Is it always smart to pay cash for a car?
August 28th, 2006 by Grant in: General, SavingI got to thinking about this topic again today after I read a post by Trisha from Building an Empire.
She recently bought a new (for a used price) PT Cruiser and paid cash for it. She thought the idea of paying cash for a car was kind of cool, but fretted the fact that she used up a ton of cash reserve to do it.
This got me thinking (actually, I’ve been thinking about this for a while), is it always smart to pay cash for a car?
After putting the numbers to it, I found that the answer is no, so long as you have the cash to pay for it anyway.
For instance:
Recently, the local Acura dealer was running a finance special for new Acura cars, indicating they would finance the purchase of a new car for nothing down and 1.9% interest over 3 years.
Say I wanted to buy a car for $30,000, and had cash to pay for it, but decide to let Acura finance the purchase at 1.9% for 36 months. I can make more than 1.9% at my local bank for the same period of time, so after 36 months, who comes out ahead?
I do, even if I’m tapping into my $30,000 in cash to make the payments every month.
The key is that you must have the money to put aside for 36 months to draw interest on for this theory to work.
However, this theory doesn’t take into account the credit effects of having a loan payment every month. Trisha is in the real estate business, and lives by her ability to borrow money. Having a monthly loan payment may affect that aspect of her business. (She’s a pretty smart cookie and has naturally thought of all this…)
The point is, it’s not always financially “smart” to pay cash for a new car, especially if you have the cash to do it. Buy always ask yourself, where can my money work hardest for me?
Something to think about!
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August 28th, 2006 at 9:20 pm
On a related note, going in to a dealer prepared to pay cash can be a good way to get a low interest rate. I just bought a car last week and went in looking for an interest rate that the finance guy said wasn’t possible to get. He instead offered something over 7% (can’t remember the exact number). So I said “no thanks, I’ll pay in cash.” I then arranged to pick up the car the following weekend. Two days later, the finance guy was suddenly able to get a rate of 5.89%. Not too bad considering I wasn’t even trying to haggle.
August 28th, 2006 at 10:13 pm
7%! Holy smokes!
You make a good point though. It used to be that dealers made their money off the sale. Now they make their money off the financing.
If they can lock people into a car (whether they can afford it or not), they know that chances are, the new owner is going to want to trade the car in on something new(er) in the near future, further extending their lease, and thereby the cash flow.
The last thing they want to do is have someone pay cash for the car.
-Grant
August 29th, 2006 at 1:29 pm
I totally agree and think the optimal strategy is: allocate some cash to a new car, but don’t buy it if the % rate for payments is under what you could make in investments. But I’d also check to make sure that I wouldn’t incur any penalties if I decided to pay it off down the road before term.
August 29th, 2006 at 6:54 pm
That’s exactly what my wife and I are doing. We’ve set up a savings account dedicated to buying a car. When we have enough money to pay cash for one, we’ll start refining our selection.
You bring up a good point though. As with home mortgages, there is a ton of fine print you need to review to make sure you’re not stuck with a bunch of junk fees when you do the deal.
-Grant
September 3rd, 2006 at 9:08 am
I think that you have a good strategy for buying a new car as long as there is cash in the bank earning higher interest rates that being paid out on the loan. However, that is a narrow focus on buying a car.
My personal strategy has been to never buy a new car. It is a known fact that the greatest depreciation is in the first year of any car. So, buy a car that is at least a year old, make sure it is in good condition and you are ahead of the game. I currently drive a car that I love to drive, a 5.0 liter V-8 Mustang convertible, that is 12 years old, that I have owned for 10 years, that has 82,000 miles on it and on which I have not made a car payment this century. I bought it with 31,000 miles and was able to get 3 additional years of warranty. At an average of 5,000 miles per year, I drive much less than the average American, so my average annual maintenance and repair cost is about $1,500 a year.
Just a suggestion to consider: unless one of your top pleasures is smelling ‘that new car smell’ for about 3 months, buy, and finance if you want, a car that is one or two years old. Over the course of 5 -10 years you will save a lot of money.
September 3rd, 2006 at 9:58 am
You’re absolutely right, David, on both counts. In order for the strategy to work, you MUST have the cash in the bank at the time you buy the car, and you MUST be earning a higher percentage at the bank than which you finance the car.
Additionally, you’re right about buying a new car, but the strategy applies to buying a used car too.
I’ve never liked the idea of buying a new car, but I can understand why some people would. Some argue that if you buy a used car, you inheirit other peoples problems, and there could be some truth to that.
My wife and I are in the process of looking for a new(er) car to replace her old (1995) Honda Accord. Dealerships have used car programs which they apply a dealer waranty to used cars.
In my opinion, this eliminates the “inheiriting other peoples problems” idea based on the fact that the car is backed by the dealer for longer than 30 days. It also lets you take advantage of the lower price.
As for the pleasure of smelling that “new car smell”? I buy the bottle of air freshener labeled “New Car”.
-Grant
September 4th, 2006 at 12:41 pm
Hi, Grant! Thanks for reading! I’m going to link to your blog, if you don’t mind. It’s interesting stuff!
Well, we had to buy our business car with cash this time. There were a couple of reasons for it. We got a steep discount for doing so. But, then, also, it would hurt us right now to have any other loans on our business’s credit. We’re selling just about every rental house we have right now to get the downpayment to purchase a big commercial property. And, our business needs to have the best credit possible when shopping for the best loans on that commercial property. A 0.25% difference in a commercial loan rate can mean $61,000 or more during the life of the loan on a million dollar property!
We didn’t want to buy the car on our personal credit with post-tax dollars, for obvious reasons. Plus, we’re about to refinance our personal home. So, there again, we need to be aware what kind of debt shows up on our credit file in order to get the best loan rates!
Just thought I’d give you some food for thought….
September 4th, 2006 at 2:02 pm
That’s what I figured Trisha. Every point counts when financing a property loan, so paying cash for the car in your case makes perfect sense.
Good luck on your commercial property acquisition, and I’ll be checking in to see how progress in the commercial real estate world is made!
-Grant
February 1st, 2007 at 2:29 pm
Nice Post.
That was well said. Always appreciate your indepth views. Keep up the great work!
John