Author Topic: Buying a car - loan vs cash  (Read 3726 times)

junioroldtimer

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Buying a car - loan vs cash
« on: October 02, 2018, 05:22:43 PM »
Quick question that I feel like should have an obvious answer:

I was thinking about buying a used car and I have the cash to do so. Let's say this car is $25,000 (for example). Common sense says to pay cash to avoid payments to avoid interest on it -- but if your rate of return on investments is higher than the interest rate on the car, wouldn't it make most sense to go for payments?

2 examples:

$25,000 car (all fees, taxes, etc. included) paid for with cash. Value of that $25,000 in 5 years @ 7% returns: $35,063.79. http://www.moneychimp.com/calculator/compound_interest_calculator.htm
$25,000 car, (2,500 down payment, 22,500 loan, 4.23% interest,  60 month term): $417/mo * 60mo = $2500 cash paid up front + $25020 = $27,520.00 https://www.cars.com/car-loan-calculator/

Wouldn't one be better off paying for the car over time than paying cash and losing out on the time value of money of full-cash payment?

For fun, I calculated 7% returns on an initial $2500.00 deposit + annual additions of $5004 (that same $417 payment * 12 months) for 5 years and that ends up being $34,297.45. Am I missing something here?

« Last Edit: October 02, 2018, 08:45:00 PM by junioroldtimer »

junioroldtimer

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Re: Buying a car - loan vs cash
« Reply #1 on: October 02, 2018, 06:04:03 PM »
I suppose one caveat would be the capital gains tax on that ~$ 35,063.79 @ 15% if you pulled it out = $1509.57 in taxes owed.

catccc

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Re: Buying a car - loan vs cash
« Reply #2 on: October 02, 2018, 09:10:32 PM »
I asked the same question a couple months ago, maybe.  Most people said "yeah, you can leverage the loan and stay invested."  One person said "no no no, leverage risk!"  You aren't missing anything here, if the opportunity cost is greater than the interest rate, yes, you come out ahead.  But 7% returns are not guaranteed, however, so you don't know if you will actually come out ahead when looking at a 5 year term.  Chances are you will, but we don't know that for sure.  You know you will definitely lose money paying interest, though.

I don't recall if I threw a dollar amount out there as an example, but my answer at the end of all this is pay cash for car that doesn't cost a lot to minimize opportunity cost.

Also, your tax estimate is overstated.  You wouldn't pay tax on the entire value of the investment after the 5 years, just the gains.  And also, if you are lucky to have a low enough income like me (ha ha) your capital gains tax rate will be zero, anyway.


Linea_Norway

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Re: Buying a car - loan vs cash
« Reply #3 on: October 03, 2018, 05:52:39 AM »
I have understood that there is a credit card that don't require interest for the first year. You can use that for the first year and invest in the stock market that year. And then hope the market hasn't crashed after a year when you need to sell you stock.

magnet18

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Re: Buying a car - loan vs cash
« Reply #4 on: October 03, 2018, 06:44:50 AM »
It's the same math as the mortgage case, but the difference is if you pay minimum on a car you end up upside down.

Ymmv, IMO, car loan in the 4.xx%, either way doesn't really matter.

I'll probably pay minimums on the car for a while and get the investments rolling, purely for psychological reasons.

neo von retorch

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Re: Buying a car - loan vs cash
« Reply #5 on: October 03, 2018, 07:59:24 AM »
It's the same math as the mortgage case, but the difference is if you pay minimum on a car you end up upside down.

Ymmv, IMO, car loan in the 4.xx%, either way doesn't really matter.

I'll probably pay minimums on the car for a while and get the investments rolling, purely for psychological reasons.

It really isn't. As catccc pointed out, the statistical certainty that the investments will result in a specific return based on history depends on the duration of the investment. If you're talking about a fixed-rate, low interest 30-year mortgage, you can look at all 30-year periods of time in the stock market to arrive at the odds that the investments will grow a certain amount. If if you're looking at a 5-year car loan, now you have to look at all 5-year periods of time instead. I'm not sure what percentage of periods where investments (i.e. "total stock market") return more than 4.23% over that duration, but there are clever posters here that can provide a good tool for checking that.

I still think the odds are really good but they are a little lower than the near certainty of 20+ year returns.
« Last Edit: October 03, 2018, 08:01:14 AM by neo von retorch »

Greystache

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Re: Buying a car - loan vs cash
« Reply #6 on: October 03, 2018, 08:04:39 AM »
We are in the longest bull market in history. I don't like the odds of making 7%  in the market over the next 5 years. I would take some of the money that I have made in this incredible bull market and just buy the car and avoid the interest on the loan.

M2 pilot

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Re: Buying a car - loan vs cash
« Reply #7 on: October 04, 2018, 08:10:55 PM »
In some cases, there are manufacturer rebates is the car is financed thru their in-house credit, for example if you bought a chevy silvarado 1500 2 months ago & financed it thru GMAC you got a big discount.  If this sort of thing applies to the car you want, you could finance, make 1-3 payments & then pay off the loan. Kia had a really strong discount on the Kia Stinger and may still have it for leasors.  Lease the car & you get a $7500 discount.  In that case you buy out the lease for cash after the 1st payment.  I did this on a car 3 years ago. Made 3 payments then paid off the loan with cash & saved a bit off the purchase price.

catccc

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Re: Buying a car - loan vs cash
« Reply #8 on: October 05, 2018, 07:12:21 AM »
In some cases, there are manufacturer rebates is the car is financed thru their in-house credit, for example if you bought a chevy silvarado 1500 2 months ago & financed it thru GMAC you got a big discount.  If this sort of thing applies to the car you want, you could finance, make 1-3 payments & then pay off the loan. Kia had a really strong discount on the Kia Stinger and may still have it for leasors.  Lease the car & you get a $7500 discount.  In that case you buy out the lease for cash after the 1st payment.  I did this on a car 3 years ago. Made 3 payments then paid off the loan with cash & saved a bit off the purchase price.

I did something similar in '04.  I could get an extra $1,500 cash back if I financed through chrysler for a $15K truck I bought new, instead of paying cash.  Took out a loan with Chrysler, paid something like $60 in interest over 3 months, then paid off the loan balance.  The move kept $1,440 more in my pocket over buying outright. 

I did not know leases had an early buy-out option!  It is unlikely I would buy a new car, but it is still good to know these strategies!

Retire-Canada

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Re: Buying a car - loan vs cash
« Reply #9 on: October 05, 2018, 07:47:21 AM »
Am I missing something here?

Just that it's very hard to predict market returns over 5yrs. You could well do worse than the loan interest. Personally I don't have any strong feelings either way. You are not going to get rich or go broke because of this choice. Just do whatever seems best to you and don't worry about it.

radram

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Re: Buying a car - loan vs cash
« Reply #10 on: October 05, 2018, 08:09:52 AM »
I would take a different approach.

6 months ago, I bought a 2008 Honda Fit with 73,000 miles for $5,500.

Find something like this, pay cash, and fully invest the rest. Since you have the money to buy another, only carry liability insurance. With the money you save, put it toward your next used car.


ketchup

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Re: Buying a car - loan vs cash
« Reply #11 on: October 05, 2018, 08:15:33 AM »
It's the same math as the mortgage case, but the difference is if you pay minimum on a car you end up upside down.

Ymmv, IMO, car loan in the 4.xx%, either way doesn't really matter.

I'll probably pay minimums on the car for a while and get the investments rolling, purely for psychological reasons.
Bold mine.  I don't see the problem in a situation like this with being upside-down.  As long as you're not broke and could come up with the extra cash if you decided to sell the car, being upside-down is of no specific consequence.

frugaliknowit

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Re: Buying a car - loan vs cash
« Reply #12 on: October 05, 2018, 11:27:56 AM »
Buy cars with cash. 

Under the borrow to stay more invested scenario:  Too much has to go right and too much can go wrong.  Poor risk/return.

ardrum

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Re: Buying a car - loan vs cash
« Reply #13 on: October 05, 2018, 12:09:50 PM »
I went with payments on my car, but my car loan interest rate was just 0.9% over 5 years. 

RelaxedGal

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Re: Buying a car - loan vs cash
« Reply #14 on: October 05, 2018, 01:14:58 PM »
I would take a different approach.

6 months ago, I bought a 2008 Honda Fit with 73,000 miles for $5,500.

Find something like this, pay cash, and fully invest the rest. Since you have the money to buy another, only carry liability insurance. With the money you save, put it toward your next used car.

The insurance requirement is the only part of the equation I didn't see in the original poster's logic.  If you were already going to carry comprehensive, then it's moot.  If you finance you need it (per the bank) but if you pay cash you can carry a lesser amount of insurance.

When I got my $12,000 used car 4 years ago I still financed.  It was at 1.25% for 3 years vs. the great returns in the market at that time.  I still haven't dropped the comprehensive coverage because I keep forgetting.

When my husband bought his $40,000 new car this February he also financed it, at 2.25% for 5 years.  Less of a sure thing in 2018 than in 2015, but when will the market slow down?  No one can predict.  In his case the comprehensive insurance was a given.

radram

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Re: Buying a car - loan vs cash
« Reply #15 on: October 05, 2018, 02:09:33 PM »
I would take a different approach.

6 months ago, I bought a 2008 Honda Fit with 73,000 miles for $5,500.

Find something like this, pay cash, and fully invest the rest. Since you have the money to buy another, only carry liability insurance. With the money you save, put it toward your next used car.

The insurance requirement is the only part of the equation I didn't see in the original poster's logic.  If you were already going to carry comprehensive, then it's moot.  If you finance you need it (per the bank) but if you pay cash you can carry a lesser amount of insurance.

When I got my $12,000 used car 4 years ago I still financed.  It was at 1.25% for 3 years vs. the great returns in the market at that time.  I still haven't dropped the comprehensive coverage because I keep forgetting.

When my husband bought his $40,000 new car this February he also financed it, at 2.25% for 5 years.  Less of a sure thing in 2018 than in 2015, but when will the market slow down?  No one can predict.  In his case the comprehensive insurance was a given.

Your gave some great examples of my original point. I did not explain it very well.

As the cost of my vehicle increases, not carrying comprehensive makes less and less sense. In your example of a $12,000 car, even if it wasn't financed, it would be hard to not carry comprehensive due to the risk of immediate loss of $10,000 after my deductible was paid. 4 years from now, when that same $12,000 car is now only worth about $7,000, it starts to make more sense to drop it, especially if I have the money banked for my next car already.

When I have a $5,000 car, with a $1,000 deductible, it just does not make sense to carry comprehensive insurance, especially if I have the next cars $5,000 banked already.




Catbert

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Re: Buying a car - loan vs cash
« Reply #16 on: October 05, 2018, 03:35:15 PM »
I recently bought a new car (hanging head in shame).  My thought was if I could easily borrow at 2% or below, I would finance it.  My credit union quoted 2.45% and the dealer financing was around 3.5% so I paid cash.  I had the cash and am too lazy to fill out loan applications and screw with financing unless the financing deal was steller. 

As others have noted, 5 years is too short a time to feel confident about the markets overall returns.

SpareChange

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Re: Buying a car - loan vs cash
« Reply #17 on: October 05, 2018, 04:38:58 PM »
Do penfed or other lenders really require collision and comprehensive on a used car loan under say 10k?

Goldielocks

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Re: Buying a car - loan vs cash
« Reply #18 on: October 08, 2018, 01:58:07 AM »
Remove money from investments and pay cash for the car.

Borrow money at very low interest rates to reinvest.

Get tax deduction on the borrowed money.
Pay the minimum interest owing on your borrowed money from your cash flow (this really pumps up your returns by essentially adding a small amount of cash over time)

Write out your plan / strategy of when to sell (at the time that you buy your investment):
Sell the investments after 5 years, if you like and the market is up, averaging 7% /yr or better. 
Hold them longer if you need to wait for annual 7% returns.  Then sell.

Pay back the investment loan with the proceeds of the sale.

Pay your capital gains / other taxes from your cash flow that year.

catccc

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Re: Buying a car - loan vs cash
« Reply #19 on: October 12, 2018, 11:09:52 AM »
Remove money from investments and pay cash for the car.

Borrow money at very low interest rates to reinvest.

Get tax deduction on the borrowed money.
Pay the minimum interest owing on your borrowed money from your cash flow (this really pumps up your returns by essentially adding a small amount of cash over time)

Tax deductions on interest paid for borrowed money are hard to come by these days.  Interest on loans secured by vehicles are not tax deductible, and if you borrow against your first or second home, the mortgage interest now has a much higher bar to cross before exceeding the standard deduction starting in 2018.

Slee_stack

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Re: Buying a car - loan vs cash
« Reply #20 on: October 12, 2018, 02:23:54 PM »
Follow the numbers.

If you can get a CD that pays more than your auto rate, you come out ahead with zero risk.

You can also invest and hope for a bigger spread with more risk.

Yes, most auto loans will require comp/collision.

If you are buying at a price that doesn't justify comp/coll, you may not come ahead...but you could end up netting zero and still having the comp/coll coverage which isn't worth zero.

JLee

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Re: Buying a car - loan vs cash
« Reply #21 on: October 12, 2018, 02:35:02 PM »
Do penfed or other lenders really require collision and comprehensive on a used car loan under say 10k?

Yes.

Dr.Jeckyl

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Re: Buying a car - loan vs cash
« Reply #22 on: October 16, 2018, 11:44:11 AM »
I'm probably doing the same thing right now. I'm likely going to go with the loan (credit union 2.75%) and investing instead. Even if the market takes a dump, that just means I'll be buying at discounted prices and will make a lot more with the inevitable rebound. The only reason I wouldn't is if I was retiring soon.

RWD

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Re: Buying a car - loan vs cash
« Reply #23 on: October 16, 2018, 12:41:18 PM »
Auto loan rates tend to be lower than mortgage rates, which helps with making it advantageous to finance the purchase. My last two car loans were 2.9% and 1.69%. Even bond returns are better than those currently! For the SP500, historically 80% of 5-year periods were better than 2.4% and 70% were better than 4.65%. So financing and investing the difference is the correct approach, but not a guaranteed win either.

As long as you aren't using financing to buy more car than you otherwise would I think it's a good tool. Of course, if you want to be a good mustachian you should probably be buying cars so cheap that the cost is a rounding error in your finances anyway.

JLee

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Re: Buying a car - loan vs cash
« Reply #24 on: December 02, 2019, 07:42:26 AM »
Speaking of this - what's the normal loan rate for a car loan? I want to buy a car for $20,000 and a credit company, which my friend recommended to me, will give me money with a 3 % rate. Is it good or bad?

I generally use Penfed as my baseline for comparison: https://www.penfed.org/auto

JLee

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Re: Buying a car - loan vs cash
« Reply #25 on: December 18, 2019, 08:17:58 AM »
Hey! I have a question. WTB a car for $20,000. What is normal interest rate for this kind of loan?

I see someone asked simmilar stuff already, LOL. Thank you.
It will vary wildly based on lender.  I usually use Penfed, but Affinity has slightly better rates: https://www.affinityfcu.com/loans/auto-solutions/index.aspx

MilesTeg

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Re: Buying a car - loan vs cash
« Reply #26 on: December 18, 2019, 08:19:45 AM »
It's the same math as the mortgage case, but the difference is if you pay minimum on a car you end up upside down.

Ymmv, IMO, car loan in the 4.xx%, either way doesn't really matter.

I'll probably pay minimums on the car for a while and get the investments rolling, purely for psychological reasons.

It really isn't. As catccc pointed out, the statistical certainty that the investments will result in a specific return based on history depends on the duration of the investment. If you're talking about a fixed-rate, low interest 30-year mortgage, you can look at all 30-year periods of time in the stock market to arrive at the odds that the investments will grow a certain amount. If if you're looking at a 5-year car loan, now you have to look at all 5-year periods of time instead. I'm not sure what percentage of periods where investments (i.e. "total stock market") return more than 4.23% over that duration, but there are clever posters here that can provide a good tool for checking that.

I still think the odds are really good but they are a little lower than the near certainty of 20+ year returns.


Except worrying about 5 year returns only matters if you intend to sell the investment at the end of the 5 year loan for some strange reason rather than keeping that money invested.


MilesTeg

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Re: Buying a car - loan vs cash
« Reply #27 on: December 18, 2019, 08:49:42 AM »
As far as risk vs reward, most people who push cash purchases due to this conveniently ignore the financial risks of a car which are generally higher than a long term investment in an index fund.

Especially with forgoing comprehensive/collision as a strategy.

JLee

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Re: Buying a car - loan vs cash
« Reply #28 on: December 18, 2019, 09:11:11 AM »
As far as risk vs reward, most people who push cash purchases due to this conveniently ignore the financial risks of a car which are generally higher than a long term investment in an index fund.

Especially with forgoing comprehensive/collision as a strategy.

Also, the whole "financing a depreciating asset" argument does not make sense.  The argument should be "is the rate worth financing $x and putting equivalent cash in the market". Appreciating asset, depreciating asset, no asset is irrelevant if you have the cash on hand regardless.

If you're living paycheck to paycheck and face the situation where you may have to sell said depreciating asset while upside down in a loan, that's a different equation altogether.  However, the premise of the discussion being "should I pay cash or finance" means we are not talking about this situation.