payment is worse to fall behind on?
That’s what a listener of the Clark Howard Podcast recently asked.
Credit Card vs. Auto Loan: Which Should I Prioritize if I Can’t Pay Both?
I just took a pay cut. I can’t keep paying my auto loan and my credit cards. Which one should I prioritize paying on time?
That’s what a listener asked on the May 9 podcast episode.
Asked Ben in Alaska: “I recently made the biggest financial oops I’ve done in years and don’t know what to do about it. I got into a car loan (72 months, 4.99%, $60,000) that I can’t afford. I knew as I was signing the papers that it was a bad decision.
“My job recently decided to do cutbacks, and at this point, I either will have to stop paying on my credit cards or stop paying on the car loan and get it repoed. Is there one option that will harm my credit less than the other?”
Left to this Sophie’s choice, the answer largely depends on the laws in your state, which I’ll explain later in this article. But there are also at least two other options to consider.
First, let’s hear from Clark on why defaulting on an auto loan can be especially sticky.
“The either/or choice you gave me, you default on the credit cards and pay the vehicle loan,” Clark says. “Because when a vehicle is repossessed, in most states, what happens is they repo the vehicle. And then they get a judgment against you for the loss and you end up paying for the vehicle you’re not able to drive.
“So paying the vehicle is really, really important. And even, may I dare say, more important than the credit cards.”
What’s a Recourse vs. a Non-Recourse State When It Comes To Loans?
First, let’s note that Alaska is a non-recourse state. So Ben is lucky in that regard.
But let’s back up for a minute. What’s a non-recourse state?
Thirty-eight of the 50 states are recourse states. If you take out an auto loan for $60,000, and then immediately are unable to pay the loan, the lender can repossess your car.
However, cars depreciate in value fast. Especially new cars that you’ve now driven. So if the lender repossesses your car and sells it, but only collects $50,000 in the sale, they’re still losing $10,000 on the deal.
In recourse states, that lender can then sue you for the $10,000. That’s what Clark means when he says you can end up paying for a car that you no longer have access to.
Since Alaska is a non-recourse state, the worst thing that can happen to Ben is that the lender can repossess his car. But it cannot legally go after him for any losses it incurs after the repossession.
Still, a repossession will stay on your credit report for seven years. Plus, you’ll no longer have a vehicle to drive to work, to run errands or anything else.
What’s a Signature Loan and Why Does It Matter?
A credit card is considered a signature loan. That means your line of credit requires no personal collateral that the lender can seize if you fail to make payments (for example, your car for an auto loan or your house for a mortgage).
Signature loans often charge high interest but you can get the money from the bank fast, perhaps even on the same day you request it.
Clark says the fact that a credit card loan is a signature loan makes it the lesser of two evils in Ben’s circumstances. Credit card lenders aren’t going to repossess your property like the auto loan lender will.
Alternate Solution No. 1: Get a Part-Time Job
Choosing a credit card vs. an auto loan to fall behind is not a fun decision. But it doesn’t have to be that way.
“What you didn’t pose an option to me that is really the best option in a bad situation,” Clark says. “Your pay has been cut back where you work.
“And I know it’s a burden to do so. But the better thing to do would be to pick up a part-time job somewhere or gig work and put 10 hours a week into doing something else that would hopefully free up enough cash that would allow you to service the credit card debts and keep up the payments for the vehicle loan.
“If you can work your way through this, the great news is you’ll never buy a vehicle like that again. It’ll be a lesson learned for the rest of your life. But having the vehicle repoed is brutal for your credit even if Alaska is not a recourse state.”
Alternative Solution No. 2: Sell Your Vehicle
Clark did not mention this option on the podcast. And depending on the vehicle, it could turn out to be a bad choice.
But Ben can also look into selling the car he bought with a six-year, $60,000 loan at about 5% interest.
Considering the value of the loan, it seems likely that Ben purchased a new car. New cars depreciate in value faster than used cars. The chances are high that Ben is upside down on his loan. Meaning the car is now worth less on the open market than Ben owes on it.
However, considering his circumstances, how much he’s upside down is important. If he’s forced to take a loss by selling the car, and he’s able to pay the lender the difference in the loan, perhaps he can avoid falling behind on his auto loan or credit card payments. And he’ll be out from under the monthly obligation of the expensive auto loan.
Consider Getting Help With Your Debt
Clark offered one final piece of advice to Ben.
“One other thing you can consider doing is sitting down either virtually or in person with a counselor or an affiliate of the National Foundation for Credit Counseling to see what they can negotiate for you at nfcc.org,” Clark says.
It’s better to avoid a situation where you have to choose not to pay your credit card or auto loan. But if you have to pick one, keep paying your auto loan.
Otherwise, you could get your car repossessed. And in most states, you may even still owe money on the car even after it gets repossessed.
If you can find a way to make enough income to get out of a bad auto loan without missing any payments on that or your credit cards, do that instead.