Reading · Love, Money + Real Estate

This Pay Dirt Q&A was originally published in Slate Magazine. I am republishing it here so that my subscribers can enjoy it. If you like these sorts of Q&As, be sure to check out the other Love, Money + Relationships posts listed at the bottom of this newsletter. And, feel free to share this post. Sharing and subcribing help keep this newsletter growing.

Dear Pay Dirt,

How should I pay for a new car? I was recently in an accident, and my vehicle was totaled. Insurance will pay for what we owe on the car, but not much beyond that. My husband and I make $100,000 a year, have four kids, own a home, and have one paid-off vehicle. We are proud of how far we’ve come, but we live paycheck to paycheck. Our only remaining debt is our mortgage and the note for this dearly departed car. We got a good deal on it a few years ago, and vehicle prices have gone up a lot since then. So we have two options:

Take a few grand out of our small ($8,000) emergency fund and finance the rest of a new vehicle. We’re looking at getting a used but relatively new van around $25,000.
Take about $15,000 out of our $100,000 retirement account and only finance around $10,000 of the new vehicle. This would keep our monthly payment in a more manageable range, but it feels short-sighted.

What are we overlooking?

—My First Car Cost $1,500

Dear My First Car Cost $1,500,

Before I weigh in on your options, let me congratulate you on living a financially successful life while raising four kids. It’s certainly not easy, but while you’re living “paycheck to paycheck,” you’re also building your emergency fund and have put away something for retirement. I don’t know how old you are, but as the kids grow up and move out, you’ll have time to catch up on your retirement savings. Your immediate goal is to avoid taking on expensive debt.

That said, you need to immediately replace your car. The most important question I have for you is, what’s your credit score? That’s probably going to drive your decision.

Of the two options you provided, using cash from your emergency fund as a down payment while taking out a bigger loan may be your best bet. I know it feels counterintuitive to take out a bigger loan. But if your credit score is good, you’ll pay a reasonable amount of interest from a bank or credit union. And car dealers may even offer better financing deals than that.

Here’s how option two might play out: If you dip into your retirement account, you’ll pay tax on that withdrawal at your current marginal tax rate, which could be 20 percent or more, plus you’ll pay a 10 percent penalty and any state tax that’s owed. On your $15,000 withdrawal, you might have to withdraw an additional $4,500 (or pay for it separately). If your employer provides a way to borrow from your 401(k), you’ll avoid the taxes and penalties, which is better. While you’ll pay yourself back, rather than a lender, that cash will be missing from your account. So you’ll miss any growth you’d have had with those investments. But if your credit score isn’t great, or good enough for a lower-interest loan, and you can borrow from your 401(k), then that may be the better choice.

A third option would be to take out a home equity line of credit (HELOC). Again, if your credit score is high enough, you might qualify for a reasonably-priced loan of around 7 percent (at today’s interest rate). While you’ll need to pay that back, HELOCs are typically open for 10 years, which would give you another way to pay for emergencies without depleting your cash. Think of it as a backup emergency fund. If you don’t use the HELOC, you generally won’t pay anything other than a small fee when you open the account.

I’m still voting for option one, although I really like the idea of having an open HELOC. But it’s all going to come down to your credit score. To find out where yours is, sign up for a free online account at Experian, Equifax, and TransUnion. You’ll get a free credit report and your current credit score. You’ll also be able to easily freeze and unfreeze your credit, which puts you more in control of your financial future.

I’m About to Be a Professional Athlete—With the Paycheck to Go With It. My Dad Claims I “Owe” Him.

I Spent Years Working a Stressful Job in Exchange for a Life-Changing Amount of Money.

My Roommate Refused the Lottery Ticket I Bought Her. That Might’ve Been the Million Dollar Mistake of Her Life.

My Husband Just Dropped a Bomb About His Will. It’s Making Me Question Our Entire Marriage.

My Sister And I Each Inherited Over $1 Million. Now Her Recent Request Has Thrown Me for a Loop.

My family isn’t rich but I have $2 million in company stock. How much should I sell?

My Parents Have Made Some Horrible Financial Decisions.

I’m About to Give My Daughters a Lot of Money

I Suddenly Came Into a Large Sum of Money...

I Want to Move in With My Boyfriend. But It Would Mean Giving Up a Once-in-a-Lifetime Deal.

I Make $100K. My Financial Adviser Has a Specific Piece of Advice I’m Not Sure I Should Take.

My Brother Thinks I “Deserve to Be Poor” for My Life Choices. Now He’s in Charge of Our Inheritance. My parents swear he’ll do the right thing.