Buying A Car With Cash: Smart Or Not?

by golbguru on July 18, 2007

I am pushing my next post in the used car buying tips series (read part 1 and part 2 here) to tomorrow, in order to squeeze this one in.

We recently bought a 2005 Toyota Corolla with 21 K miles on it. Earlier, I did not disclose the price, but it will be relevant here, so let me say that we paid about $12,200 as the drive-out price [drive out price = final price after taxes and other fees]

We had the option of financing the used car at about 7.0% APR, but we still chose to go ahead with paying cash for it (a decision which I now question .. sort of).

One of the most important reasons for the cash payment was my almost-all-cash portfolio. The cash has been sitting there in high-yield savings accounts, but it hasn’t been invested in the stock market. So, although I have been making the cash work for me - it’s not realizing it’s maximum potential (which it would have realized if it was invested properly). Anyways, all that cash sitting there made me think - “heck, if I have the cash, why go for the auto loan?“. Plus, paying cash would be totally hassle-free, which further encouraged the decision. However, in retrospection, I am not convinced that it was a “money-smart” decision. I think we totally ignored the leverage aspect of the loan. Here are a few thoughts on the subject.

Paying With Cash

To the casual observer, not availing a car loan may seem to be the *smart* thing to do - because you won’t be paying a dime to the bank in the form of interest on your car loan. So if you car costs $X, you pay exactly $X and the deal is done.

But one has to keep in mind that, in doing so, you will be losing the earning potential of the cash (in our case we are going to lose the interest it was earning through the online savings accounts).

Let’s run some basic math (crude approximations), include the cost of lost interest, and see how much paying in cash will cost us over the next four years (that would have been our loan term).

  • Cash paid: $12,200
  • Car loan interest costs: $0
  • Interest lost on cash (48 months @ 5.15% APR): $2790
  • Total cost of the car: $14,990

Plus, paying with cash has a few psychological perks like not having to worry about paying additional monthly bills, not being “under debt”, etc.

Paying With Auto Loan

On the other extreme, if we had availed the car loan @ 7.0% APR, our numbers would have been:

  • Cash paid: $0
  • Car loan interest costs + principal (48 months @ 7.0% APR): $14,022
  • Interest received on the unspent cash (48 months @ 5.15% APR): - $2790
  • [read TFB's comment below - I knew something was amiss ;) ]

  • Total cost of the car: $14,022

What!? what happened here? I am definitely missing something. How does the car loan come out to be cheaper in the long run?

Well, there is one flaw in the above calculation - it’s in the assumption that the entire $12,200 is available for earning interest in savings accounts. You have to realize that you are paying off the car loan (with monthly payments of about $292) from the unspent $12,200 cash. So each year, your cash reserve goes down, and so does the interest earned on it. But even if you consider the extreme scenario in which you didn’t earn any interest on the unspent cash, the total cost of the car still comes to about $14,022 - that’s still cheaper than the first option. You could probably account for taxes in the first scenario and that way it won’t make too much of a difference (in our particular case). But, if you are earning say 8%+ return on your money in the stock market, going for a used car loan (typically around 6~7%) might be the best option for you, instead of paying cash ~ or that’s how I am figuring it out.

Of course, now that we have paid cash, we won’t have the “psychological” feeling of being under debt (in a Dave Ramsey style), but I am not sure if that’s worth about $900+ over the next four years.

Btw, if you don’t consider the cost of lost interest/returns, then it is obvious that paying cash is a better choice; but we are sort of going beyond that thinking in this post.

What do you have to say about this? am I doing the right thing in considering the cost of lost interest (lost returns) in the total cost of the car?

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{ 95 comments… read them below or add one }

1 Super Saver 07.18.07 at 2:18 pm

Golbguru,

You have created a mathematical illusion by looking at only the car and savings transaction:-) To get a realistic picture, you have to consider your total available funds.

In your example, you didn’t include that $292 monthly payment. It needs to come from somewhere - either from savings or from giving something up in your monthly expenditures. Also, you didn’t include that you don’t need to reduce spending or saving if you pay cash. If you include everything, I think net cash outflow should be lower with the cash version, or you have to reduce spending elsewhere.

For reference, the logic I shared doesn’t work if your savings interest rate is higher than the loan interest rate. In the case where saving interest is higher, it may make sense to borrow. But I bet there is a certain gap that’s needed to do better than break even.

2 Lazy Man and Money 07.18.07 at 2:38 pm

This is another reason why I’m against Dave Ramsey. He’s great on the psychology side of things, but he’s not so good on the math.

Many people love to pay off their mortgages in advance because it gives them peace of mind. I wonder how much peace of mind they’d get if they realized what they were losing in opportunity costs. Look what you found out with a 7% car over a short time-span. Now apply that to a home that might be a tax-deductable 6% and compound that over the 30 years that most mortgages are. That kind of peace of mind can cost tens or hundreds of thousands of dollars.

3 moom 07.18.07 at 2:40 pm

From an economic perspective the cost of owning the car is depreciation, maintenance etc. and the interest cost. Neither principle repayments nor the upfront cash payment are costs. The only difference between the two scenarios then is net interest cost. Under the cash scenario your cost is 5.15% of the total price. Under the loan scenario it’s 7.0% on the outstanding loan and 5.15% on the money you have paid back minus 5.15% you are earning on the money you haven’t paid back yet.

So clearly the loan is more expensive when you think about it in this way. This is as long as you rate of return is lower than 7.0%. Things get more complicated if we bring risk into the picture :)

4 golbguru 07.18.07 at 2:45 pm

Super Saver: This is where I address the $292 payment per month: “Well, there is one flaw in the above calculation - it’s in the assumption that the entire $12,200 is available for earning interest in savings accounts. You have to realize that you are paying off the car loan (with monthly payments of about $292) from the unspent $12,200 cash. So each year, your cash reserve goes down, and so does the interest earned on it.”

I am considering the total available funds - four years from now.

The problem when posed mathematically, becomes: if you have $12,200 now, would you rather get an auto loan to buy a car worth $12,200 or pay the entire cash for it? After four years, how much cash would you have in hand with either options?

You said: “In the case where saving interest is higher, it may make sense to borrow.” - you don’t need a saving interest higher than the loan rate, since you are paying off (reducing) your loan every year. So, it seems it’s ok to borrow even if the interest rate is a couple of percentage points above your rate of return. I will run a few numbers on this over the coming weekend.

Moom: Depreciation and maintenance is the same in both the cases - whether you pay upfront or borrow the money. Also, like I said in the above paragraph, the interest rates cannot be directly compared - I think you need to calculate an “effective” rate of interest on the loan before you can compare it to the savings rate - that’s because, in the case of the savings account, the principal remains the same, whereas in the case of the loan account, you are paying off part the principal every month.

Lazy
: Dave Ramsey definitely ignores leveraging concepts. You are right, that peace of mind might cost a lot when we think of bigger costs.

5 TFB 07.18.07 at 2:47 pm

You made the right decision. Don’t second guess yourself.

By the way your math is wrong. You double counted the loss of interest. You can’t add it to the cost of paying cash AND subtract it from the cost of borrowing a loan. Do one or the other, not both.

5.x% in a saving account earns you maybe 4% after tax. The car loan costs 7%. No contest there. To break even with the 7% car loan, you need a return of 9-10%, which no investment can guarantee.

6 golbguru 07.18.07 at 2:55 pm

TFB: “You double counted the loss of interest.” - I think you are going in the right direction here.
I thought of that and tried to take it into account with this “But even if you consider the extreme scenario in which you didn’t earn any interest on the unspent cash, the total cost of the car still comes to about $14,022 - that’s still cheaper than the first option.” In this case, we are not subtracting it from the cost of borrowing a loan. And yet it’s expensive. :)

7 alex 07.18.07 at 3:07 pm

I suspect you are making a mathematical error when you are calculating the interest rate on the $12K, which steadily declines as you pay off the car loan.

According to Bankrate.com a 7% loan on a $12K car would have a car payment of $287.35 a month ($3448.20 a year) meaning at the end of 4 years you have paid off $13792.

If you take your $12K and multiply it by 1.0515 and then subtract $3448.2 for 4 years, you end up with -$226.67, meaning the car loan is $226 more expensive than the all-cash option.

In point of fact you would have even less since your principle is actually being depleted on a monthly basis, not an annula basis.

8 Engineer 07.18.07 at 3:10 pm

Another factor not mentioned are the taxes. You would have to pay income taxes at your marginal rate on the cash left in the bank. You don’t get to deduct the interest paid on a car loan.

9 Engineer 07.18.07 at 3:12 pm

Hit the submit button too soon. The income taxes you pay are on the 5.15% interest paid on the cash left in the bank (not on the entire balance).

10 Mike Stankavich 07.18.07 at 3:14 pm

I’m with Alex on this one. I did a quick excel exercise and came out with a net loss of $301.57 based on Alex’s payment estimate of $287.35 and the APR of 5.15% on the savings. My assumption is that you would withdraw the $287.35 to make the loan payment each month. In essence you end up making the 48th loan payment out of pocket.

11 Mike Stankavich 07.18.07 at 3:17 pm

OK, now that I read Engineer’s comment, I added in a marginal rate of 15% for income tax and came out with a bottom line of $517.96 shortage at the end of the term. Obviously your tax rate may vary significantly from the nominal rate I used.

12 golbguru 07.18.07 at 3:26 pm

Moom and Super Saver: After Mike’s quick number crunching, I stand corrected (thankfully - I couldn’t have lived with myself if I had ended up paying more with the cash). I think the depleting principal after I borrow from the auto loan is confusing me.

Mike: If you have your excel sheet ready, would you care to share at what loan APR the two options break even? Does it come out to be the same as the savings interest APR?

13 Mike Stankavich 07.18.07 at 3:47 pm

golbguru, it looks like it breaks even around 4.4%. I suspect that tracks fairly closely to the 15% assumed marginal tax rate. I should mention that in my case, I also have 9% state income tax in addition to 15% federal so I would be facing a 24% marginal rate.

The excel sheet is kind of quick and dirty, but i went ahead and posted it at http://www.kwyk.net/car_loan_example.xls

I also adjusted it to the notion that you only pay taxes once per year. I made the assumption that you would pay taxes on the 12th, 24th, 36th and 48th months of the loan.

14 Super Saver 07.18.07 at 3:50 pm

Golbguru,

Here’s another way I thought about it.

If it cost less to borrow than using cash, we could all make money borrowing at 7%, putting it in a 5.15% savings account, and paying off the 7% loan in 48 months, even if we didn’t buy a car. We’d all be rich from this easy money :-)

You made the right decision paying cash.

15 TFB 07.18.07 at 4:18 pm

Your monthly payment would’ve been $292.14.

PMT(0.07/12,48,-12200) = 292.14

The present value of this payment stream, without considering any tax effect, is $12,648, which is exceeds your cash cost by $448.

PV(0.0515/12,48,-292.14) = 12648

If you factor in a 15% tax rate, the present value becomes $12,842, which means you lose $642 if you financed. The higher your tax rate, the more you lose had you borrowed.

PV(0.0515/12*0.85,48,-292.14) = 12842

16 golbguru 07.18.07 at 4:29 pm

Mike: Thanks for sharing the Excel sheet.

Super Saver
: Now that you put it that way, it does sound wrong.

TFB: Thanks. It’s slowly going through my thick head. :)

Lazy: We will continue with the Ramsey vs. Leverage discussion when the numbers are in our favor. Right now, with our savings account, it does seem to be OK to pay cash.

I guess I am trying to cope up with the big hollow that the $12,200 has left in my pocket - it throws me into a panic, as in, “holy cow, I just spent $12,200 cash” and makes me run for the calculator. Hopefully, I will get out of it in a few more days. :)

17 Randy C. 07.18.07 at 4:33 pm

Something totally different to consider regarding financing or not. I have not done the following, but have been told by a former car salesman that financing can sometimes get you a better deal on the final price because the dealership plans on profit on the “back end” of the transaction.

Scenario roughly as follows. You walk into a car dealership, and claim that if they can beat your credit union’s rate of whatever the going rate is + 1.5% or so, they will start to see $$ potential in giving you a higher than market rate loan through the dealer.

This in turn gives them additional wiggle room on purchase price, if they expect to gain $xxx in interest over the terms of the loan. Then you work on getting the purchase price as low as possible, while they are thinking they will give you an 8.0% loan in a 7.0% market.

You accept the loan, after driving down the price, then pay off the loan in the first month. Verify that there is no prepayment penalty before taking out the loan.

I’d be interested to hear if anyone has used this technique. Hypothetically applied to your recent purchase of $12,200, lets say you got a 8.5% loan but with a purchase price of $11,200, then paid it off in the first month.

BTW, the salesman ends up loosing commission on this once the lender gets its commission back from the dealer for arranging the loan.

Hoping to hear thoughts on this.

18 Super Saver 07.18.07 at 4:48 pm

Golbguru,

Of course, car salesmen don’t want you to think “holy cow, I just spent $12,200″ They want you to think, “great, it’s only $292.14 a month.”

If everyone paid cash for their cars, the cost of all cars would be lower :-)

19 Kevin Raymond 07.18.07 at 8:56 pm

First of all, why are you buying a Toyota Corolla at all? That’s a bad investment whether you pay cash or not.

But since you did buy it. I guess I would say, if your cash isn’t doing what you want and it’s the absolute best choice for you. Well done. I personally would have invested that money in something else and taken the loan if I really needed a car.

20 broknowrchlatr 07.19.07 at 3:43 am

The bottom line, after correcting calculations, is that with a 7.0 % interest, you have to have a return greater than 7.0% AND have your extra money invested at greater than 100% for it to be a good deal with the loan. This is because any money you owe on it will accrue interest for every day that you owe them money. So, you would have to have it invested allt he time too.

The fact is, there is no way you can get a guaranteed 7.0% return anywhere. And, looking at investments that are good for a short time of 4 years, its too risky to play the market.

Paying it off is by far a better deal.

21 Derek 07.19.07 at 3:45 am

Note that you don’t have to take out the car loan when buying. I am sure that your local credit union or capitol one will be glad to allow you to take out a loan against your car if you really feel that paying cash was the wrong decision. You may end up with a better than 7% interest rate as well.

22 golbguru 07.19.07 at 4:13 am

Kevin: “First of all, why are you buying a Toyota Corolla at all? That’s a bad investment whether you pay cash or not.” - how is Toyota Corolla a bad investment as compared to other cars? I am not just thinking reliability here, how about getting 37 miles per gallon on the highway?

Looks bland? I don’t care about that - probably suits me since I wear jeans with holes in them. :)

23 Bill H. 07.19.07 at 5:49 am

Paying cash completely takes risk out of the picture. Once the transaction is done, there are no further payments or obligations.

And, what is a $12,200 car worth in 48 months? Probably not what you paid in on the loan.

Just my thoughts.

24 Geekman 07.19.07 at 7:00 am

Just a little question to throw in the mix here. Has anyone thought about the pro/con of putting some money down on the financed car vs. paying in full? For example, how would the math work out if Golbguru paid $6K on his car and financed the rest at the 7% vs. paying the full $12+K?

Also, if Golbguru had an extra $300 in his monthly budget to make car payments with, and thus his original $12+K became an emergency car payment savings account which he could put into a stock index fund at 10% (maybe), how does the math work out then? These are (to me) important things to look into because by ONLY looking at the actual cash on hand everyone seems to ignore the very real possibility that a persons current (and future) income can by itself meet their needs.

Personally, (and without doing any math on it) if I were buying a car I’d probably put the full amount into a fund and take out a loan as long as the loan was ~7%. In fact, just thinking about it right now, I would probably call up a credit card and take out a loan from them at 0% for the first year and 6.99% thereafter. I wonder how the math works in that case?

25 Dr. D 07.19.07 at 7:34 am

I contemplated a similar situation when buying a new car at 5% interest. I wasn’t so cash heavy, however, as I do invest in mutual funds. Selling them and incurring the tax penalty would have been pointless.

However, I was more interested in taking out the loan because I had not paid on a loan in over a decade (and my credit cards are paid in full each month). I was interested in maintaining my credit score, and the 5% cost seemed small in light of the stock market’s returns these days.

Don’t forget that proving yourself credit worthy often requires borrowing. And when it comes time for a home loan, for example, the better rates go to the higher FICO.

26 Moneymonk 07.19.07 at 8:24 am

Seems like you are only talking a few dollars lost. What’s the Big deal?

You must be an engineer, you are good with the numbers. Paying it cash is the smart approach. You are not “under debt”

“Many people love to pay off their mortgages in advance because it gives them peace of mind. I wonder how much peace of mind they’d get if they realized what they were losing in opportunity costs”

Not all people like to invest money, My parents home is paid for. I doubt if I tell them I can make them more money by not paying off the mortgage, they will look at me crazy ! Some people rather not take the gamble.

@golbguru

let’s say you lose your job tommorrow, will you still question yourself about paying cash for the car?

27 Debbie 07.19.07 at 8:26 am

Two more points:

1) If you take out a loan, the lender makes you have collision insurance. In your example, with a two-year-old car, you want collision insurance anyway, so this point is moot. But since I buy ten-year-old cars, I never want to pay for collision insurance, because the car is worth so little that even the tiniest problem is considered totalling the car and they don’t pay you much. So I always pay cash.

2) If you’re making payments, something could go wrong. You could accidentally mail one late. Even if you’re paying automatically electronically, there could still be some kind of problem. Maybe you want to change banks or there’s a computer glitch or who knows. This way, your car is totally paid off, and no kind of mistake or glitch is going to take that away from you (at least so long as you keep your receipt and/or title).

The fact that you’re feeling a little weirded out that $12,200 has just disappeared is good, because $12,200 did just disappear. At the same time, a practically new car has appeared. Hopefully that’s a big deal, too.

28 Debbie 07.19.07 at 8:31 am

Moneymonk’s comment about losing your job reminded me of another point. If you had taken out that loan, you would have had more flexibility with your other money. You could spend some of it without selling your car first (though you’d eventually have to get more to keep paying off the car) whereas now you can’t.

29 Kitty 07.19.07 at 8:59 am

I also paid cash for my car - more or less because the interest they charge is higher then what I get in a bank considering my tax bracket (plus high NY State tax). Once upon a time, when the interest was tax deductible (a very long time ago), I had a car loan. But after it stopped being tax deductible, I started paying cash for cars (changed a couple in 20 years or so for various reasons). I always compare with bank rates rather than stock market because you cannot be guaranteed that stocks are going to be up at exactly the time you may need the money, but you still have to make payments.
“Many people love to pay off their mortgages in advance because it gives them peace of mind. I wonder how much peace of mind they’d get if they realized what they were losing in opportunity costs”
Not really. As I mentioned, you still have pay your mortgage, even if you loose a job at exactly the time of stock market crash. Sure if your mortgage rate is less what you have in guaranteed accounts, it may make sense to keep the mortgage. It also depends on how secure one’s income is, and one’s age and tolerance of risk. What makes sense for 20-something doesn’t necessarily make sense for 40-something.

30 Kitty 07.19.07 at 9:23 am

‘“First of all, why are you buying a Toyota Corolla at all? That’s a bad investment whether you pay cash or not.” - how is Toyota Corolla a bad investment as compared to other cars? ‘
I have the same question. I used to have a Corolla and I loved it. Now I drive Honda Civic, but I looked at both when I was buying and choose the one where the dealer gave me a better deal. These are my two preferred models though.

Incidentally, judging by how much insurance paid for my 2003 Corolla when I totalled it in 2006 - I don’t have the numbers with me, can find them later - it hasn’t lost that much value over three years (of course, I couldn’t sell it for this amount, it was more of a “suggested retail” value, but even if I could get a couple thousand less it still would be OK). Corollas are also pretty reliable from what I heard.

31 golbguru 07.19.07 at 12:20 pm

Geekman: “Just a little question to throw in the mix here. Has anyone thought about the pro/con of putting some money down on the financed car vs. paying in full? For example, how would the math work out if Golbguru paid $6K on his car and financed the rest at the 7% vs. paying the full $12+K?” - Instinctively, without involving math, it has to be on an intermediate ground between paying-all-cash and paying-all-loan. If paying all cash is the best option, then, whatever loan amount you borrow, your option will step a little bit down from the *best* option - the extreme case being paying-all-loan. Hope that makes sense.

Dr. D: Thought about that, but right now my FICO score is 742, so I am not much worried in that department. This loan *could* have raised it to beyond 750 (after a couple of years with regular payments), but I think I will cross that anyways in about couple of years or slightly more. Plus, I am not expecting to borrow for anything till that time, so I took this consideration out of the equation.

MoneyMonk
: “let’s say you lose your job tommorrow, will you still question yourself about paying cash for the car?” - Honestly, I don’t see how that will make a difference. Once I buy a car worth $12,200 - whether I pay it upfront or get a loan, I will be in equal trouble if I lose my job. If I get a loan, then I am reserving my cash at present - which I will use to pay off the remaining loan if I lose my job.

I think I am a safe player in that department (some people even call me risk-averse), even if I had taken the loan, I would have had enough funds to cover it in times of a disaster - that is, if I lose my job or something. Things are problematic here when people borrow because they don’t have the money - I am going to steer clear of such situations as much as possible. This thinking is going to put me in trouble when I look for a house, but we will see what happens then.

So, my dilemma has been more along the lines of “is it possible that the cash that I paid upfront may have earned me greater returns if I opted for the loan instead?

Debbie: Yeah I know what you are saying with this “At the same time, a practically new car has appeared. Hopefully that’s a big deal, too.” … Apparently, it looks like I love my money more than the new car ;) that’s what causing the panic.

Kitty: I agree with you on Toyota reliability and resale value. Of course, my younger brother calls Toyota “a brand for the aged” (it’s that bland at times), but even he doesn’t dispute the reliability.

32 Moneymonk 07.19.07 at 2:43 pm

I guess I commented before I knew your finances. If you have a enough cash to protect you when you get laid off. Well for the sake of leverage, you would have came out less if you financed it. Because of the leverage

33 bubba 07.20.07 at 3:07 pm

Dude, yer crazy. Instead of looking at how much the car *costs* why not add up how much you can potentially *gain*.

Say you have $12,200 cash in hand.

Option 1: Take the loan and pay $292.14/mo to your debtor while investing the $12,200 at 5.15%. After 48 months, you have $14,984.18 in the bank and will have spent 14,022.92. Net gain = $961.26

Option 2: Pay cash and put $292.14/mo into a savings account at 5.15%. After 48 months you have $15,536.24 in the bank, and will have spent $12,200. Net gain = $3,336.24

Looks like a no-brainer.

34 H20 07.21.07 at 5:29 pm

Congrats on buying a Toyota. You bought one of the most reliable cars. I paid cash for my BMW and that car has broken down on me several times. Whereas my Toyota has not had 1 problem since the day I drove it off the lot.

Cash is the only way to buy a car as it forces one to only buy what one can afford. Unless you a low APR like 0.9%.

35 SkitzoCrowe 07.23.07 at 7:00 am

One of the benefits to financing for me in particular is a service offered by my credit union called a courtesy mortgage. Basically, the credit union will record your loan as a mortgage on your real estate, which may make the interest on your vehicle loan tax-deductible. There is only a small recording fee of $39 for the first loan, and the credit union handles all the paperwork for you.

So for a 60 month term (which I never use, always 36 months, 48 at the max), at the 7% APR you indicated, the Effective APR after the potential savings of the tax deduction can be around 5.25%, making it more competitive with paying cash. Personally, my last loan was for 36 months at 5%, with equals about a net effective APR of 3.75% or so.

I think it boils down to personal choice. Until interest rates go sky-high, I would prefer to take advantage of (reasonably) low-interest financing and a regular monthly payment rather than deplete my cash reserves. There’s a certain comfort level I have knowing that it’s available to me.

36 Chris 08.20.07 at 12:58 pm

I’d rather not deal with the bank. I prefer cash. If that means I lose a few bucks, so be it. I’m dealing with my wife’s auto loan right now. Bank didn’t have correct insurance info and decided to charge us their own insurance by discretely taking it from the monthly payment and not bothering to tell us (and not even indicating it on the payment breakdown, the interest and principle payment just didn’t add up and we had to call just to find out what was happening).

I have better things to do than deal with these people and their underpaid CSRs making mistakes every day.

37 urtrue 08.22.07 at 4:56 pm

Cash paid: $12,200 ????

Paid by CC…CC paid in full at due date..Earn points, higher Credit score ;-))

38 BigStar 09.21.07 at 6:53 am

If you are earning 5.15% on your cash you must factor in the inflation rate of around 3% which makes your cash earnings of only 2.15%, you must also factor in that same rate of inflation in reverse on the cash deal which makes your money and paying cash a more valuable option, because your money loses no value when you pay cash in fact it gains.

39 cpfoutz 10.14.07 at 9:00 am

It’s interesting how people say they have better peace of mind by paying cash…So long as the interest rate is low, I have better peace of mind by taking a loan. If I have 15,000 in savings and use 12,000 of that to buy a car, that leaves me with $3,000 in savings. I’d rather have the 15,000 there…what if I were to lose my job? If you’re disciplined and always make sure you can pay 100 percent of your debts (except your mortgages), you never have to worry about not being able to meet your payments, so really there is more piece of mind by borrowing.

To the poster that said an if you could make money on a 7% loan then everyone would be out there making loans just to get rich…you’re forgetting this is a secured loan. A bank won’t give you a 7% loan unless you’ve got an asset to back it up. I have a 2% student loan…you can’t tell me I can’t make money on that one…but not everyone can go out and get a student loan.

40 Jaiden 11.15.07 at 9:58 am

About two years ago, my wife and I ruined our finances by creating a restaurant. I truly understand the crushing weight of debt. Shortly after this, my wife lost her professional job out of the blue. After two years of struggling we have just begun to recover by re-entering our professions.

If we would have remained in our fields we would have been fine, but in that unfulfilled way. We know now that anything can happen and not having money to pay bills is beyond scary. It is living with your parents for two months when you are over 30 scary. Everything bad that could happen except for illness did happen.

Although, personally, I would not have paid that much cash for a used car, it was an excellent decision.

While our combined salaries now put us in that top 20 percent of wage earners, we owe a lot of money.

Before our business, we were credit and credit card free, except for school loans. We are trying to reach that level again, minus the school loans….

Cash is almost always better. Living well below your means is beyond awesome.

As Redd Foxx said, “I bet I can enjoy my nickel better than you can enjoy your dime.

41 Dave 11.26.07 at 6:15 am

Hi,

I haven’t seen anyone mention Insurance. When you pay for a car in cash in full you can reduce your insurance coverage to just liability. This can often provide savings beyond the interest, provided you’re willing to take a risk betting on your driving ability. I’m confident in my driving ability and don’t feel I’ll be at fault were an accident to occur. Even if it were to occur, I can afford to buy another car outright so the risk makes financial sense for me.

42 Jay 06.07.08 at 7:10 pm

The logic is pretty simple here i guess. If the lender(bank) could have made more money on savings, instead of of lending it out they would have effectively done that without lending money on collateral that depreciates.
So making a cash purchase here makes sense to me.
Also the interest rates are always on mercy of the great feds

43 Architect 10.12.08 at 1:48 am

Interest lost on cash withdrawn from account (48 months @ 5.15% APR)
Interest lost on Loan for car instead of cash (48 months @ 7.0% APR)
All remaining equal it is a no brainer:
Interest Lost on Loan (48 months @ 1.85%APR)
Also as Engineer said, you must pay taxes on interest from cash remaining in the bank.
One more thing with the cash option happens, the first of the month is like the middle of the month, no worries. Also, you will truly earn the right to put a bumper sticker that says: don’t laugh it’s paid for.

Cash talks and credit walks. Save and buy cash.

44 Crash 01.14.09 at 6:08 pm

I am just now considering cash vs loan. I pretty much went with the “what will I have (in cash), at the end” way of figuring that Bubba went with. I played around with interest rates (reasonable and current rates), my tax bracket, rates of return on investment (reasonable and conservative) and in most scenarios for me it always came out pay cash. I also ensured that I saved the amount of what the car loan monthly payment would have been to recover that expenditure over time.

Now, the point about afford-ability came to play. I have enough saved that I could buy a really nice car, but I would obviously deplete my savings leaving me with that “up the creek with no paddle” knot in my stomach. On the day the world comes crashing in on you, a shiny new car won’t earn you any comfort points over a more practical one. In fact, it’ll probably give you an acute case of buyer’s remorse. But, a cheaper, more practical car paid with a fraction of your savings allows you to have transportation AND an emergency fund to play with (as well as no loan to have to pay off.) Unless you can grab that rare 0-2%, I can’t see too many scenarios where there’s a better way to go …

45 Okree 01.24.09 at 9:09 am

I think a duffel bag full of cash would have convinced a private seller to let me have that ‘05 Corolla for $11k. My plan for wealth doesn’t involve trying outsmart the system with clever math and the use “other peoples money”. You might as well save for retirement with the cash back and points from credit cards. Cash… you did good, although I suspect you’ve not yet fully embraced the psychological benefits. Enjoy the freedom!

46 John 02.12.09 at 7:04 pm

The loan payback would come to at least $15,616.

47 jhon 03.07.09 at 1:03 pm

Ohh yeah you forgot to calculate the taxes you have to pay the IRS if you make interest from the bank. Also when you get a car loan you pay document fees, processing fees, underwriters fees, etc… The no brainer move is to pay cash.

48 JamOnIt 04.14.09 at 11:49 am

There seems to be really knowledgeable advice on this site, so I wanted to ask my own question which pertains to the originally stated car buying question and hope for some helpful advice. I have a unique situation and am unsure of how to proceed. Your time is much appreciated if you read on.

I came into some money recently. After paying off personal debts, credit cards and starting my first retirement annuity, I now have $95K in the bank. The car I want is $20K which will leave me with $75K in the bank (if I pay cash).

I really want the fully loaded 2008 Honda Accord and feel like I deserve a safe, practical and reliable car for the first time in my life. There is not much difference in the ‘09 Accords from the ‘08 except for saving money. So I plan to purchase an ‘08 Accord and that would make me very happy since I could never afford a decent car in the past. this is the only major purchase I am allowing myself with this new money.

After a failed business and a divorce, I filed for Chapter 11 in 2004. I am financially responsible despite (or because) of that occurrence. Last I checked, my credit score was about 620 and I am certainly interested in raising it. I am aware that financing a car responsibly is a good way to do that. But at what cost?

My question:
I want to purchase the ‘08 Accord for $20K. Is it still better to pay cash when I have a decent reserve of money in the bank? My credit union offers either a secured loan for 4.5% for 2 years, or a car loan which will be certainly a higher rate and most likely a longer term, especially since my credit is not great. With a secured loan, they won’t own the car title, so would paying off a secured personal loan will help my FICO the same way a car loan would? The secured loan would also auto debit the payments from my credit union savings account which only earns 0.25% at the moment. I would put $20K in that account and leave it to auto pay on it’s own for the next 2 years. But does that help my FICO?

Or, by taking a regular auto loan, will having the extra $20K in another higher yield bank account (somewhere) be beneficial in terms of leveraging or gaining interest to offset the finance charges? I can’t seem to locate any decent APY’s from savings accounts, CD’s or Money Markets that would compete with a likely 7% car loan (my HSBC savings account started at 4.5% in 2007 and is now 1.65%). I keep looking for rates on-line, but there’s only so much I can find. I certainly hope to get my FICO up and own a condo one day, but don’t have enough for a down payment to make a potential mortgage worth it to me because my rent is quite cheap. So for now, I just want a decent car to go with my small 1 bedroom rent controlled apartment.

So in my case, should I buy my modest $20K dream car with cash, finance with a car loan at (estimated) 7% or higher for a few years, or take a secured credit union loan for 4.5% at 2 years? Either way, I have money left over in the bank, but I do want to build my credit as well as have money to make wise investments. Your professional advice is greatly appreciated. Thank you.

49 Eric 05.21.09 at 1:24 pm

Debt increases risk. You have to factor that into the equation as well. Simply put, you will almost always be better off using cash than taking out debt.

50 Jen 05.27.09 at 6:48 pm

There’s another reason to pay cash for a car. You don’t need to buy the most expensive insurance coverage. If the car is financed, the insurance is extremely high for me.

51 Paul 07.27.09 at 5:37 pm

lol…I’d say that “cash” is a much better choice in July, 2009. Good luck getting even 2% for that cash sitting around. The only way I’d take a loan is if it was for 0% and there are some deals out there like that. Still you have to usually give up a rebate.

52 anon 07.28.09 at 6:08 am

Hi all. Im from Malaysia, and all these talks is really interesting. Im trying to save up for a car that i can afford so i can buy it in cash, then i found this blog on the net. Tell you what, you all are blessed enough to get an 05 Corolla (with 21k miles only…) for USD12,200. Here in Msia an 05 Corolla with almost 100,000km (thats more then 50k miles) cost us RM81,000, which translates to almost USD23,000… almost nobody buy car in cash in Msia, new car especially, thanks to our hefty 200% tax on imported car to protect local car manufacturer. Its there since the 80’s….

Im saving up RM30,000 so i can afford to buy an used car with cash. but that leaves me options everything from before the year 2000… However, for car loan interest rate in msia for new car is only 2.xx% and 3-5% on used car.

Sorry off topic but yeah, im in support of buying in cash, because i pretty much want to avoid debt before i start on a home mortgage. (just started work a year ago)

53 Kevin 08.21.09 at 6:27 pm

I believe that if one has to finance a car, they are buying a car that they can not really really afford. Financing a car is a bad financial decision because one is borrowing money with interest on something that depreciates quickly (especially with brand-new cars). So, not far into the duration of the loan, one often owes more than the car is worth! This doesn’t add up or make any sense- to borrow money to buy something that ends up being worth less that what you still owe.

People who buy expensive luxury cars often buy them in cash because they know that borrowing money to buy cars makes bad financial sense, especially for expensive ones. Perhaps this is one of the reasons that these buyers have money- one would have to assume that they made have wise financial decisions. Chances are better than not that most people I know who drive (or driven around in) expensive luxury cars bought them in cash.

The only reason that I can think of how borrowing money to buy a car makes sense is if one does not have a lot of cash on hand and needs a car for transportation. In this case, it would be best to borrow money for an inexpensive used car, borrowing as little as possible.

54 Kevin 08.21.09 at 6:33 pm

Regarding my previous comment, “Chances are better than not that most people I know who drive (or driven around in) expensive luxury cars bought them in cash. “,

Those who are driven around in these expensive luxury cars also pay the salary of their chauffeur in cash, too!

55 Kevin 08.21.09 at 7:40 pm

Another thing… buying a car in cash allows one to be in a better negotiation position, especially when dealing with that pesky car salesperson who is trying to squeeze as much money out of you. By buying a car in cash, the dealer is more than likely to sell the car to you for a discount and you do not have to deal with financing companies or banks, etc.

The dealer would very likely sell a car at a discount, if it is bought in cash because 100% of the money is right there. On the other hand, if the car is purchased by financing, the dealer is very unlikely to sell this car at a discount because is not guaranteed that 100% of the money is there.

For example, if one is purchasing a car like an Audi A6, the MSRP price is around $52,875 (close to the price of the one on the showroom). Please note that this is ONLY an example, not an actual case of 2 different persons purchasing this same particular car. Also, this car, the Audi A6 is used as an example for the sake of illustrating my point. In addition, I have no financial interest in and not employed by Audi AG, any of its sales agencies, or any Audi parent or affiliated companies.

Back to the original topic, if one goes to the dealer intending on buying it with cash, negotiates aggressively with the salesperson, and outwits the salesperson’s tricks, charm, and slick-talking, one can likely get this car for as low as around $38,000-$40,000. This price is slightly above the invoice price for the dealer and the dealer still has a profit at this price (although a thin one).

On the other hand, if one goes to this same dealer intending to finance it, one is unlikely to get this much of a discount as the cash buyer. This buyer would be lucky to get this car at a discount for around $47,000-$49,000. This is also based on the same assumption that this buyer is smart enough to outwit all of the salesperson’s tricks, charm, and slick-talking. The only difference here is that since the buyer does not have the cash and is financing the car, the dealer will not extend the same discount as they will to a cash buyer.

There is a cliche that says, “money talks and bullshit walks” and another one that says, “cash is king”. This certainly applies in this case.

56 terrence 11.12.09 at 6:39 pm

You also missing something else. Insurance.the extra cost for insurance on a financed car possible to include gap nsurance.

57 Farhad 02.21.10 at 11:28 pm

Guys, Dont you think cash in hand playes an important factor in todays economically unstable market ?
Can some one guide me !!!!!

58 Mike 08.27.10 at 2:03 pm

Its funny how the comments are added over the years.
I dont know if any one has done up to date calculations, but in 2010 no stock investment is earning 10%, I’d be happy with 3%.
An average high yeild savings account earns less then 1.5% and loans are over 2%.
Cash all the way???

59 Chris 08.31.10 at 2:57 pm

In all the math you people are discussing you have ignored one important element: risk.

Risk is always greatly enhanced when you take on debt, that’s why they call it a liability. What happens if you take out a loan and you lose your job, your spouse gets sick or the engine has to be replaced? It’ll be a lot easier to overcome a financial storm when you don’t have to make payments to the bank.

Not only that but if you tuck the monthly car payments of $300 you would have been making in a growth stock mutual fund that has averaged 10 percent over a long track record you would have $650,000 in 30 years. What kind of car do you think you would buy with that kind of money in the bank?

This how millionaires become millionaires. Cash all the way.

60 Alan 09.04.10 at 4:17 pm

What a mixed bag!

Great comments, but I wonder why there is so much pointless discussion and math running around the idea of cash versus credit. Obviously (as some have said) credit will always cost more than cash. The formula is immune to marginal tax rates, inflation or any other dynamic. Banks could not exist if they paid more in interest than they can recover in interest..simple!
So, as has been mentioned, the value of credit (and therefore it’s reason for existence) is opportunity. Those contributors who believe that wealth is generated from saving money “piggy bank” style are misinformed.

Anyone with limited resources should consider the time that it took to acquire them.
Rather than look at the cash/credit argument with money in the bank, you should step back to a zero balance situation. You have no private vehicle, and no savings. Now, check your options for that $12000 car.

1. Save $200+ a month for 40 months or so and be without private transportation for that time. Even if you shave the time to 30+ months (factoring interest payments) you are still looking at a long time without the transportation that you have already decided that you need. This time without mobility represents a big delay in your plans.
As mentioned by others, this is an “opportunity cost”.

2. Borrow the money and get in the car now. Sure, you pay a few points in interest, but look at what those points have afforded you! You have been driving the car and (hopefully) making good use of it for three years sooner than a cash plan would allow for.

I would ask you to calculate a savings plan that would buy a home for a first time buyer. Sure, you could probably get there…but how old would you be? Where would you have lived and raised your family during the saving time?
Credit, when viewed in the broader sense is very cheap.

Cash is hard to accumulate, and keep. The true value of cash is as a hedge against uncertainty. I keep a cash fund for the UNEXPECTED not the expected! Vehicle expenses are not unexpected and should not deplete your safety net! Credit purchases are always negotiable, even after the fact. Cash payments are final!

Alan.

Get wise.

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I bought a car and paid off right away. Even with very low APR that are happening right now, I felt it was still better than getting a credit.

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Just to add to my previous comment. With a low interest rate environment, it might be worth considering credit at this moment and investing cash somewhere else.

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