Should you pay cash for a car?
That question isn’t just a hypothetical anymore. We need to buy a car. And that means we need to make a five-figure decision.
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 finance bloggers told me I’d be nuts to pay cash.
It Began With a Podcast …
You see, it all started one night while I was recording 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!)
I’m one of four people on this podcast segment. The group of us are chatting one evening, and I mention that Will and I are planning on buying Will’s next car in cash.
The podcasting 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. (Because it’s a rental property, a refinance isn’t in the cards.) We’d forgo some tax savings, but the math still works 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 percent. 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 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.
****
Your Turn! It’s the Invest vs. Pay Cash showdown. What would you have done? Sound off in the comments.
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I would have just payed cash and be done with it. The numbers you are talking about that you could possible earn by playing the game and investing are just not worth it for me. You are looking at a difference of 100 to 400 a year in profit. There would be extra paperwork and loan origination fees and several other things that would have probable eaten up that profit, or at least bringing it down to next to nothing. At the end of the day it is nice having your car totally paid for and not having to worry about making payments on time. If you multiple those numbers by 10 or more than it might be worth talking about, but only if you have a proven system, not if you are just thinking you could do something with it. If you are already making a great return somewhere else and you could easily make a lot more with the additional investment than it becomes worth it, but still most likely not at the 10K mark.
That is how I would look at it.
@KC — That was Will’s thinking, as well. A quick back-of-the-envelope calculation said that we’d save about $2,500 over the span of 5 years if we took out a 2 percent car loan and used the money to pay down the mortgage. Subtract the loss in tax benefits, and we’d save closer to $1,800 (very rough ballpark figure) over the span of 5 years.
That’s $30 per month. Which is “real” money, of course, but is it worth the hassle? The fees, the paperwork, the loan origination, the credit check …. Will said he’d rather just earn an extra $30/month than deal with this level of hassle and risk.
I replied that $1,800 is still very real money. If this causes 18 hours of hassle, we’re earning an hourly rate of $100/hr.
One of the things that your boyfriend is including is risk. Its not just $1,800. You have to adjust for risk.
1) You have the risk of making the payments. Ie what if you get sick, a tenant doesn’t pay, downturn in the market, etc. We just saw the greatest buying opportunity in our lifetime on property. Those who had minimal debt and large piles of cash were able to clean up on real estate.
2) there is the risk the market goes down not up. The Nasdaq went down in 2000, and didnt recover for 15 years. If you took out a car loan to reinvest, you ended up behind.
3) Opportunity cost. It seems to be real estate is your bread and butter, its the one real asset class that a middle income investor can use leverage. I for one have personally found it best to have as little debt as possible on consumer goods. This has given my wife and I opportunities to put together multiple property purchases in a way we never could have done with a loan. It also has given us the flexibility to move immediately on a property when we do come across a deal. We have bought 3 properties in a little over two years. All three we bid within 3-4 days of those properties showing up on Zillow (2 on MLS, 1 FSBO). Had we been messing around with car loans etc, we would have missed out on all three, our debt ratios would have been too high to qualify.
4) It distorts the signal between what someone can/should afford for a new car. If you pay only in cash, you make different purchasing decisions than if you take on loans for cars etc. Heck there is some risk at making poor decisions with loans on real estate.
I bet when you actually factor in risk weighted returns and the distortions in buying patterns that the actual return on a car loan so the money can be reinvested, is negative.
Totally Agree!
It’s unfortunate when emotion is allowed to overwhelm rationality. Have you done the calculations to understand the loss you incurred to indulge his emotional need to purchase the car with cash? Does he place that kind of value on his need?
Au contraire, mon Slug!
I know you are just making a quick blog comment, so I won’t be too hard on you.
My job is one that involves critical decision making on a daily basis. I’m not trying to be a snob, but honestly, chasing that kind of money just isn’t worth it to me when you factor in how much mental energy it would be to deal with it, both to set it up and on an ongoing basis. Again, without wanting to sound like I am too good to care about that amount of money, I can easily gain or lose that amount when I am bidding on a new project. And the more I fill my mind with worries, hassles and commitments, the less useful I become and the more likely it is I will make a much bigger mistake. Paula didn’t mention those biographical details in her post, so there is more to the story than you may have considered.
-Will, with the paid-for Acura
Will,
I’m in your boat. I belong to the cash-flow/debt free/zero obligation to loans category. I always have a car fund for this reason. Investing is like gambling. Nothing is guaranteed. A paid off car—now, that’s a guaranteed return.
It is only paid off because you paid cash. With new car loans at zero or .9 percent, paying cash is not always wise. In addition, having a low interest loan paid off over an extended period does wonders for one’s credit score.
Will…smart man.
Martilyo
The Angry Millionaire
Despite the math coming out saying that the loan would have netted you more money, I’m with you.
KISS: Keep It Simple, Stupid
It’s just not worth the effort over such a long span of time. Earn more, penny pinch less.
I have to agree with Will. Everyone one is talking about investing and how the money could possibly (POSSIBLY) do well elsewhere. However, lets not forget that by owning the car (depending on what state your in) it lowers your financial obligation to the insurance company. You only need limited coverage/ Liability. A gigantic savings in the North East. Hundreds of dollars save per year. I’m in NY
How about a Tesla Model S car? That’s my dream-car at the moment
Nice car choices! I hope you enjoy them.
I would have paid cash too. I like to keep my business and money making activities separate to my personal consumption. A car loan means no, or one less, monthly payment going out every month from personal cash flow. That is appealing. If I use my car for business purposes, I ‘charge back’ its use against that business’ or property’s costs, and in the UK there is a specific thing in the tax law that allows for this properly too.
I’ve seem my mom buy her last two cars in cash and been frustrated by the decision – what’s worse is they were new! I would have gotten the loan and paid off more than the minimum each month so as to reduce the interest on the car as well as get rid of the balance faster. But would have used the rest of the money to either pay down a higher interest mortgage or invest.
Allesen,
If your mortgage is at a higher rate than your car loan, shouldn’t you refinance? Buying a new car with cash? I would never fathom it… Used cars are the way to go and they are best bought with cash…
Martilyo
The Angry Millionaire
Perfect post! Perfect Solution! There are always opposite view points. It is important to do just what you did; review your options and choose the one in line with your values. In the same situation I chose to finance the car and pay down a mortgage. Our decision was based on net carrying cost savings and having access to cash for another income property.
I’m pretty sure I’ve read somebody here on this site who says we should spend the money we save on whatever we want, whatever will bring us the most happiness. It sounds like this is what he wants to spend his money on. I see nothing wrong with that. 🙂
And, of course, you went along with it, because you value the relationship far more than you value the little bit of extra cash you’d have eventually earned the other way. That’s what you spent it on. Sounds like a smart investment to me. 🙂
@Rich — That is the best comment EVER. I’m seriously thinking about printing out your comment and tacking it to my office bulletin board. I hadn’t thought about it like that … thanks for keeping it in perspective. 🙂
Paula, this is a SUPER interesting discussion, by the way. The part that makes it so interesting is the fact that it’s a discussion between two very intelligent, rational people who are already smart with money and thinking of ways to be even smarter.
That being said, your husband’s point of view probably works best with the general population (although most of the general population probably wouldn’t be in a financial place to take advantage of what you’re proposing, but regardless…). For most people, taking out the car loan would trigger some intense emotional responses and force our natural desire to have all of the things we want, quickly, and without having to prepare to have them… so it could be a bit of a slippery slope.
The two of you would easily be able to handle doing it the way you’ve suggested, but it sounds like his emotional happiness and peace would be worth the potential loss of interest.
Thanks for putting this out there for us to see!
Awww, thanks Tim!! 🙂
Cash ainec. Psychology trumps numbers. Yes, I realize that if you have a 2.5% APR loan, you only need a 4.74% CAGR in your investments to make this a good deal (less if you use it as a mortgage swap), which is 4.18% less than the historical market CAGR, and even only 2.32% worse than the 10 year CAGR.
Still, is a 4.74% annual return on $10k (you’ll wind up $2,604.65 to the good at the end of 5 years if you invest in the market and get the historical CAGR) worth all of the consternation it’s going to cause in Will’s life? Clutter of the mind is costly.
It’s the same reason we buy our investment properties with cash.
@Jason — Exactly; mental clutter is costly.
The principal behind Dave Ramsey’s “debt snowball” is to minimize the psychological toll of having multiple debts, by paying off debts in the order of smallest balance to largest balance, regardless of the interest rate on those debts. (That tactic, like most topics in personal finance, is controversial. But it has worked for a lot of people. It also costs more money.)
In this instance, we’re paying a “higher interest rate” (our mortgage) for the benefit of having one fewer monthly bill / one fewer debt account. It reflects that snowball principal.
But it is the right choice? Psychologically, it’s great. Mathematically … it’s questionable. 🙂
When you have $10,000 to throw around at 1 of 5+ goals, it’s a VALUES decision, not a financial one. And that totally makes sense that he went with the action that best reflected his values.
I had the same decision a year ago. I bought a 2003 Mini Cooper from a private seller for $10,000 after tax. I put down $2000 and financed the rest at 2.9% at my credit union. Since I didn’t yet have enough savings to buy the car outright, I think I have the deal of the century – the low interest means that the interest I pay every month is so low that I hardly feel it.
I also know that if at any time I just can’t stand the loan another minute, I can sell the car. Consumer Reports recommended putting 20% cash on any used car to cover tax and fees (10%) and a bit of depreciation. You’re unlikely to be upside down that way.
At the same time, my mom (who has enough money for anything she wants) bought a new $42,000 SUV. (She’s frugal and she’s also 90. Her philosophy right now is, hey, I’ve always wanted a new car and I can afford it so why the hell not?) I asked her why she didn’t finance it since interest is so low, then invest what she would have spent on it, and pocket the difference, and she said she didn’t want to drive a car the bank technically owned. I think buying a car is just an experience she wanted done and gone.
@Leslie — Good for your 90-year-old mom! When I’m 90, I’m spending my money on anything I damn well please. ESPECIALLY if I have plenty of cash.
I’ve had this same conversation with friends multiple times who go the Dave Ramsey route where they scratch and save for years in order to pay cash for a car. My friends would rather have security and piece of mind of not having debt; I’d rather come out ahead in the long run. I have loans on both of my vehicles at 2.5% interest and am putting all available cash into rentals that cash flow at a much higher rate. Seems like a no brainer to me.
Hey, Nick, thanks for the comment. I think we all want to come out ahead in the long run, but it’s just a difference in how we each think we will get there. For me, I make a distinction between consumer debt, like a car and investment debt on a rental house. I know all the arguments about if you buy x while you owe money on y, then you are really financing x with y. I just wanted to keep it simple. I wouldn’t be upset at someone who chose differently, but that kind of reward just wasn’t going to make a big enough difference in my life to hassle with.
Having paid-for things has served me well. I started my first real company by selling a paid-for VW Jetta and I have absolutely no regrets about having paid cash for that car or having sold it either.
Will,
You are so right in your decision. Less hassle equals more money in the end. It keeps your mind clear.
The only thing no one brings up about investing is markets go up and sometimes they go down. If you invest in the market you should always be prepared to lose 50 per cent otherwise you have no business being in the markets. The average return the market brings may no coincide with the time frame of the loan. My opinion is its not worth the hassle!
Peace
@Howie — I’m glad to see so many people bringing up the notion of keeping your mind clear & uncluttered. As I’m sure you know, I’m a huge proponent of the idea that your mental bandwidth is limited, so you should viciously guard your mental energy — and spend it only on the things that matter most. Will felt that the hassle of getting a car loan wasn’t worth any potential down-the-road gains.
Your credit has a huge play in this question as well. If you have really good credit there is no reason not to finance. If you have EXCELLENT credit you can even purchase a brand new Toyota right now with 0% apr for 5 years. If you don’t have to pay any interest on the loan, why not span it out and not shovel all of that cash out? People with good credit that use it wisely always end up paying less for many things and pay for them over small spans of time.
@Uncle Casey — We both have excellent credit. But neither of us are a fan of brand-new cars. The money that you lose to depreciation far, far exceeds the amount that you’d pay in interest.
A brand-new Camry LE starts at $22,235, according to the Toyota website. A 2010 Camry LE (only 3 years old) with only 36,000 miles on it sells for $15,000, according to Kelley Blue Book. That means it loses $7,000 to depreciation in 3 years. That’s much, much more than you’d pay in interest.
The new vs. used argument is actually not as case-closed as it used to be. In the mid-Atlantic and Northeast of the US the used car market is extremely tight right now, due to a combination of Hurricane Sandy flood damaging a ton of vehicles (supply is down) and the recession stimulating demand for used vehicles (demand is up). Frankly, the price difference between a new car and a 1-3 year old car is trivial for many models. I always assumed I would buy my next car used, but when I did the research on the model I wanted (Honda Fit) it just didn’t make any sense to buy used.
Note: I did not consider models older than 3 years like you did because they lacked safety features I wanted (specifically, Vehicle Stability Assist, for which the Honda Fit was recently recalled). Just can’t win some times.
Rizzo,
You actually believe supply is down on used cars in your area? I would bet that there are many used cars for sale in your area. Check out Craigslist. I am sure you could find a nice higher mileage vehicle for a lot less than a new car.
Martilyo
The Angry Millionaire
People underestimate the ‘peace’ factor when it comes to investing and to relationships. Often it’s not about the cost or bottom line; it’s about whether or not you are happy with your life and can sleep at night. In this case, I think recognizing and acknowledging a partner’s priority/goal/need to be free of consumer debt and another monthly obligation was prioritized over potentially earning an extra $500 or so ($10K invested, earning 5% after auto loan cost). Arbitrage is great and can be a powerful wealth-building tool but if the invested funds don’t perform as expected (a short term investment looking at long-term historic results may not generate consistent monthly payments) the loan still has to be paid every month. If there are any other factors involved (i.e. income inconsistency, other priorities) they could make the risk greater and the peace factor that much more important. Live and spend according to personal values and priorities.
I also just bought a new car with cash. It is a NEW car from a dealership. The first time I’ve ever bought a car with cash. There were two reasons I did this. Initially, I was going to buy the vehicle on a three-year loan but it would have ended up costing me about $2600 more. The only reason to get a loan would have been so that I would have more money in my bank for other uses. I eventually decided to pay cash to avoid the extra cost but mainly for the peace of mind knowing that I won’t owe any money to anyone. This peace of mind is worth a lot to me. I won’t have to remember to pay a monthly payment and I know that no one will be able to take the car away from me for missing payments (which, thankfully, has never happened to me so far).
Ah, quite the dilemma!! Well, not really, for you as you have the cash on hand. IF you look at this decision in isolation though, there is indeed something your podcast-mates are not considering. That’s risk. Sure, if you look at it strictly from the interest incurred vs interest earned, it is a no-brainer. But, while Will’s position might simply be philosophical, his aversion to debt is probably because it represents risk. Debt is inherently risky and, therefore has to be quantified somehow to make a truly comprehensive decision.
Thanks for a great post!
I’m with KC. Too much thought/paperwork for the potential gain.
When I went through a 7 month decluttering after spending almost 2 yrs in bed and losing most of my vision, I was SHOCKED at how much bandwidth keeping track of minutia took up. I got rid of a TON of stuff – I gave it away – although I needed cash, I needed to get rid of stuff and THINKING about stuff more. I never regretted it and I am a healthier person for it. For me, this car financing thing for a larger yield someplace else is like extreme couponing – it wouldn’t have been worth my peace of mind. Buy and be done.
This is really a very good point. A car loan payment is one more thing on you mind. It doesn’t matter if it’s automated payments, it’s still on your mind and part of your cloud of things to manage.
I think Will is crazy. You take the low interest loan and you pay more towards the higher interest loan. That’s just math.
The other reason not to pay for a car in cash is because you might total the car and the insurance company may not pay as much as you paid for it. You can get GAP insurance on a loan to cover that spread, but there’s no insurance when you pay cash.
@Kevin — Since the cars are so old (7 years and 5 years), they’ll depreciate more slowly, so I’m not too concerned about the “gap” between an insurance payout vs. our cash outlay. There will be a deductible, of course, but otherwise the depreciation will be minimal.
Kevin,
What do you think the statistical chances are of totaling a used car and having a huge “gap” between the value and the pay off of the car? The older the car is, the less the gap is in cost vs value. I can understand having gap insurance on a new car if you are going to finance it. But honestly, why would anyone buy a brand new car and finance it? 0% interest? It may sound good but if you buy a brand new car and finance it over 5 years at 0% are you going to be able to make more money in investments than the car will lose in value over the same amount of time? Just a thought.
Martilyo,
The Angry Millionaire
I would have paid cash and for sure not of invested in the market with borrowed money, even in the index fund. Plus just keep it simple And not involve any loans /banks. I am with husband on this one.
Hello Paula,
Thoughtful fight. I would go with your idea. Getting 2% car loan and paying mortgage, very simple and profitable deal. I think your ‘Will’ need to come out from some sort of fear of consumer debt. Sometimes we have to think little long and different. I believe that is not harmful.
Anyway, congrats for your new cars.
Your ardent reader.
Saurabh Chavda
Nothing wrong with skipping the debt from psychological reasons – sending monthly checks to multiple banks might be a bit distracting from your goal of passing Ted Turner in land ownership. It may not be mathematically ideal, but it’s not a world-ender (else you could yell at bloggers who don’t have a loan for not leveraging themselves enough).
Oh, I should mention – that’s a great podcast!
@PK — It’s a pretty awesome podcast, eh? Maybe I should tagline it: “The Podcast That Encourages You to Go Deeper Into Debt!”
That’s some nice arguments you guys got. I think the advice they told you that investing it or putting it on something with higher interest like mortgage are two great suggestions and if I where in your situation, I would invest the money first and then pay for my car through a loan.
My wife and I took a loan for our last car–got 1.9% so we felt happy with it. However, if we had the money on hand, we would have gladly paid cash for the car.
Interesting… I keep seeing those 2 something % car loans advertised, and remembering that there were 0% car loans, about 10-12 years ago I think? At the time a relative of mine got a loan for a car she could easily have paid cash for, saying “its like getting free money!” That is when I will look into an Evil Car Loan, if 0% ever comes back.
If a deer walked across in front of your television in your living room you would notice it no matter how carefully he tried to be un detected. If you were hunting for that deer in the woods wearing camouflage it is more likely that he would see you before you would see him. Unfortunately the saying goes when you walk into that car dealership you are as vulnerable as the deer that walked in front of your television. The sad reality is that the consumer never really wins. Dealerships have tactics from A to Z to guarantee the profits they want to make on the sale of a vehicle. 0.0% almost always means that you’re going to pay a little more for the vehicle. After making the best deal on a 2002 Dodge Ram I had a salesman tell me that he couldn’t give me the 0.0% that was advertised on all their windshields, I had a choice between The price that we negotiated or the 0.0 % financing. In this case I couldn’t afford to pay cash for the price we negotiated, so I excepted the 0.0 but there was about a $1900 difference in price. So I say bang out your best deal then bang them with cash if they don’t like it then walk out.
YEAH PAULA & WILL!
That’s awesome that Will replaced his stolen car, and in the process you decided to “upgrade” too.
I’m with Will on this one; especially considering that I am currently, NOT in a position to pay cash for the type of car I want (Benz), so anybody who can, I say, “More power to you!” Also, It’s also difficult to have a car payment when you haven’t had one for a long, long, long time. Prior to me purchasing my Accord in 2002 (Brand New…note, I won’t ever do that again); I hadn’t had a car payment for over five years, and currently, that Accord was paid off in 2007, so I haven’t had a car payment in 6 years, and can’t even fathom.
I am in that camp of: the fewer bills to have to pay out every month, the better…for me, anyway.
Late to the conversation party here, but I’ve got to side with Will on this–and with the early commenter’s line about spending our savings on what we love. Will loves debt-free-ness and Paula love Will’s-happiness. Discussion over, right there.
But it’s also a question about how much we need. Do we so need the extra few percent we could make via a slightly complex ten hour invest, that it is worth any risk? Can we afford to come out on the losing side of that investment if (when) the market is down on the day we call the deal over?
In the end, it’s almost a religious choice, like Apple OS versus Windows. The woman I love dearly prefers one and not the other, so why on earth spend time trying to change her? She and I have far more important things to do.
And Paula (and Will), thanks for being so honest and open. Again.
@Bob — “almost a religious choice, like Apple OS versus Windows” — that’s hilarious!
Glad to be honest and open. I hope it helps people think & learn more about finances, career and life.
Haha Great post! We intend to save up and buy a new car in cash next year as well. Is the 2% offer just for new cars or used as well? Because where I am, new cars have 0-2% finance offers, but most used cars I think are at 3 or 4. So the extra 3% returns you’d get is really not worth losing sleep over. The other thing to consider, is you have much more negotiating power with cash. I bought my last car in cash, and saved about $3500 on a $15000 purchase, because I was able to pay the dealer upfront. And that’s a lot better than the 3% return. Sorry, but I’m with Will on this one.
CASH. We, too, just bought a car to keep out at our winter home – a 2010 Honda Civic with only 12,000 miles on it ($14,600 + taxes, etc.). We have always paid cash for our cars – we buy them and drive them forever. My last was a 2004 Honda Accord manual that I absolutely freaking loved – had it for 15 years, gave it to a friend who really needed a car, and it’s still going (had about 148K miles on it when I gave it to her). Bought a 2009 Camry for cash that I absolutely love. I’ll drive it into the ground. We hate to have to do the monthly payment. So paying it off alleviates having to make the monthly payment. May just be a mental thing – but we have no debt and just don’t want to have any for the rest of our lives.
We were actually in a situation when we bought our last car in which our credit union offered us a lower rate to finance than they were offering in their own term shares (aka CDs)… so we could have leveraged that money risk-free with the same bank! (At the time, online savings rates were pretty high, so we put it in an online savings account until rates dropped lower than our loan rate, then we paid off the balance.)
If we were offered a lower interest rate on a car than our mortgage rate, I would absolutely put that money towards the mortgage and pay off the car slowly. We haven’t been in that situation.
p.s. Re the hassle factor– with our credit union it was maybe an hour work total, and automatic payments. We were surprised at how easy it was. If it had been more of a hassle we’d definitely need to run the numbers on how much we’d be saving. (For example, I haven’t moved my annual savings for the unpaid summer to a term share because it isn’t worth the $80 difference for me to deal with that, even absent the loss of liquidity. Back when rates were higher and we were poorer, it was absolutely worth it.)
I would have gone your way too, but I don’t know if that would lower your access to other credit, namely a mortgage for the next property. I took a cash advance on a 0% credit card once to invest and that lowered my other options for cheap financing.
I’m all for maximizing return, and I’m ok with profitable debt. Our cars were bought with 0% for 72 months and 1.9% for 60 months. I put down as little as possible. It affects your debt-to-income ratio for future loans, but once you’re within 12 months of paying it off, the banks don’t count the payments anyway in debt service. Our 72 month loan will be within those 12 months for us when we’re ready to buy our next property.
Thanks for mentioning your podcast. I’m going to add it to my playlist.
My 2 favorite hobbies are real estate investing, and poker. Emotional decisions are not welcome in either. That being said, whats important here is that you guys considered all of the options and made your decision based on what works for you.
I stumbled across this blog recently and I must say I like it so much that I am going to share it with my FB group where I am trying to teach my young nieces and nephews how to handle/invest/respect money. Great work here.
So funny. Will is Connie (my wife) and I’m with you @AffordAnything
When #Katrina hit, I hit the road with my #Adjusters license and came home with an extra $100k. I wanted to invest it (our mtg was only 4.85%). Connie wanted to be Debt Free. Connie won. A few weeks ago, we discovered tha I needed (wanted) a Lexus RX350 (2007ish) to replace my Lexus ES350 (2007). By the end of that conversation, Connie had me excited about our joint commitment of “driving the wheels off” her 2004 Honda Accord – before buying another vehicle. At the end of the day, I’m just thankful to have my #Harley #Fatboy #MunchMac in Houston, Texas.
@Jim — Wait a sec … you spotted an opportunity to earn a quick $100,000 after a hurricane? Okay, I think THAT’S the real story! I’ll be contacting you to get details … I love to share stories on this blog about people who spotted opportunities, pounced on them, and walked away with 6-figure rewards.
I would have taken the car loan as well. But it’s only 10k, so in the big picture (of your financial independence) it’s not going to make a huge difference either way. If you were doing this every month (leaving money on the table) that’s another thing. It’s a small price to pay for your boyfriend’s peace of mind, and it’s not like it’s completely stupid to pay cash for a car.
I’ve been in the pay in cash camp. But that’s because I was time-mental-constrained with career/kids. Next year or two, I hope to “retire early” and at that point, I can clearly see myself doing the “low interest” option.
@Kay – There’s definitely something to be said for taking a simpler route when your mind/energy/time is already pushed to the brink. Paying cash, or taking a low-interest loan and investing, could both be good options depending on what else is going on in your life.
Ha! Check this out! Here is what happens on your site when I go on vacation….that’ll teach me to take a couple weeks off, huh? 😉
I’ll admit that I never cared (on the podcast) how this ended, I just know that decisions work better when we fully discuss all the outcomes. Check out this discussion! I think we’ve all learned a ton just from the diversify of opinions. Awesome.
The difference isn’t really 2,500, though, (the number Jason pointed out). If you’re using that money long term (toward retirement) we can use the rule of 72 to find our way easily to $80k. If you aren’t, then it’s a short term hassle without any real value.
@Joe — Yep, this will teach you to never go on vacation again! Haha!
Hmmm … okay, rule of 72. We’ll assume an 8 percent long-term annualized return. In 9 years, that money doubles to $20,000. In 18 years, we have $40,000. And in 36 years, we have $80,000.
Inflation eats away 3 percent, so we’re “really” talking about $50,000 in purchasing power. That’s still a decent chunk of change. (Ahem, Will, see my point? Borrow money and invest in index funds? Ahem?)
****
Will still thinks the notion of investing in the stock market with borrowed money is far too high-risk. He’s not budging on that idea. Paying off the mortgage is the closest thing he’ll entertain. 🙂
Do you have any cash reserves sitting around?
If so, go out and get a loan on those reserves and invest the whole thing in an S&P fund.
If the answer is no, its too risky, isnt that essentially the same thing? its your risk meter kicking in.
That’s an excellent point, George! 🙂
I have a friend who talks about how he regrets paying off his mortgage. He says that if he had invested that money instead, he could have earned more in the market. So I challenged him: “Why don’t you take out a home equity loan and invest that money?” … and he balked at the idea.
You’re right — reframing this is a great way to gauge your risk meter!
Awesome discussion here. I’m with Will on this one, except I buy older cars (like 10-12 years old….or older) so that they don’t depreciate at all. But when I have some more cash, I’m totally going Will’s route. It’s more of a security thing, and an ownership thing. But for me, I won’t spend over probably $6,000 for a car, so the invested difference isn’t a whole lot, and doesn’t compare with the peace of mind.
I would take out a car loan and use the cash to pay down the mortgage. With this option, the rates are fixed and I could be certain that I’m paying less interest this way.
Maybe I’m biased against the stock market. The thing is, historical rate of return is just that: something that has happened in the past and may or may not happen again.
But I can also see how having two fewer loans to worry about bring the sort of value that’s unquantifiable. I know I hate having to keep track of due dates.
I love how you are both such “financial nerds” (your words, not mine) that your arguments even mirror one of the most common ones in the PF circles.
IMHO, anyone who suggests taking putting borrowed money into the stock market (index fund or otherwise) has zero credibility (unless you are Bill Clinton and it’s White Water) and is spouting financial fantasy to sell “advice” to the unwitting. Can these so-called market experts guarantee me that I will even earn the market rate over the life of the car loan (2-5 yrs)? Without the guarantee, it’s just all fantasy and wishing.
Case in point about market timing and payoffs: I have 2 friends–one made an incredible sum on the 1990’s tech bubble and cashed out at the right time, the other made lots of paper profits and lost everything (including principal) when he held on too long and it came crashing down. Can the experts ensure that even the principal will be there at the end term? That also doesn’t include transaction costs, taxes, commissions, etc. Market averages don’t mean anything over a short, 2-5 year term. You made the right decision.
Bob2 — No one said anything about investing the money for only 2-5 years, the life of the car loan. If that money was in an index fund, it would be held there for 30+ years. It would simply get a 5-year headstart, that’s all.
I know a guy who was in a similar situation. His Accord had lots of miles on it like the one that you are refering to.
We have always purchased our vehicles with cash. It has worked for us but with all big decisions there are ups and downs. Best of luck to you. -Joy
We always finance our cars. However we don’t have kids, that may be a game changer to car buying.
I absolutely would NOT have paid cash for the car. People think debt is a bad thing. But debt can be a great thing if properly leveraged. If you can get a low-APR loan that is money that you can put to work for you and not some institution.
Also, having a car loan also positively improves your credit, in a way credit cards cannot. So if you got a loan you can make more money, you can improve your credit, and you get lower interest rates on other things like mortgages, credit cards, and other loans. Plus, employers often pull credit records.
I highly disagree with you. I pay cash for ALL of my cars and my credit ratings are all above 800. My FICO scores remain at over 800 although I have not ONE car payment but have many credit cards that I always pay off at the end of every month…never do I pay credit card interest…NEVER
I’m a little surprised at you buying cars with such high mileage. Won’t they cost you a lot of time, money, and aggravation if they start breaking down a lot? Don’t get me wrong, I always buy used cars, but I usually won’t go over 50,000 miles because any time I let a car go over 100,000 miles, they start costing me a LOT in repairs. I mean, there are so many parts in a car and as they all get older, they start wearing out. I try to pay cash for cars also just because I hate car payments, but the argument does make sense on the interest rates.
Adrian,
How much money do you lose in trading in your car when you hit 50,000 miles? Also, how much money do you lose in depreciation when you buy your next car? Cars are the worst money investment. I understand if you have a car that is costing you left and right, but as long as you buy a good car (Honda/Toyota) that have proven themselves to be reliable, I feel you are just wasting your money buying cars every time you hit 50K miles. If you buy your cars used, how many miles are on them when you buy them? My last car was a 1998 Honda Civic LX with 215,000 miles. I wish I never sold that car…
Martilyo
The Angry Millionaire
When my wife and I had twins (unplanned!) to make us a family of 5 two years ago, we had to shop for a bigger vehicle to replace her small sedan. We originally shopped for SUV’s 2-3 yrs old, but quickly found that new ones were only a few grand more with 0% financing. We were planning on paying cash but we instead took the $33k and put a down payment on a package of 5 turnkey single family homes. I paid $139k for the package, put around $30k down (20% plus closing cost). The houses gross $3600/mo, with a net of about $1000/mo. It is a 10 year ammoritization @5.65%, about $800/mo toward principal. The car payment is about $600/mo, so obviously the net cash flow more than makes the payment. At the end of the 60 months, not only will the tenants have paid off around $50k of the mortgage, they will have bought the vehicle for us ($33k) and supplied us with an additional $24k in cash flow! With all that said, I despise the car payment! But my wife, who is the much more patient, rational one points out how beneficial this will be in just 3 more years when the car is paid for not to mention 8 years when both the car AND the houses are paid for.
@Geoff — Wow, that is the BEST car financing story I’ve ever heard!! (And a package of 5 turnkey homes for $140k sounds like an amazing deal! What part of the country is that deal in?)
Paula,
Sorry for slow response! I’m located in St. Louis and these homes are lower end, but not war zones. Strict tenant screening is huge, and gotta keep rents affordable for the income level of the area. There are lots of 2 and 3 bed rentals in these neighborhoods for $28k-$40k. Prices are slowly rising for these types of rentals as we seem to have a lot of out of town investors in the last 12-24 months. We are have at least one, maybe two large hedge funds in town buying everything. I listened to your entire podcast and I just want to say congrats on your current and continuing success! Also, I enjoy you website, keep it up. I really enjoy seeing drive and determination in people!
@Geoff — St. Louis sounds a lot like Atlanta … we have good 2-3 bedroom rentals in lower-end-but-not-terrible neighborhoods, but we’re also seeing a ton of out-of-town investors, particularly hedge funds, gobble up the inventory.
Thanks for the compliment! I’m glad you like the blog!
Excellently done!!!
While I appreciate Will’s desire to avoid a car loan (I hate them as well), I can see taking an approach like this. It makes more sense to me than an index fund. Looking at this several months after the article was published, 2013 turned out to be a great year in the market. We don’t tend to get years like that very often. Now, if the market had recently tanked, I would give the stock market index fund serious consideration.
@Cameron — Yes, although hindsight is always 20/20. We can’t predict the future: The stock market might skyrocket or tank within the upcoming year. We can make “projections,” which is a fancy word for “guess,” but we can never know the future.
I think its safe to say that over the very-long-term (e.g. 10+ years), the markets will rise 7 to 9 percent over a long-term annualized average. (Based on historical trends over the past century.) But any given 6-month period is too short, too volatile, to make an accurate prediction.
Paying cash for a trivial asset like a $10,000 car is the correct answer and here’s why:
1. While 2% come-on APR loans are technically available, they are available for NEW CARS only, and only if you have an immaculate credit score, and often if you forgo rebates. For used cars, they are a lot harder to get – particularly for anything over 5 years old.
2. The savings in interest (which would actually be more than 2% due to compounding) is a GUARANTEED SAVINGS, like a government-backed bond. When you compare this to a speculative investment, like stocks, you are comparing apples and oranges.
3. The stock market does go down (remember 2008?). So if you borrowed money to buy the car, and then “invested” the $10,000 in stocks, there is a chance that 3 years later, when the loan is paid off, your $10,000 is worth LESS, and you come out behind. This is, on a small scale, what homeowners did in the 2000’s – borrowed money to buy a house, which went down in value, and invested their cash in stocks. They ended up broke.
4. Chances are, you won’t put the $10,000 into anything. These “opportunity cost” arguments are made by car salesmen all the time. But the upshot is, the buyer usually doesn’t have the cash anyway, so they borrow money and DON’T put anything into savings. The vaunted 5% delta investment strategy thus never has a chance to take effect.
5. Paying CASH for a car forces you to make hard choices. When borrowing money, everything is on monthly terms. Go to a car website and see. A $3000 option package is touted as “only $25 a month!” (leasing, of course!). So it is easier to spend more on a car, and not be concerned with the bottom line. When you pay CASH, your priorities change rapidly, and suddenly the panoramic sunroof and leather-trimmed seating surfaces don’t seem that important.
Debt-free is the way to be. You can’t borrow your way to wealth, just as you can’t spend your way to wealth. And you can’t deduct your way to wealth either.
Sadly, most Americans try all three – and wonder why they are broke!
@Robert: Excellent points! Happy to see a reader contribute to the discussion.
In response:
#1: You can often get better financing terms from credit unions, rather than dealerships. We have awesome credit, and our local credit union offers less than 2 percent on any car loan.
#2: True, you’re comparing apples to oranges with regard to risk and volatility. You’re still comparing returns against returns, but you’re comparing them at different risk levels. That’s the main reason we decided to pay cash.
#3: We’re not investing for the short-term (3 years), we’re investing for the long-term (30+ years).
#4: If you’re a regular AA reader, you know that I’d invest that $10,000. After all, I invested 100 percent of my income in the year 2012. And the devoted AA community would do the same. AA readers act on the principles that they learn on this site; that’s why I get dozens of emails from readers telling me their success stories. However, the masses — the non-AA readers — might be sloppy and choose to fritter away that money on champagne and caviar; that’s why they can never escape the 9-to-5.
#5: AA readers know they shouldn’t lease a car.
Again, awesome thoughtful points. You certainly can’t deduct your way to wealth, though you CAN invest your way to wealth.
I haven’t had a car payment since I paid off my 1988 Toyota Camry- the only brand new car I’ve ever bought, in l992. Not having a car payment is supreme and once you’ve been car payment free for a long time, you never want to go back to payments. It shocks me when I hear how much my friends are paying each month for their “new” car. However, I have had one bad experience with paying cash and that is with my current car.
Don’t make this mistake like I did- do not pay cash for a used car without having a substantial amount of savings available should the car need major repairs. Unfortunately, this last car of mine has been a bit of a lemon. Shortly after I bought it, the engine went out and I had to make the terrible decision whether to put in a new engine or let it go. I put in the engine but then had other major repair expenses. I did not have a substantial savings and so spent most of one summer without the use of my car and had to cancel a planned camping trip with my children. I assumed that because it was a Toyota, (like my other 4 cars which had no problems) it would be reliable. Wrong! Had I thought it out more or read Dave Ramsey’s Total Money Makeover book, or been reading your blog at that time, perhaps I would have bought a less expensive car in order to keep at least $2000 available in savings for potential repair costs.
That’s a great point, Nora. I often recommend that people start a savings account that’s earmarked specifically for “future car repairs.” Put some amount — $20 or $50 or whatever you can afford — into this account every month. Then ANYTIME you need a car repair, you can take from this account.
I also advise homeowners to start a separate savings account that’s specifically for “future home repairs,” for the same purpose. As a rule of thumb, they should put 1 percent of their home price into this account each year. If they live in a $200,000 home, for example, they should put $2,000 per year, or $166 per month, into this account.
A real miser would have just bought a $3000 car and kept $7000 to spend on insurance and gas.
Good thing I’m not a miser. 🙂
Not sure if anyone made these points but here goes. I’m with Will on this one. In fact,I’m in the process of buying a 2 year old used Honda right now, and am in the fortunate position of being able to pay cash for it. Here are the advantages as i see them:
1. no loan initiation fees or additional paperwork.
2. no need to put a very low insurance deductible on the car. In fact, if i choose i could just take out liability insurance. i won’t, but i have taken a higher deductible, saving $280 annually.
3. i have money invested in the market, both cash and my IRA and 401k. Having some money tied up in an asset, even a depreciating asset, is not a bad thing.
4. i was able to buy the car at below market value because the seller didn’t have to worry that i was going to be denied credit. Cash makes everything easier for everyone, and psychologically it’s just more appealing.
5. i’m determined to keep my fixed costs low, so that if at any point i want to quit my job, or if my job quits me, what i need to sustain my standard of living could be supported on very little money. This gives me a lot of freedom. If i invested the money instead, i may have to pull it out of the market when it’s down, or in a year when any earnings will be taxed at an unfavorable rate.
Most of all, though, paying cash made me very careful to buy a car i can easily afford. It’s harder to hand over a chunk of money than it is to agree to paying that chunk over several years. Paying cash has a very positive impact on my behavior as a consumer — i.e., i consume a lot less than i did when i thought credit was the way to go.
Those are excellent points, Mary … Point #5 especially! The main reason that I’ve avoided consumer debt is because I love freedom. And having no bills — other than groceries — gives you a LOT of freedom. 🙂
You’re also right about how paying cash “restrains” your budget to only things that you can afford. Will once noted that debt allows you to “do stupid longer,” by spacing out the payments on something you never should have bought in the first place, because you didn’t have the cash at the time.
(Not “you,” Mary. The general “you.”) 🙂
Now that we’ve paid cash for both cars, I have to admit that I’m pretty freakin’ happy that we don’t have a car payment … theoretical interest-rate savings be darned.
Thanks. I love the “do stupid longer” nugget, by the way. I bought the car as planned and feel really great about having chosen a car that meets my needs perfectly, and represents zero stress because it doesn’t detract from my goal of getting back to more meaningful though lower paid work.
Now I’m going to read more of your blog, which i really like the look of.
For me, one of the greatest benefits of buying an older car for cash is that you aren’t required by the loan company to carry comprehensive and collision insurance. That alone can save 400-600/year. Of course there’s the risk that you’ll wreck your car…
…but you are a strong saver. You had enough savings to buy the car and should have enough cover repairs. You can minimize your risk by getting collision insurance with a higher deductible.
great post! very related question with a different twist. I’m young (23), and my fiancee and I are looking at getting her a used car to replace her old clunker. We’re looking in the 6-10k range and easily have the cash (seperate pool for emergency fund, both have 401ks etc). I’m a fan of the pay cash option. I’m a big hater on debt (neither of us have college debt). She has heard that to build credit history for a mortage in the future we should take out a car loan. We’ve both had credit cards, never missed payments but neither of us have ever had a loan in our name. Thoughts?
@Spencer — That’s such a good question that I answered it here, in this post.
I realize I’m dragging up an old post, but it caught my eye. We are in a similar boat. Pay off the car or invest the 10k. We can do better by investing the money, but decided to pay off the car. We are pushing to “retire” by 40 and the car is a $300/mo payment that must be made. Its a cashflow issue. We want to minimize our expenses so we need less positive cashflow to live off. The $300 reduction is guaranteed and permanent, investment returns are not. Should we invest the money and our returns sour for a bit, that $300 car payment is still required.
Paula, thanks for allowing folks to look at all sides of the debt/investment debate.
Jason
Just pay the car in cash and be done w/ it. I hate having payments.
I’m going thru the dilemma now of paying off my mortgage vs. going the normal route.
Hi – I just stumbled upon this interesting discussion – regrettably, I’m coming in late.
I did not see anybody bring up an existing HELOC. Would any of you draw down from a 4% HELOC even if you had the cash?
Thank you!
@i_witness — Great question. Answer: Absolutely not. Never borrow against your home to buy a car, pay off your credit cards, or do anything else. If you secure your car note against your house, you risk losing your house — a penalty that’s far worse than getting your car repossessed.
Spend as much as you can! I don’t realize the point in discussion. See it is pretty simple; if you have money then don’t store it for the welfare of your bank and if you don’t have then how can your back be wealthy when you are not? I would prefer to be a risk taker, may be a silly one but then I wont ever regret or grumble 🙂
One aspect that seems to always be omitted from this debate is the cost of insurance. When using traditional financing to purchase a car, full coverage insurance is required. When paying cash for a car, the state minimum insurance can be used. The difference in cost between the two is very significant, and easily trumps any interest rate spread.
Alternatively, one could use a 0% balance transfer offer from a credit card and maintain the state minimum insurance. This would produce the lowest overall cost, unless an interest free loan without fees is available elsewhere. Of course, the most beneficial option would be to use the $10,000 to purchase one or more additional rental properties.
A debt is like a slave-collar. As long as you are indebted to someone, they hold a certain amount of influence and control over your life. If you have the cash to buy it outright, you should. If you don’t have the cash to buy it outright, save up.
Stumbled on this looking for more ways to put leverage to work. This one is a no brainer, take out a loan on the car. We just did exactly this. Girlfriend has 8% highest student loans rate, so buying a car cash is essentially an 8% $10,000 car loan. I dont understand how you cant fit this in your headspace? It comes out automatically every month and you pay the saved cash into higher rate loans or a good index fund. Either way, you’re making money firing about 3 neurons…
You pay cash. Playing with interest rates, doesn’t account for risk and harassment of having a payment to manage.
Yes, I know you have the cash to pay it off anything goes wrong. The idea that the money could be better used in the market or reducing your mortgage debt doesn’t hold because if you really wanted to use the money in that way, you would have done it already.
When you take out an auto loan, you’ve already spent the money. It’s just a matter of whether you pay only 10,000 for the car or closer to $11,000 once you factor in interest.
I’m with Will. 🙂 Pay cash. Pay cash and when in doubt, pay cash.
@Ron — “if you really wanted to use the money in that way, you would have done it already.” — That’s an excellent point. 🙂
Heya Paula & Will
This was such a great article. And the comments that followed were equally insightful.
I am a proponent of the “minimise your mental clutter” ideology, and am constantly streamlining my lifestyle and investments. So Will’s decision with regards to purchasing a car in cash resonates well with me.
Now I know this is slightly off topic, but what are your thoughts on carrying over this philosophy of minimising admin into your investments as well?
I stay in South Africa, and one can earn roughly 15% by investing in index tracking funds (this is a cautious estimate, as my returns have been around 20% to 25% over the last several years).
Our yield on property is between 5% and 9% depending on where one invests (so let’s go with 7%), and capital appreciation is around the same. Inflation sits at around 6%, and our prime interest rate is around 9%. Most mortgage loans are thus sitting around the 9% mark (perhaps slightly lower based on the strength of one’s credit profile).
With all this in mind, I have found that when taking a long-term view, investing in equity is far better – both from a perspective of maximising returns as well as minimising mental clutter (by eliminating all of the administrative overheads associated with buying, renting out, and maintaining properties).
I’m not sure if you guys work with property in your day-to-day lives, but I for one don’t, and therefore having to administer a property rental portfolio strikes me as both time-consuming and stressful (especially considering the risk of bad tenants and / or damage to property).
What are your thoughts on this?
I understand the power of leverage, and the wisdom in shelling out minimal cash for a deposit on a mortgage loan whilst having the tenant’s rental income service the overall bond repayments, but when comparing the long-term returns with that of equity, is the admin and the headaches worth it?
Keep up the great blog by the way. I only just discovered it, but I suspect I’ll be returning regularly.
Cheers from Cape Town!
Ok, here’s what we’ve done in the past. My wife and I have owned many cars both new and used. We always weigh the options when making the decision. We recently bought a new CUV and found new and one year old models had substantially better fuel economy and safety features than older models and the prices weren’t that much different. My wife’s commute is 60 miles a day so a reliable, safe car is a must. The car we sold (not traded) to make room for this one was a 9 year old Honda Accord with 160K miles on it. It was still a great car the day we sold it but she needed an automatic transmission. We have two other cars I switch between with 140K miles each on them. My commute is 40 miles each day.
In 2001, I bought a new truck (we still have it). At the time, trucks held their value incredibly well and you couldn’t save money buying a used one. I was also driving 30K miles a year for work at the time. The truck was offered on a 36 month 0% loan. We took the loan and paid off our home mortgage with the money we had saved for the purchase and the proceeds from selling (not trading) our old car. We essentially refinanced our 6% mortgage to 0%.
Between 2001 and 2013 we bought two other cars, initially taking out low interest loans and then paying the loans off within a few months. We still have one of the cars bought in 2004. In 2013 when we bought our most recent car, we were offered a 36 month loan at 1.9%. Since we were planning to buy a house within a year, we took the loan.
We bought a house in March and used the funds we would’ve used to buy our car to put down on the house. The mortgage is 3%. We actually saved 1% by taking the car loan. We generally can’t itemize on our federal taxes so mortgage interest deductions don’t play a role here. Also, we kept our old house making it our second rental property. The rent is more than enough to pay the 10 year 3% mortgage on our new home.
In case your’re wondering, we max out our retirement accounts and have an emergency fund. We have comprehensive on the new car and only liability on the old ones. We plan to drive them until they drop. We would’ve kept the Honda too but my wife insisted something had to go!
Oh lord, how many times have my boyfriend and I had this debate?? I thought we were strange because we have all-out meltdown arguments about whether newer cars and car loans are the devil, or sensible since you’re getting a more reliable vehicle.
Only difference is, my main argument is that we dump loads of money every month into our three old junkers anyway, why not pay a small monthly payment on something reliable? You just opened up a whole new point of view for me. Great post!
It just depends on whether or not you are willing to take some risks with your money. Paying cash for a used car is risky, but paying for a used car with borrowed money could be even riskier. I’m not sure what I would do in this situation, but I know that I would be hesitant to buy a used car with cash. It would probably end up needing a lot of repairs down the road.
Paying cash for a used car is not anymore risky than taking out a loan. Regardless of what happens, the loan has to be repaid. The risk is the same.
There is actually one benefit of paying cash for a used vehicle if the financing is not attractive. Depending on a person’s credit score, interest can be onerous.
Many times a new vehicle purchased at OEM subsidized financing,say zero or .9 percent, can result in a lower payment than for a used vehicle. And of course, new means less repairs and often no maintenance for a few years.
Great discussion and comments.
I’m having a similar dilemma. We have the option of paying cash for a 2012 Honda Civic for my wife or financing it through our credit union for .79% interest. We also have a reward checking account there that earns 3% interest so we are leaning towards financing and keeping the money earning interest in the account.
That being said we hate debt (only loan is a 3% 15 year mortgage) so I can understand that peace of mind that comes from paying in cash.
I went through the same issue. I decided to borrow 10k @ 1.5% for five years. I kept my 10k in the bank as my real rainy day fund since I have other obligations that force me to spend money in unpredictable ways.
Paying 1.5% now is a lot better than paying 10% later. I look at this interest as insurance and peace-of-mind.
The usual answer: it depends. (I know you hate that.)
1. Paying cash: no decrease on your FICO score (you have more debt.) 2. No comprehensive insurance premiums required on your part. Same with doc paperwork fees when buying. 3. When dealer asks, “how are you going to pay for this car,” the price you can negotiate will ALWAYS be lower by saying, “Cash.” Tell them, “Finance it,” and your purchase price will go up. Even if you say, “I’m not sure” dealer will assume “finance.” Dealers pay insurance premiums for cars financed. Assuming you default, go bankrupt, car is stolen or destroyed, they get paid.
Finance: 1.You use the car extensively for business (your car insurance rates will be higher) AND only if you can deduct auto expenses IF you itemize your taxes (you are working for someone.) If you own your own business, you deduct car expenses against your income (good financial break.) 2. You need the money to put into the “match” of your 401K. (401K employer match is free money for you and do don’t pay personal income tax on this money…builds tax deferred. 3.You’re certain investment income after taxes will beat the 2% finance cost (plus the higher price you pay for the car.)
Conclusion: If nothing in the “Finance” section applies to you, pay cash. Even if choose to have no comprehensive insurance, car is stolen or destroyed, you can finance your next car if money is tight.
One size doesn’t fit all! If I have an emergency fund set aside and have a mortgage, I’d get a car loan and pay down the mortgage. I’ve done it in the past. Now I have no mortgage, emergency fund and no debt. However, it took me a long time to get here. Be frugal nd be patient!
Ha! This is a wonderful story. Car loans to pay off mortgage loans — very interesting thought. Car loans to pay off student loans — also an interesting thought. Thanks for the read!
Because I pay cash for EVERYTHING, my house is paid off, my cars are paid off and we pay our credit cards off each month paying NO Interest. Here is my delima. I now havec over 200,000 dollars setting in our savings account making .5% interest. I am at a loss of what to do with that. SO, this is my question: “I have saved and saved and saved and have no debt. But, I know I am supposed to be doing something with this money besides letting it just set making a half percent interest. Any advice would be great. I am 60 and my wife is 52 if that helps you help us.
@Gary — If I were personally in your shoes, I’d put that money into low-fee, broad-market index funds with a low-cost brokerage like Vanguard or Schwab. You sound fairly financially conservative, so I’d go with the rule-of-thumb “Your age in bonds,” with the rest in stocks. In other words, create a 60% bond allocation and 40% stock allocation, and put those into just three funds: Total Bond Market, Total Stock Market and Total International Market. By choosing low-fee index funds, you avoid unnecessary costs like fund loads, high expense ratios, etc. This article might help: http://affordanything.com/2015/02/25/investing-broken-down-to-its-ridiculously-simple-core/
The logical and most financially sound solution is not paying cash for cars. However, IF you are someone who is a worry rat (…Will…?) wouldn’t you pay someone $30 a month if it meant not having added stress? I would pay a whole lot more than that if I could afford it to not have added stress; when you are stressed you aren’t yourself and you feel trapped, and feeling free is a crucial factor in being happy (for me at least). I was initially baffled by Will’s apparent disregard for all logic, bc I am a rational/Spock-like person in most every instance-reading some of his comments, though, has shed some light that he seems to have most definitely understood the financial advantage and has made a conscious decision to “pay” for feeling less stressed (rather than the impression the article seems to give of him kinda having tunnel vision). I can certainly get on board with that, bc when something actually does cause me stress I am not the same person and I’d happily pay $30 to get back to my content state (Spock mode). After all, the whole point of having money is to alleviate stress (for 99% of us). So if having more money is instead causing more stress, it isn’t really serving its purpose. Benefit-cost analysis is contingent (ultimately) upon the benefit and cost to the individual not to his/her bank account
@Jes — I completely agree. As more time has passed between when we bought those cars and today, I can increasingly understand why he’d “pay $30/month,” so to speak, for the lack of stress and mental clutter. Sometimes, it’s just nice to know that an item is paid-in-cash and you don’t need to think about it anymore; it’s nice that an item doesn’t occupy space in the back of your mind.
As an earlier commenter said: If we were talking about numbers that were 10x greater — a purchase of $100,000, rather than $10,000 — then perhaps the additional effort and complexity would be worth it. But at this level, there’s definitely an argument to be made for paying cash for the sake of preserving peace-of-mind.
Thanks for commenting!
P.S. (I should clarify that Will’s objection was a philosophical one. By contrast, I don’t have a philosophical objection to a car loan, but from a pragmatic perspective, I see the logic in stress-avoidance and mental-clutter-avoidance. In other words, even though it might be “financially logical” to take out the loan, there’s an “emotional logic,” or an “emotional pragmatism,” as well.) 🙂
Great concept for an article, enjoyed reading.
Hello everyone…
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Thanks. vivian
Thanks for sharing your thoughts about snuff.
Regards
I would love to have my own car without any worries regarding mortgages and other payments. So why face all the hassle if you have a cash in hand.. That is if you have a cash in hand! Right now I do not have the cash to buy my own car so I settle on auto loans.
I apologize if someone has already stated this as I didn’t read all the comments. I think the answer to this question depends on each individual. My mentor has given me a process in which we will pay cash for our cars instead of taking out a loan. For me, that works, for my wife, not so much. But, I don’t think either way is right or wrong.
Here’s my warped thinking: If I know nothing about investing, option 1 (buying with Cash) is better for me. If I choose option 2, what will most likely happen is I will get a car loan and then spend my cash on something else. So option 2 in my opinion will only work well if you are committed to keeping that cash until the loan is paid off. This will protect you from the unforeseen.
My dilemma is I like option 2 better, but as my mentor has pointed out, I should be clear of all debt (with the exception of a mortgage) before I start investing outside of my 401K.
So I think both options are good, but you have to apply them to your own situation and you have to make sure that if you take the loan option, you can cover the worse case scenario without going into bankruptcy.
I financed my last car and felt like that was a big mistake. I have never hated having a payment worse than for that car. I paid it off early and will be paying cash for my next car. I think not having debt is a huge stress relief and it’s definitely worth it so save and pay cash for vehicles.
I just traded a used Mazda I bought for cash 3 years ago for a used Town and Country that I financed. I thought I would keep the Mazda for a very long time when I bought it but it just didn’t suit my needs.
I was stressing about paying cash for it and selling it so soon, but I did a little math and it seems if I had financed it at the time I bought it with the loan rate offered I think I would have come out paying about the same. And yes the lack of payments and hassle at the dealer is very nice!
The T&C I think I will keep it for a couple years to go camping around the country, then sell it. To me it just seems at an interest rate of 2.7 I will have less invested in two years when I sell with a lot of miles on it.
What do all of you think?
Kudos for looking for a good secondhand Japanese car for $10K or under. Smart move.
The “opportunity cost” argument the loan people are making is bullshit. People wanting to sell you loans make this argument all the time. Investment advisors who want commissions make it all the time. My advisor who wants 5% of my house, says I should mortgage it and buy mutual funds from him. Hmmmm….. how does that work out for him? I think I’ll keep the house unencumbered, thanks. It keeps me in a lower tax bracket.
But getting back to this “opportunity cost” argument: First of all, you won’t get a 2% car loan on a used Japanese car with 50 to 90K on the clock. Your credit union will likely charge 4.5% or more, depending on your credit rating. 2% is new-car loan rates, these days, particularly since the Fed raised rates.
Also the BEST DEALS are going to be from individual sellers, and they aren’t going to offer loans. You’d have to go to a credit union, and get a loan, and that would be 4% or more, maybe much more. A used car dealer will offer a loan, but at a higher rate than 2%. And they get a “taste” of every loan they make, so they will make the “opportunity cost” argument as well.
Finally, $10K just isn’t a lot of money, and the amount you’d “make” in the market, minus the interest rate (again not 2%!) isn’t going to be much more, at least in a safe investment.
Just buy the darn car and be done with it. Sorry, but ten grand isn’t a lot of money, and playing games with loans on the premise you’ll “invest” it, is a bad idea.
Because let’s face it, human weakness being what it is, you’ll spend that 10K not invest it.
UPSHOT: Ask yourself this question – would you go to your credit union TODAY and take out a loan using your car as collateral, in order to gamble in the stock market? Of course not.
Buying a car with cash has several advantages. Firstly, dealers will be more open to haggling than if you were to finance. With financing, you have less of a chance to strike a particular deal that will be in your favor. Secondly, the most obvious is avoiding interest, more interest means more out of pocket money down the road regardless of percentage rate.
It entirely depends on the type of vehicle you’re buying. If you’re buying a high-end luxury vehicle they’ll laugh in your face if you try to push them on interests rates. For your average middle-class vehicle you have all the power you need. I just bought a 2018 Subaru Crosstrek – waiting to take delivery. While I have the cash to buy it outright I chose to finance because the sale was conditional on 0% over 48 months if they wanted my business. They balked and said they’d do 0 on 24, I said ‘No sale. Thanks but I’m going to buy a Kia Niro instead.’ – That vehicle was my second choice and the Kia dealer had already agreed to those terms. They came back an hour later an agreed. You just have to be fully prepared to walk and go somewhere else. It never fails to amaze me how people are terrified of negotiating and end up paying for things they don’t have to, like car financing.
So long as your weighted return on your investments is double the loan’s interest rate you’re always better investing. Sure it may go down, but it may go up too. I average 7 points but I have years where it’s dropped as low as 4 but risen as high as 12, regardless I’m not LOSING any money, which I would be if I paid cash. Personally I’m all about the DRIPs. As they say everybody has to work hard so why shouldn’t money?
If everything goes south somehow and you’re going to end up bankrupt you may as well be on the hook for as much debt as humanly possible. So there’s no real reason to fear debt at all.
Not sure if anyone has mentioned it, or if it applies in GA, but a huge consideration would be insurance. In CA at least, financed vehicles require full coverage insurance. This is a pretty huge extra bill that would likely eat away at all of your potential gains (I would assume). It was a factor I failed to consider when I “saved” money by leasing a very, very cheap car. Just my 2 cents. Love the blog!!! Found it very recently!
I’ve been thinking about taking out a loan for my car. I have the money to pay it off but I’d rather use the money to my advantage now and just continue on smaller payments. The idea of investing it is interesting but I think I’d rather just put it into more important payments and go with the loan. We’ll see when I find out what my payments will be probably.
Wow, that seems like an overly emotional reasoning to pay cash. Also, I have to ask, do you factor in pleasure to your buying decisions? Buying a car with 90K miles on it for cheap might feel good initially, but then you’re driving a 7 year old car with 90K miles on it. You are not taking any money with you to the grave – does enjoyment never factor in?
I spend a lot on cars, and I’m sure fiscally conservative people think I’m nuts (I bought two brand new cars this year alone totalling about $430K, and I have 6 cars right now), but my family and I feel good driving them, have a lot of fun, and enjoy life. I use financing to leverage my cash. I still put down substantial amounts (on just those two I put down about $120K in cash), but financing is useful for sure. Businesses use equipment lines of credit, I use personal loans – it’s all the same. Utilizing credit to increase your spending power can be done wisely.
As an entrepreneur I don’t much think about the consumer items I buy – I buy what I want, take risks, and attempt to come out on top. That’s how real wealth is made, IMHO. Not by making sure that you go to your grave without ever having had a car loan.
On the one hand you believe you are climbing the ladder or success by being super fiscally conservative, but in reality that isn’t how the wealthy make their wealth. Taking a quick look around your site, you say you’re happy being independent from a paycheck, but owning 8 properties really doesn’t make you independent. Not sure how large your mortgages are, but even if they are all paid off, you are betting on your rental income to sustain you (and your management team). You’ve traded one set of shackles (a boss at a job in a cubicle) for another (renters). A major financial event could cause the rental market to stutter. A natural disaster could cause your properties to be unusable (and unsellable). Yes, these are intangibles that, maybe, appear impossible right now, but it’s still a very real possibility.
Personally I would not want to have such potential for disaster looming overhead. Building real wealth means taking risks, which involves taking loans, which involves betting big. There is a reason that “professional gamblers” in Vegas spend hundreds of thousands a night – overall, they win big. Where Vegas wins are the conservative players who bet small, and over the course of a day, or week, eventually lose it all. By trying to horde and protect your assets, you ultimately lose it all.
Anyway, if driving old cars that you spent very little on in cash makes you happy, that’s fine. But to say that loans (and other financial instruments) are crazy, then I guess everyone from Bill Gates on down are crazy (along with every major company out there too).
Thanks!