It’s been almost two months since Will’s car got stolen, and it’s time to buy a replacement.
His last car, as you may recall, was a 16-year-old Honda Accord with 275,000 miles on it. This time, he decided to shoot for something nicer.
“I’m thinking of buying a well-made Japanese car, between 5 to 7 years old, with 50,000 to 90,000 miles on it,” he told me.
Hey, what a coincidence — that’s my dream car, too!
He set a budget of $10,000 for his car purchase. And obviously he planned to pay cash. Because taking out a car loan is stupid. Right? Right?
That’s what I always assumed – until three personal finance bloggers told me I’d be nuts to pay cash.
It Began With a Podcast …
You see, it all started one night during a conversation with Joe Saul-Sehy (from the Free Financial Advisor), Dominique Brown (from Your Finances, Simplified) and Len Penzo (from his eponymous blog, Len Penzo dot com).
The four of us meet weekly to record a segment for the Stacking Benjamins podcast. (Have I mentioned that I have a weekly podcast segment? We’re the #7 investing podcast on iTunes. C’mon, do the sports chant with me: We’re Number Seven! We’re Number Seven!)
So the four of us are chatting one evening, and I mention that Will and I are planning on buying Will’s next car in cash.
The guys reply: Why?
The question caught me off-guard. Why wouldn’t we pay in cash? Cars are supposed to be purchased with cash.
We’re not raiding an emergency fund or short-changing retirement to make the purchase. We have plenty of savings for home repairs, car repairs, health savings accounts, travel, and quarterly taxes. We have cash reserves for all of our rental properties. Our retirement accounts are maxed out.
On top of all of that, we have some extra money floating around. We’ve been scratching our heads, trying to figure out what to do with it. Then Will’s car got stolen. So why wouldn’t we use a small portion of that — $10,000 – to buy him a 7-year-old replacement vehicle? In cash?
Here’s why, the podcasting guys reply: Car loans are going for two percent APR. You could take out a loan at two percent and invest the $10,000 cash for a better return, they said.
I tried to imagine what that would look like. First, I would make a lump-sum $10,000 deposit into an investment account – so that I’d know that I was actually investing the cash, rather than frittering it away.
Then I could invest the money into an S&P 500 index fund. Historically, those have a long-term annualized return of 7 to 9 percent. That’s substantially greater than the two percent APR that a car loan costs.
In other words, I could borrow at two percent, invest at 7 to 9 percent, and pocket the spread.
Hmmm. The idea made sense. I floated it by Will.
“Are you smoking crack?!,” he replied.
“What do you mean?”
“You want to borrow money and put it in the stock market,” he explained, slowly, placing the emphasis on ‘borrow.’ “That’s the worst idea I’ve ever heard.”
“I’m talking about a broad-market index fund, not Facebook stock,” I offered.
He shook his head.
“You’ve lost your f&*%$ mind.”
How About Paying Off the Mortgage?
Okay, so that wasn’t going to work. I brainstormed that night about how else to optimize the cash, and came back to him the next day with an alternative.
“What if we borrowed money for the car, and put the $10,000 towards paying off the mortgage?”
I figured that idea would get him listening. He LOVES chatter about paying off the mortgage. And our highest bank-issued mortgage rate – 5.25 percent – is substantially higher than the interest on a car loan. It’s also early in its amortization schedule, when a large paydown would really move the needle, saving us a ton on interest payments. (And because it’s a rental, a refinance isn’t in the cards.) We’d forgo some tax savings, but the math might still work out.
Strangely, though, Will didn’t seem interested.
“I don’t believe in car loans,” he said. “I don’t believe in consumer debt. I only believe in cash-flow positive mortgages. And even those I want to pay down aggressively.”
He was touching on a contentious topic. I prefer to shovel money into retirement accounts and acquire more rental properties. He prefers to pay off our mortgages. It’s the old pay-off-the-mortgage-or-invest dilemma. I take a Robert Kiyosaki view of money; he favors the Dave Ramsey approach.
“Then don’t think of it as a car loan,” I replied. “Think of it as refinancing $10,000 of your mortgage into a lower interest rate.”
He looked at me suspiciously. “Any time a financial explanation is that complex, something’s wrong.”
“Look, all I’m saying is — who cares how the loan is secured?” I replied. “At the end of the day, your total liabilities are $X, and their cumulative interest rate is Y. Who cares whether a car or a house secures those loans?”
“Car loans are being offered at less-than-inflation,” I added. “Think about that. Less than inflation.”
“We have a clear exit strategy,” I continued. It was my last pitch. “If a worst-case-scenario unfolds, we have the cash to pay back the loan instantly. Why not put that money to work, rather than ‘parking’ it?”
Will shook his head.
“I just want to go to my grave knowing that I’ve never had a car loan,” he replied.
At that point, I realized two things. One, financial nerds (that’s us!) have very weird deathbed ambitions. Who aspires to look back on their life and say, “I never had a car loan?” Finance nerds, that’s who.
Second, this issue was clearly a non-starter. We were going to buy the damn car in cash.
In the end, that’s precisely what we did. Will bought a 7-year-old Acura with 90,000 miles on it. I bought a car, as well: a 5-year-old Honda Civic, to replace my 15-year-old Camry. We paid cash for both, and vowed to keep them for at least a decade.
Okay, it’s the Invest vs. Pay Cash showdown. What would you have done? Sound off in the comments.