Rant First – Useful content below
I wasn’t planning on writing this post anytime soon but was recently highly motivated by one particular finance officer of a car dealership. Theresa and I spent the past 15 months researching and saving for the purchase of getting her a new car. We ended up purchasing about a 3 year old Kia Sorento. Anyway, after a few days of dealing with this car dealership we finally had everything ironed out and agreed upon and we were minutes away from walking out the door with our car. As I was writing the check for the car I made the comment that I don’t think I’ve ever written a personal check for that much money and out of nowhere the finance guy tells me “I hate to tell you this but paying cash for a car is about the worst financial decision you can make.” If someone is getting ready to hand me a check for thousands of dollars I would just keep my opinions to myself. Especially when they involve telling your paying customers that they are making a huge mistake. Let me also point out that this wasn’t part of his sales pitch to get us to finance but was literally the last step in the transaction.
Now I was already tired of dealing with them for the past few days and was really thinking about just letting that comment go just so we could get out of there. However, without any reply from me he decided it necessary to tell me about how he use to be a financial adviser and he never would have allowed one of his clients to do such a thing with their cash. “Don’t you know that this car is going to do nothing but depreciate in value? Wouldn’t you rather earn money investing it”? I know it has to sound like I’m kidding or exaggerating but I promise these are exact quotes. Anyway, I’m pretty sure Theresa was about one more comment away from ripping up the check I was writing and telling the guy were to stick it. I simply told him that we are paying cash for this car because we don’t know the future. If I lose my job I still would have to make that car payment and keeping losing my guaranteed 3-7% in interest on the loan. His response as he so beautifully put it was “why would you lose your job?” I responded with an eye roll that I’ve seen lots of people broken by unexpected lay offs and know that it can happen to anyone. As we were leaving he was still rambling about the rate of return from the stock market and how that is more than what we would be losing or something like that.
In the end I believe the guy was pissed that we didn’t purchase any of his extended warranty stuff, didn’t do any financing and honestly I believe that he was simply jealous that we had been disciplined enough to save up that kind of money. It was a rather painful experience all the way around but I suppose that is sadly typical when buying car from dealerships.
Actual Useful Stuff
The decision to pay cash for a car or to finance a car is rarely even considered by most people. Most people think it would be impossible to save up the necessary to cash to buy a car. I mean everyone has car payments right? Well you don’t have to. Typical car payments are around $400-500 a month over 60 month terms (5 years) and people with good credit can get loans for around 5% interest. So a $25,000 loan at 5% interest is $472 a month payments. Over the life of the loan you will pay an extra $3,307 interest.
Now one of the main arguments I hear for financing is that you can earn more in stocks to make up the difference. On average if you know what you are doing you can get a net return of around 8% after fees. However, you can also lose your ass (think 2009). I’ve never heard this whole argument articulated in a way that makes since beyond that. Are they suppose to make a $472/month car payment and invest $472/month in stocks with the hope to earn a couple percentage points? Most people don’t have enough extra income to pay the car payment twice each month. I believe the argument is you should discipline yourself to save up to pay cash for a car but once you get the cash together invest that whole chunk at once and then take on the car payments. But that still doesn’t hold up because of your losses your are taking on the loan.
If you invest $25,000 and get 8% return your money will have grown to $36,733 in 5 years.
If you pay cash for the $25,000 car then invest what your monthly payment would have been of $472 and get 8% return your money will have grown to $34,430 in 5 years.
Now it might look like the payments make better mathematical since but wait.
The car cost $25,000 when you paid cash upfront. When you take on the payments the car ends up costing you $28,307 (purchase price plus interest to lender).
So when paying cash upfront, then investing what your car payment would have been you profit $9,430 ($34,430 – $25,000) over 5 years. If you take on the payments and invest the purchase price upfront you profit $8,426 ($36,733 – $28,307) over 5 years. Pay cash upfront and earn more with substantially less risk.
And to address the people who love there car payments and say “yeah but I got my loan for 1% interest so I do earn more in the end.” Assuming the car dealer didn’t just bake your reduced interest rate back into the sale price of the car (which he did) I still would always pay cash because of the reasons below.
Reasons why we always pay cash for our cars.
- We don’t know the future. Sure we make plans for the future and try to prepare for things but in the end we have no idea where we might be a few years from now. People get sick, people lose jobs, people have lots of kids, people decided they want to work from home, etc. If you have a car loan they want that payment no matter what and it can be quite stressful trying to make a $500/month car payment when things are already tight because you lost your job unexpectedly. You can easily stop investing as much into a 401K to temporarily increase cash flow but you can’t tell the lender you will pick up payments again in 6 months.
- You will almost always spend less. When you have spent a couple years saving money for this one purchase you are going to be very tight with it. Trust me. It hurts to let that money go and you will be on the hunt for exactly what you want and a great deal. You have felt years worth of pain and will be a lot less likely to overpay. We walked away over only $200 on our last car and most people just don’t walk away from cars they want, especially over that amount.
- You are more likely to get exactly what you want. You’ve spent a couple years thinking about and researching what would be the best fit for you. There are tons of vehicles in every category and researching them all and test driving them takes a lot of time. This also leads to a much lower chance of buyers remorse.
- Because debt sucks for so many reasons. You have to pay interest on your debt which is just throwing money away. You have less money to invest every month. Your fixed spending every month is increased. As they say the borrow is slave to the lender. Not a good feeling.
The only time I think it makes since to take out a loan for a car is if you absolutely need a car and don’t have the cash. I mean you really NEED a car. As in public transportation isn’t an option, riding a bike isn’t an option, car pooling isn’t option, you don’t already own a freaking car. If for example you are right out of school and your first job is in the middle of the country and you don’t have a working car I would say taking out a max of $5000 for a car would responsible with the focus of paying it off as quickly as possible.
When it comes to money don’t be normal. Be different. Just because most people are in debt up to their eyeballs doesn’t mean you have to be too.