Author Topic: Replacing an old car. Pay cash or invest the cash and get a loan? A 401K loan?  (Read 1141 times)

catccc

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We are replacing our family's main car.  I intended to pay cash.  A friend was recently asking if she should invest $$ or pay off her car loan.  Since her rate was really low (~2%), I suggested she invest the $, because her long term investment will likely out earn the interest she is paying.  After telling her this, I realized that this logic makes my choice to pay cash a bad idea, assuming I can get a rate lower than I would expect an investment to return. 

So I started googling about it and saw in reddit someone else uses a 401K loan when they are buying a vehicle, since the interest you pay on the loan is to yourself, rather than to the bank.  I checked out my plan, and to borrow $15K (as an example, IDK how much we will spend), there is a $175 set up fee and then I pay myself 4.5% interest.  For a 2 year loan, this works out to be $1048.23 in interest I pay to myself.  In the meantime, I take the cash I have saved up, and put it in my index fund (taxable brokerage at vanguard, all tax shelters are maxed out), and leave it there until I start drawing down after FI.  But, the $15K I take out of the 401K is no longer invested, so I am forgoing gains.  Assuming the index funds that I invest in my taxable account perform equally in comparison to what the 401K money would have earned if left invested, doesn't this all wash out to just mean paying $175 to spread out my payments over 2 years, an overall less $ in my pocket situation?  Am I missing something?

But, if I could get a loan for a few percent, and invest the cash I have, then my investment could out earn my interest payments.  Of course the risk here is that the gain on the investment might not exceed the loan interest, but I think generally people are in the logical/mathematical camp of not rushing to pay off loans under a certain %, and not in the emotional camp of just wanting to say "I'm debt free!"  I've been debt free all my life, anyway, its NBD to me...

jc4

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I think your reasoning is right:

401K loan:
-$175 fee
-$15000 invested (loan)
+$15000 invested (cash)
Net:-$175

Standard Loan:
-$??? Origination fee
+7%/ yr: $15000 invested
-3%/yr: $15000 loan
Net: +4%/yr on $15000 - $??? origination fee

Also, for faithfulness to mustacianism: Unless you're getting a new Leaf (EV), $15000 more than you need for a good condition, efficeient, used car.



UniversityEmployee9

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401k loans are almost always a bad idea. The money you borrow is taken out of the market for the length of the payback period and many plans will force you to pay back the loan immediately if you separate from the employer for any reason.

talltexan

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The problem with financing a car is that you might buy a bigger car than you would if you just paid cash. What psychological commitment can you make to a budget for this car purpose that prevents this? Once you have an answer, financing isn't terrible in this case.

nkt0

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If you are buying new (MMM says you shouldn't), some manufacturers offer zero interest car loans. I'd go with that if it fits your make/model preference.

If you are MMMing it, buy a cheap used car.

catccc

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Thanks all, particularly to jc4 for confirming my logic!  Yup, I just threw $15K out there as an example, we won't necessarily spend that.

I have plenty of cash and I did state that I understood that the money is not invested during the loan period.  I did not state that I have oodles of cash, so payback if in the case of separation would not be an issue.  But I won't go the 401K loan route anyway, because there's no mathematical upside.

I am very math/logic based when it comes to behaviors around $; I would never buy more car than I needed because the monthly payment was a particular amount.  So I guess bank financing is an option.

It's highly unlikely we will buy new.  I have a spreadsheet that I use to compare possible purchases that calculates cost per mile based on purchase price, current mileage, and expected fuel efficiency.  Cost per mile to 200K miles, as that is the earliest we consider replacing our vehicles.  It does not account for estimated maintenance/repairs, but I really can't guess at those very well with my knowledge base, so I just assume there will be some and it will be around the same for the types of vehicles I am considering.  (Primarily looking at the toyota corolla or prius.)  That is the biggest downfall of this analysis method, in not accounting for repairs, I am not accounting for the pre 100K miles being less $$ (and trouble) than the post 200K miles.  I should add a column that puts in estimated repairs at the same amount for the vehicles, and even though it's the same, since the miles are different, that will probably make for a better analysis. 

It's possible a new car could come out at the top of the analysis depending on dealer incentives.  There were amazing incentives on '17 prius primes in the spring/summer that would have put the cost per mile next to that of a used corolla.  I couldn't pull the trigger because we wanted 5 seats.

frugaliknowit

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401K Loan (for anything):  Fagetaboudit!

Auto Loan:  Pay cash.

New car:  0% (FAKE) or otherwise, Fagetaboudit!  (let someone else pay the depreciation).

Auto loan rate versus POTENTIAL stock market returns:  Fagetaboudit!
« Last Edit: August 17, 2018, 11:50:08 AM by frugaliknowit »

catccc

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Auto loan rate versus POTENTIAL stock market returns:  Fagetaboudit!

Really?  Over time it is highly likely there is a mathematical upside.  The numbers say yes!  Do you just think it is too risky?  Itís not any more risky than investing other $ I have sitting around, since I donít plan on withdrawing it any time soon.  Actually, if it drops I can harvest losses to reduce my taxable income, and reinvest in a similar but not identical index.  Then when I have capital gains at the eventual sale, itíll be tax free anyway (assuming current tax laws), since I can probably stay in a bracket for capital gains tax of 0%.  (HHI is about $135K but we can put 66K in pretax accounts.)

frugaliknowit

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Auto loan rate versus POTENTIAL stock market returns:  Fagetaboudit!

Really?  Over time it is highly likely there is a mathematical upside.  The numbers say yes!  Do you just think it is too risky?  Itís not any more risky than investing other $ I have sitting around, since I donít plan on withdrawing it any time soon.  Actually, if it drops I can harvest losses to reduce my taxable income, and reinvest in a similar but not identical index.  Then when I have capital gains at the eventual sale, itíll be tax free anyway (assuming current tax laws), since I can probably stay in a bracket for capital gains tax of 0%.  (HHI is about $135K but we can put 66K in pretax accounts.)

I suggest googling "sequence risk" and "leverage risk" and note the return of the S&P index from 2000-09 was negative.

Simple Dad

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Pay cash

Tuskalusa

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Pay cash for car.

RWD

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Auto loan rate versus POTENTIAL stock market returns:  Fagetaboudit!

Really?  Over time it is highly likely there is a mathematical upside.  The numbers say yes!  Do you just think it is too risky?  Itís not any more risky than investing other $ I have sitting around, since I donít plan on withdrawing it any time soon.  Actually, if it drops I can harvest losses to reduce my taxable income, and reinvest in a similar but not identical index.  Then when I have capital gains at the eventual sale, itíll be tax free anyway (assuming current tax laws), since I can probably stay in a bracket for capital gains tax of 0%.  (HHI is about $135K but we can put 66K in pretax accounts.)

I suggest googling "sequence risk" and "leverage risk" and note the return of the S&P index from 2000-09 was negative.

My used car loan interest rate (1.69%) is less than my Ally savings account APY (1.80%). I can't think of any reason why I wouldn't take the loan in that scenario.

whodidntante

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Many plans will force you to pay back the loan immediately if you separate from the employer for any reason.


The TCJA changed that. 

Telecaster

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So I started googling about it and saw in reddit someone else uses a 401K loan when they are buying a vehicle, since the interest you pay on the loan is to yourself, rather than to the bank.  I checked out my plan, and to borrow $15K (as an example, IDK how much we will spend), there is a $175 set up fee and then I pay myself 4.5% interest.  For a 2 year loan, this works out to be $1048.23 in interest I pay to myself.

The guy on Reddit is a fucking moron.   

Think about it for a second.  You don't pay anything to yourself.  You can't.  All you are doing is putting money you already have into a different account.  In this case, from your checking account to your 401(K).   If you moved a dollar from your left pocket to your right pocket you didn't pay yourself.  You had the same amount of money the whole time. 

But you might have screwed yourself.  Because you pay back the loan with after-tax tax dollars, which then go into a tax advantaged account.  So when you take the money out it is taxed again.   And it could be even worse than that.  Many plans don't allow you to make new contributions until your loan is paid off.  If that's the case, then you are likely paying a marginal higher rate (remember, you get the 401(k) deduction at your highest marginal rate), and then using those higher marginal rate dollars to pay off the loan.  So not only do you get taxed twice, you likely get taxed a higher rate.   

hdatontodo

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I disagree with the taxed again point.

Money you borrow from 401k is not taxed when borrowed. Money you borrow from a bank is not taxed either.

You will pay either source back with after tax money.

With the 401k loan, you are paying yourself the interest.

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Telecaster

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I disagree with the taxed again point.

Money you borrow from 401k is not taxed when borrowed. Money you borrow from a bank is not taxed either.

You will pay either source back with after tax money.

With the 401k loan, you are paying yourself the interest.

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Agreed, it isn't taxed when it is borrowed, it is taxed when it is withdrawn.  Here's why:  You borrow pre-tax money.   But you pay back the loan with after tax dollars.  Then, when it comes withdraw money from the 401(k) during retirement, those after tax dollars are taxed again.  So all that money you "pay yourself" back with is taxed twice: first when you earn it, and then again when you withdraw it. 

And no, you are not paying yourself interest.  You have the same amount of money the entire time. 








catccc

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A couple more votes to pay cash. My partner pointed out that thereís no reason we canít do both- invest the amount of cash it takes to buy the car, and buy the car in cash.  Since we have so much cash sitting around.  Well, heía right, thatís true.

The guy on Reddit is a fucking moron.   

Lol.  I feel like I should go back and tell him (nicely) that his math doesnít work.