Author Topic: Buy car with cash or take out loan and pay down mortgage?  (Read 6384 times)

badger1988

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Buy car with cash or take out loan and pay down mortgage?
« on: January 25, 2015, 03:19:54 PM »
First, a little background: I currently drive a 2008 Chevrolet Cobalt, which has been a very good, low cost, decent gas mileage car for me the last three years. I'm a spreadsheet nerd, so I can go into more detail if anyone is interested. Problem is...I have the 2-door coupe...and my wife is pregnant with twins due in July (poor foresight on my part when I bought the car). It looks like I will inevitably be trading it in for something larger. I tried convincing her that we could make the Cobalt work, but for the sake of marital harmony I don't intend to go down that path:) I have plenty of time to decide, but currently have my eye on a 1-year-used Ford Fusion with the intention of driving it for the next 2 decades. I'm particularly interested in the Fusion because (through 2014) it was one of the few mid-size sedans that still has an optional manual transmission. With the trade-in value of my Cobalt ($4500) I expect to pony up somewhere in the neighborhood of $13,000 OTD.

Now to the question...I was very set on paying cash for the car transaction. I'm expecting a $20,000 bonus in March, so I'll have some un-utilized cash in the very near future. We already max out both 401ks and both IRAs, so my original plan before we started talking cars was to plug the bonus into our mortgage. We are 2 years into a 15-year, $68,000 mortgage with 2.5% interest rate ($59,600 outstanding). Assuming 15% marginal tax bracket, I figure this is equivalent to a 2.125% interest rate with itemized deductions...not a lot of incentive to pay it off early, but I'm one who likes the feel-good idea of not having a mortgage. Out of curiosity, I looked up current rates and noticed used auto loan rates are very close to, if not slightly below that 2.125% rate. I've started thinking maybe it would make more sense to take out a car loan and throw the $13,000 at the mortgage instead. What do you all think? Also, If you had an auto loan and a mortgage with equivalent interest rates, which would you pay off first?


« Last Edit: January 25, 2015, 03:28:12 PM by badger1988 »

Goldielocks

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Re: Buy Car with Cash or Take out Loan and Pay Down Mortgage
« Reply #1 on: January 25, 2015, 03:30:50 PM »
What do you all think?

At this open invitation, my two cents:

1)  Trade in value?!  WTF Trade in?   You need to post an ad (craigslist, autotrader, work, neighbors, whatever).  Just state your car details and that you have been offered $4500 trade in value  and if anyone wants to beat that, it's theirs.    Open to offers.    you will likely easily get $200 and more likely $500 more, with almost no effort, as it is worth at least $5500 on the market (the car dealer needs to make at least $1000 to cover carrying costs and commissions)

2)  House poor,  ie cash flow poor with expenses = income is a bad place for me to be in, so I look for ways to reduce monthly on-going costs.  In this case your car loan is a high monthly cost, higher than committed / decreased mortgage, so I would pay cash for the car.    Yep it is a mind game because you have the cash either way, but I usually lock off the long term investments and just work with monthly cashflow.

Cassie

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #2 on: January 25, 2015, 03:36:13 PM »
I would also pay cash for the car.  Then take whatever your monthly payment would have been & put it on the mortgage every month.

frugaldrummer

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #3 on: January 25, 2015, 03:49:45 PM »
My 2009 Toyota Matrix has a stick shift, 4 doors, and is a hatchback (which has been very handy for hauling any number of items).  It's actually the closest thing I could find to the car I had when my 3 kids were small - a Honda Civic Wagon (too bad they don't make those any more!).

phillyvalue

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #4 on: January 25, 2015, 04:02:53 PM »
If the effective interest rate on the mortgage, considering the tax benefits, is equivalent to the interest rate on the vehicle, then it makes no difference financially. However, in order to make life simpler, in such a situation I'd pay cash for the vehicle, just so I have one fewer payment to make each month.

Depending on the vehicle / dealer, a possible incentive is often very attractive financing, perhaps <2%. In such a case I'd definitely take advantage of it and pay down the mortgage instead.

badger1988

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #5 on: January 25, 2015, 04:42:37 PM »
Thanks for the early answers, keep 'em coming! I appreciate the honest feedback. I'm surprised no one dished out any face punches for my plans to buy an ~$16500 car yet. A few more details:

-Re trade-in: I would list the cobalt privately...but I honestly don't think I'll get more than the $4500 (no way I would pay that for it) and it doesn't seem to be worth the hassle. KBB has my car valued at $2,900 for trade-in and $3,900 for private party sale. I have no idea what the salesman at the dealership was thinking when he agreed to my suggestion of $4500, but I wasn't going to tell him that.

-As far as the cash-flow/house poor, I understand what you're saying but I'm not too concerned. We've got an emergency fund we're comfortable with. Also, current housing costs (mortgage/insurance/property tax) was only ~6% of our net income last year...should be even less this year not including early payments. Adding in ~$283 per month for a 48 month auto loan would have bumped that to 8%.

-Frugaldrummer, I'll keep my eye out for manual Matrices(?). Looks like they are more-or-less on par price-wise with the Fusion.

-I agree with the general sentiment that, interest rates equal, it makes more sense to pay cash. So I guess I'll revise my question a little. If the interest rate on an auto loan was significantly lower than the mortgage, would you take out the auto loan. How much would you consider to be significant?

Also, my second question was more of a hypothetical that I also want to revise: If you already owed an equivalent amount on a mortgage and auto loan, with the same interest rate and equal required monthly payments, which would you pay off first?


Goldielocks

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #6 on: January 25, 2015, 04:55:48 PM »
Taking out a loan on a rapidly depreciating asset is always a poor choice, all else being equal.

How about revising that $16.5k car purchase decision?

phillyvalue

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #7 on: January 25, 2015, 06:40:51 PM »
Taking out a loan on a rapidly depreciating asset is always a poor choice, all else being equal.

How about revising that $16.5k car purchase decision?

Having to take out a loan in order to buy a rapidly depreciating asset is a poor choice. Borrowing X dollars secured by a rapidly depreciating asset that you would have otherwise bought anyway is no poorer a choice than borrowing the same amount secured by a different asset. That is the rational way to look at mortgages / car loans / etc. You are choosing to borrow X dollars at Y% per year, and that borrowing is secured by a particular asset as collateral. The last part matters to the person making the loan to you of course, but shouldn't matter to you much outside of potential tax benefits.

On the question of how attractive the car loan terms would have to be: on a $13,000 principal, the difference between, say, 1.5% and 2.125% would be $80 per year. So even if I could borrow at something like 1.5% for the car, I would just forget it and pay cash, because it isn't worth the hassle of the car loan for such a small amount. Unless you are buying from a dealer that happens to be very adamant about you financing and thus would give you a better price on the car that way.  Otherwise, maybe if I could borrow at 0%, thats ~$270/yr and is probably worth it. My guess is for a used car that kind of financing wouldn't be offered unfortunately.








Goldielocks

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #8 on: January 25, 2015, 08:40:39 PM »
Taking out a loan on a rapidly depreciating asset is always a poor choice, all else being equal.

How about revising that $16.5k car purchase decision?

Having to take out a loan in order to buy a rapidly depreciating asset is a poor choice. Borrowing X dollars secured by a rapidly depreciating asset that you would have otherwise bought anyway is no poorer a choice than borrowing the same amount secured by a different asset. That is the rational way to look at mortgages / car loans / etc. You are choosing to borrow X dollars at Y% per year, and that borrowing is secured by a particular asset as collateral. The last part matters to the person making the loan to you of course, but shouldn't matter to you much outside of potential tax benefits.

On the question of how attractive the car loan terms would have to be: on a $13,000 principal, the difference between, say, 1.5% and 2.125% would be $80 per year. So even if I could borrow at something like 1.5% for the car, I would just forget it and pay cash, because it isn't worth the hassle of the car loan for such a small amount. Unless you are buying from a dealer that happens to be very adamant about you financing and thus would give you a better price on the car that way.  Otherwise, maybe if I could borrow at 0%, thats ~$270/yr and is probably worth it. My guess is for a used car that kind of financing wouldn't be offered unfortunately.
Just for fun to push the point...

Would you say the same thing if the OP wanted to borrow money to finance a $16.5k vacation (a more rapidly depreciating asset)?

phillyvalue

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #9 on: January 25, 2015, 09:38:44 PM »
Taking out a loan on a rapidly depreciating asset is always a poor choice, all else being equal.

How about revising that $16.5k car purchase decision?

Having to take out a loan in order to buy a rapidly depreciating asset is a poor choice. Borrowing X dollars secured by a rapidly depreciating asset that you would have otherwise bought anyway is no poorer a choice than borrowing the same amount secured by a different asset. That is the rational way to look at mortgages / car loans / etc. You are choosing to borrow X dollars at Y% per year, and that borrowing is secured by a particular asset as collateral. The last part matters to the person making the loan to you of course, but shouldn't matter to you much outside of potential tax benefits.

On the question of how attractive the car loan terms would have to be: on a $13,000 principal, the difference between, say, 1.5% and 2.125% would be $80 per year. So even if I could borrow at something like 1.5% for the car, I would just forget it and pay cash, because it isn't worth the hassle of the car loan for such a small amount. Unless you are buying from a dealer that happens to be very adamant about you financing and thus would give you a better price on the car that way.  Otherwise, maybe if I could borrow at 0%, thats ~$270/yr and is probably worth it. My guess is for a used car that kind of financing wouldn't be offered unfortunately.
Just for fun to push the point...

Would you say the same thing if the OP wanted to borrow money to finance a $16.5k vacation (a more rapidly depreciating asset)?

The way I view it is that there are two distinct decisions to be made, and they should be made independently. The first decision is whether or not to purchase the asset. The second decision is how to finance the purchase.

So yes, I'd say the same thing. If the OP had already made the decision to go on a $16.5K vacation and was going to go through with it no matter what, and somehow he could finance the entire thing at 0% for 5 years, then he should take the loan for the $16.5K.

I think the reason a lot of us have hesitation about financing a car, vacation, or other consumption "asset" is that we observe that most people in our society are unable to separate purchase and financing decisions, and thus we are afraid of falling into the same trap. Many people end up purchasing a more expensive car than they otherwise would because of the attractive financing terms available. And in addition, if many people were in the above situation - planned to pay cash for their vacation but were able to borrow the cost at 0% - they would end up utilizing the extra $16.5K of cash to increase their consumption, rather than investing it. But for those on this forum, who have far more willpower, we should be able to trust ourselves to act more rationally. It's rational to take advantage of the ability to borrow money when it makes sense, as a strategic decision, as long as we do not let borrowing change our  level of consumption from the level we would choose if we had to pay for everything in cash.
« Last Edit: January 25, 2015, 09:41:21 PM by phillyvalue »

alsoknownasDean

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Buy car with cash or take out loan and pay down mortgage?
« Reply #10 on: January 26, 2015, 12:08:23 AM »
Given those two options, you'd probably be better off paying cash for the car as it may lower your insurance premiums, and you can't deduct car loan interest like mortgage interest.

Also paying cash means you're less likely to overbuy.

Are you able to swap your Cobalt for a four or five door version? The Honda Fit is well regarded around these parts too. Not sure how they go as far as kid carrying though (although I spent my early formative years in a 1983 Corolla).

Jack

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #11 on: January 26, 2015, 12:51:38 PM »
I'm surprised no one dished out any face punches for my plans to buy an ~$16500 car yet.

Your 2008 Cobalt is 10 years newer than the newer of my two cars. And you want to buy one even newer than that?!

I see no reason why you couldn't fit twins into a 10+ year old hatchback just fine, for a whole lot less money than a Fusion.

FarmerPete

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #12 on: January 26, 2015, 01:15:45 PM »
First question that comes to mind is whether this is the only car in your family or not.  Does your wife have a car?  If so, there is no reason you need two cars that can carry both kids comfortably.  Having one car that can carry them comfortably and one that can carry them uncomfortably in a pinch should be sufficient for now.  Lets assume that you are a one car family, and that you absolutely can't squeeze two babies into your car.  Why the 2014 Fusion?  You stated that earlier Fusion model years had manual transmissions available.  Why go with the newest year version?  Why not get a 2010 and save a few thousand dollars?

You mention that buying the cobalt was a bit of bad planning on your part.  Are you sure you aren't doing the same thing here?  How sure are you that you wont have additional children?  If your wife doesn't like the idea of having two kids in the back of your cobalt, is she going to complain when you try to fit three car seats in the back of the Fusion?  To me, it looks like you're justifying this large luxury expense by annualizing it over 20 years.  That might even be a good argument, IF you keep the car for 20 years.  If you "outgrow" the car in 3 years, your decision to buy the expensive model/year will have been an expensive lesson.  Realistically, things change.  Even if you don't have more kids, how long will it be before your wife complains that she can't fit your kids friends in the car?  Will you fight that battle, or will your marital harmony override your good sense yet again?

frugaliknowit

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #13 on: January 26, 2015, 01:27:04 PM »
1.  Try to get your wife to understand that you don't need a new car yet.  A 2 door coupe is fine for quite a while.  If it proves to be unbearable, you can change your mind later.

2.  Pay cash for any car.

ltt

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #14 on: January 26, 2015, 01:43:47 PM »
Pay cash for the auto.

For goodness sake, why would you want your wife to try and struggle with getting two car seats into the back of a two-door vehicle????  That's insane.

And what is it with all the men on this thread who are saying it will work just fine???  No, it won't--trust me on this one.  You will have a very unhappy wife--not worth it!! 

You might want to consider saving money for a van with sliding doors in the future----go with me on this one.

tweezers

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #15 on: January 26, 2015, 01:48:59 PM »

For goodness sake, why would you want your wife to try and struggle with getting two car seats into the back of a two-door vehicle????  That's insane.

And what is it with all the men on this thread who are saying it will work just fine???  No, it won't--trust me on this one.  You will have a very unhappy wife--not worth it!! 

You might want to consider saving money for a van with sliding doors in the future----go with me on this one.

Exactly to all of this.  You need a 4 door vehicle, and if you've given your wife any grief over it you also need to apologize to her.  She's right.

MustachianAccountant

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #16 on: January 26, 2015, 01:57:53 PM »
-Re trade-in: I would list the cobalt privately...but I honestly don't think I'll get more than the $4500 (no way I would pay that for it) and it doesn't seem to be worth the hassle. KBB has my car valued at $2,900 for trade-in and $3,900 for private party sale. I have no idea what the salesman at the dealership was thinking when he agreed to my suggestion of $4500, but I wasn't going to tell him that.

Probably because he's planning on making up any "loss" on the trade in with the price of the car he's selling you. Part of the mind games auto dealerships play.

Singularity

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #17 on: January 26, 2015, 02:58:59 PM »
-Re trade-in: I would list the cobalt privately...but I honestly don't think I'll get more than the $4500 (no way I would pay that for it) and it doesn't seem to be worth the hassle. KBB has my car valued at $2,900 for trade-in and $3,900 for private party sale. I have no idea what the salesman at the dealership was thinking when he agreed to my suggestion of $4500, but I wasn't going to tell him that.

Probably because he's planning on making up any "loss" on the trade in with the price of the car he's selling you. Part of the mind games auto dealerships play.

Agreed the salesman is probably increasing the cost of the new car or calculated assuming your financing which makes him lots of extra money.   Get cash price quotes without trade-in from other dealers. 

badger1988

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #18 on: January 27, 2015, 07:28:40 PM »
Thanks for the responses everyone! I'm not going to take the time to respond to everyone, but know that I did read and consider all that was said!

First of all I'll just say my wife is awesome and I'm lucky to have her. We are definitely on the same page financially, which is great. We currently are a two car family, with the 2008 Cobalt and a 2011 Ford Fiesta [both have manual transmissions:)]. We have discussed cutting back to one car in the past, but without going into too much detail here, it doesn't appear that it would save us any significant money without making our lives significantly more complicated (including ideas such as moving closer to one of our jobs, which are both in areas with far less affordable housing than our current location nestled comfortably midway between the two). In addition, one car is essentially paid for by mileage reimbursements I get due to frequent work-related travel to other facilities.

As an aside...We actually (Gasp!!!) bought the Fiesta new (special factory ordered base model with zero options), and I do not regret that decision at all. It has turned out to be a very affordable car. I have been doing a bit of an experiment the last 3 years comparing the cost of ownership between our cars (including fuel, maintenance, repairs, insurance, fees, and depreciation) and so far the Fiesta has been surprisingly only slightly more than the Cobalt in terms of "normalized" cost-per-mile ($0.33/mile vs. $0.29/mile). That is, cost-per-mile adjusted to account for the fact that the Fiesta's cost per-mile is lower ($0.27/mile over 59,000 miles in 3.5 years) than the Cobalt's ($0.38/mile over 26,000 miles in 3 years) due to spreading the cost of annual expenses over more miles.

Although we plan to keep the Fiesta and it should work fine (not sure if the rear-facing seats will fit), I don't see the request to have a decent-sized family car at all unreasonable. We are big fans of doing cross-country camping road trips and also like to make frequent (read: monthly) weekend visits to our family who all live >200 miles away. That is a lot to ask of a Fiesta from a family of four. In the case that our family continues to grow in the future or we find a mid-size sedan to be insufficient, we would swap out the Fiesta for something like a minivan.

Anyway, as far as the car purchase cash vs. loan thingy...I hadn't thought about the effect on insurance premiums. That is an interesting point I hadn't considered, and that definitely swayed me towards cash until I thought of another none-of-the-above idea. My new plan, if/when I decide to buy, is to sign-up for a new rewards credit card, use the car to cover the spend for a juicy sign-up bonus, collect additional 1%ish points, and immediately pay off the balance in cash.

As far as the car decision itself, I've communicated a very low, firm offer to the dealer ($2000 less than the amount I mentioned before and $4000 below their asking price). They seemed to be quite offended with my offer, but maybe they'll call me back later. The comment about making up any "loss" on the trade-in with the cost of the newer car was absolutely correct, but I just look at things in terms of net transaction price. I figure if they accept my offer, the next 3-4 years worth of depreciation will be covered in the deal. Meanwhile, I will keep looking for other potentially more budget friendly options. I've got 6 months until the babies arrive, and there is no immediate rush after that to make the switch unless we can't fit them in the Fiesta.

Goldielocks

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #19 on: January 27, 2015, 11:21:39 PM »
Most car dealers only accept cc'd for the first $2k to $5k or so. Unless you are talking about a balance transfer card, but you don't usually get points for that. So ask the dealership their policy limit on cc'd first.

chasesfish

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #20 on: January 28, 2015, 05:53:47 AM »
I'm with the other poster who said they're two independent decisions to be made here:

1) Do you pre-pay a 15 year mortgage at 3%?  Mathematically you're almost always better off investing the difference, but you also can't put a value on the peace of mind that comes with a free and clear home.  That's a personal decision that most people struggle with.

2) What do two kids have to do with a chevy cobalt?  I believe a cobalt has back seats that are capable of holding a car-seat.  To me, it seems a little whiny to say "I have to be able to load my children through their own dedicated door".

If you want a new car, that's your personal choice, but the MMM forum is probably not the best place to ask for support for your desire to purchase a $16,500 car to replace a 2008!  You're replacing a car that's newer than anything in my (admittedly) luxurious, over consuming fleet of steel.

frugaliknowit

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #21 on: January 28, 2015, 05:56:30 AM »
Echo goldie.  Any deal on a car with a cc'd will be tainted with a higher price.

Neustache

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Re: Buy car with cash or take out loan and pay down mortgage?
« Reply #22 on: January 28, 2015, 07:46:14 AM »
I feel your pain, a bit! 

My situation is different, but I'm considering refinancing a paid for car to get rid of PMI on my mortgage.  And a two door car is probably fine with one child, but twins...no.  Probably even okay with two kids given the 1st child is old enough to manage getting in and out by himself while mom puts in the infant.  But two infants at once. No.  :D