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Guest Post – Never Finance: Always Pay Cash For Cars

My Strategic Dollar Financial Planning, Guest Posts 37 Comments

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Today we have an excellent guest post from Grant over at LifePrepCouple.com, a lifestyle blog ran by he and his wife Theresa.  They are new parents juggling building wealth, training for marathons, play dates and chasing early retirement.  Today’s post is about why you need to avoid those car payments and instead pay cash.  Enjoy!

“Grant, I hate to tell you this but this is the worst financial decision you could make.”

Who made this comment and what were they talking about?  I pride myself on being good with money.  Am I really making a catastrophic financial mistake?

Well, that little quote above came directly from someone in the finance department of the car dealership we bought our last car from.  This guy was letting me know how awful of an idea it was to pay cash for a car.  One might say he was just trying to make some extra money by getting me to finance.  However, this was at the very end of several days of negotiation while I was handing him the check.  The guy was a total prick who I would have loved to argue with but decided to let it go.  Here is what I would have told him had I had the patience.

The Power of Cash

One of the best decisions we have ever made was that we would always pay cash for our cars.  This wasn’t always easy but it has paid off many times over.  Most people will look at you like you have two heads if you tell them that you are going to pay cash for your car.  It is just assumed that any car that costs over two grand must have payments attached to them.  The fact that people will think you are crazy is the greatest endorsement you could hope for.  Normal is broke and we want better than that.

The only argument that can be made for financing is the ability to use the cash for investing.  Instead of spending $20,000 upfront on your car you invest $20,000 and make car payments.  The idea is your interest rate on your loan would be less than what you make in the stock market.  I would imagine that less than 0.01% of people actually do this who take on car payments but let us look at the math anyway.

The Math

If you invest $20,000 and get an average annual growth of 8% after fees in six years you would have $31,737.  Not bad.

Your car loan of $20,000 at 4.4% interest (average) has monthly payments of $317 for 72 months.  Total cost of car $22,824.

Net Profit Of Financing – $31,737.49 – $22,824 = $8,913

Now if you paid cash for the car upfront it will cost $20,000.

Instead of paying the $317 each month to the bank you invest it.  Which people without car payments actually do.  You end up with $29,101 at the end of six years.

Net Profit Of Paying Cash $29,101 – $20,000 = $9,101

So the one and only argument for financing a car doesn’t even hold up.  And, even if you somehow got a rock bottom interest rate that they didn’t bake back into the loan (they did) you still shouldn’t finance.

There Are No Guarantees

Whenever people talk about debt, they always like to talk about the ability to leverage their debt.  I always hear that on average the market will return around 8%.  That is a safe assumption when talking about 20-30 year time periods but not when talking about 6 year time periods.  You might get double-digit growth like the last several few years or you could lose money.

The only guaranteed money is the money you have to pay the bank in interest.  They are going to get their 4.4% regardless of what the market is doing.

The bigger problem is you don’t know what the future holds for you.  Our expenses look totally different now than they did three years ago when we bought my car.  We are now paying for daycare and the other baby related expenses, we are saving for college and investing about 3 times as much as we were.  All of this wouldn’t be possible with a couple of car payments.

Thankfully we have remained employed but if one of us loses our job we will have to cut back on how much we are investing.  Disappointing for sure but much better than not being able to make your car payments and having it repossessed.

Spend Less

Now it used to be that you could get a better deal by paying cash for cars but for the most part, this isn’t true anymore.  It might give you a slight leg up in certain situations but may actually hurt you others.  What gives you the advantage is that you are talking bottom line.  Most people who are taking on payments get distracted by “what will my payments be?”

It is much much easier to negotiate when you only have one variable to focus on.Click To Tweet It gets much more challenging when you have changing interest rates, terms and payments to worry about.

Naturally, you will spend less because you have a fixed amount saved.  A fixed amount that took time and discipline to save.  You are much less likely to buy the extended warranty and heated cup holders when paying cash because you want the most bang for your buck.  When the bells and whistles only cost another $30 a month it doesn’t seem so bad.  Multiple studies have been done on this and people always spend more, on average, when financing or buying on credit.  This will also help keep the dreaded buyer’s remorse away.

Paying cash for your car will make you a ruthless negotiator.  We literally walked away on a car that we really liked over a hundred dollars.  That actually let us walk out the door over a hundred dollars.  When they called back the next day I told them it would be $200 and they agreed.  People don’t fight like this when it isn’t their money but the bank’s money.

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You Will Feel Fantastic

It simply feels amazing to not have debt and this can not be overstated.  There is something that is so rewarding about avoiding debt or paying it off.  It is like a weight gets lifted off your shoulders.  When we paid off our student loans we felt like the two richest people in the world because our net worth was over zero.

As we know cars are a depreciating asset.  They drop in value and keep dropping.  Maybe the first year your car payment doesn’t depress you because you are paying $300 a month for a $20,000 car.  It gets depressing when you are still paying $300 a month for a 5-year-old car with 80,000 miles worth $8,000.

Conclusion

Buying a car is huge purchase for millions of people every year.  90% of the new cars will be financed and only a small percentage will be bought with cash.  Let’s change that so we can put more money in our pockets and happiness in our life.

If you want more information on saving for a car payment check out my article on how we do it.

What side of the fence are you on?  Have you ever paid cash for a car?

-Grant

Comments 37

  1. Pingback: Never Finance: Always Pay Cash For Cars - Grant and Theresa's Life Prep

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      Author

      Yessir! Sometimes it’s difficult to take all that cash out of your possession and turn it over. But hey, at least you got it paid off! Great work! Thanks for stopping by.

    2. That is about the same as paying cash if you pay it off that quickly. Good for you for not overspending and paying it off quick.

      Once that car starts loose it’s shine is usually when people decide they need to hurry up and sale while they can still get something for it. Then they just finance the next one while trying to keep similar payments but extending the debt for another 6-7 years.

  2. Well said! Nothing like making deals with REAL money. That dealer truly sounds like a real jerk! I bought my car with cash and finished paying off our other car. Now all that money is being invested. Thanks for this awesome post.

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      Thanks for stopping by! I’d never consider dealing with a car salesman that told me something shady like paying for your car with cash is a bad thing….shame on him.

    2. An amazingly immature jerk. I wanted so badly to tell him off after that comment but decided against. I felt like he was the type of guy to intentionally screw up our paperwork or something like that.

      It feels so good to have your money going to work for you instead of the bank.

  3. Excellent write up Grant!!!

    Wow I didn’t know the rate of financing a new car was so high! 90% of Americans need loans? The moment they drive it off the lot it’s a 20% depreciation, what are you thinking!?

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        I read recently that student loan debt is $1.4 trillion and car debt is $1.2 trillion…and student loans are the only problem…?

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  4. Paying extra in interest when you don’t have to never makes sense! I don’t agree with everything Dave Ramsey says, but I do like his take on buying cars – buy a really cheap car you can afford while you save, then buy the “next level” car in cash while you save some more, and so on. Great post, Grant!

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      Totally agree! I just don’t see the need for people to finance expensive cars for more than their salary!

  5. Thanks for sharing. I oscillate between what makes more sense. I think it comes down to one’s temperament. If you’re normally disciplined with money & investing, and already have a healthy cash-flow, with moderate leverage, I don’t think it’s that bad. For example, my wife and I both drive Honda Accords financed at 0.9% (mine is 2015, hers is 2016). I used to be in car sales, so I got the best deal possible on these. But at the same time, I have enough cash in the bank, to pay for these outright whenever I wanted to. But 0.9% is too easy to beat. Inflation is 2%. In other words, if someone wanted to lend me money at 0.9% in any other circumstance, I would ask them how much would they be willing to part with? =) I’d take on a trillion dollars at 0.9%. And really, you’re locking in the payment over 5-7 years with future dollars that’ll be worth less every year due to inflation. PLUS you’re getting on average 6-10% returns a year. And I’m big on liquidity. I’d much rather have a ton of money liquid, than tied up because it gives me a ton of wiggle room, and feeling of emotional stability. That’s the odd thing. I feel better having cash in the bank, or liquid investment accessible in a taxable account “doing something” even though it means being more indebted (within reason of course).

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      That’s a good point. There are certain instances when financing things makes sense, especially if you’re able to leverage that debt and increase your net worth. Good point about cash flow and liquid cash as well!

    2. Hey, Tim thanks for taking a counter position. 0.9% is really really low but I still wouldn’t take the payments but I understand your argument.

      If someone would lend me a trillion dollars at 0.9% I would also take it but not if part of the stipulation was I had to buy something that would be worthless in 20 years AKA a car.

      I just hate having consumer debt and the risk that comes with it. It just sucks having to write those checks every month. I’ve never had a car payment but the same argument is made for student loans. Paying those off felt like one of the greatest things ever and it instantly felt like we got a raise.

      I agree that buying a new car with payments isn’t horrible for people that know what they are doing and are on top of their financial situation and could have paid cash but choose not to.

  6. I am definitely all about paying cash for a car. I hate debt and would much rather pay off whatever I owe rather than the slow drip of a loan payment. Plus on top of that I figure if I had a loan that I’d probably buy more car than I can really afford. So it keeps me in check 🙂

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      Author

      Totally true! GIven that car loan debt is at an all-time high at $1.2 trillion, I’d say you’re right!

    2. I had a feeling you might be on my side 😉

      I 100% agree with you that paying cash helps keep you in check. You just act differently when you know that Net Worth is about to suddenly take a hit and no one likes to see that go down. You just can’t put stuff like that into a spreadsheet.

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      That’s one of my favorite quotes! And it’s 100% accurate. Just think about a world where nobody purchased anything with credit, but rather only with the cash they had? I bet it would look a lot different…

    2. We live in a society of overly impatient “I want it now” people.

      We bought a $600 couch at Rooms to Go and my coworkers just assumed we financed because they offer 0% for 24 months or whatever it is.

      Wal-Mart will let you finance anything over $50.

  7. “The fact that people will think you are crazy is the greatest endorsement you could hope for.” This was my favorite line in the whole post. I agree with you. In my mind, no debt is always better than debt, no matter what the rate of return. Peace of mind trumps profit.

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      That’s definitely what I’ve heard from those who have paid off debt. It isn’t always about the return, because generally it is more profitable in the long run to leverage debt, but it’s the peace of mind being debt free provides.

    2. Haha. Thanks!

      Real estate debt is the only debt that really makes sense to me. It appreciates (typically) in value and can be rented out to produce income.

      A car is guaranteed to be almost worthless in just a few years.

  8. I’ve never paid cash for a car. My parents bought my first car when I was 17. I bought my second car in 2013 and financed it at 0%. I’m ahead in payments, so I shouldn’t run into interest payments.

    That said, I definitely want to buy our next cars slightly used and in cash. The $276 I pay each month is just a money suck. I’m ready to be done!

    What you say here, Grant, is perfect and it sums up everything we as personal finance bloggers attempt to convey (although sometimes I’m not perfect at it) — ” … people always spend more, on average, when financing or buying on credit.”

    1. Thanks for the comment. I agree with you the revolving consumer debt just sucks. Even worse is as the car gets older. Those car payments really sting when the car is worth about a third the original price but the payment is still the same.

      Not all things with money can be calculated on a spreadsheet like the intangible stuff like spending less and negotiating harder.

  9. I go crazy when I hear people taking out loans over any period more than 5 years. IRS depreciation for business says a car has a 5 year life. I know that well maintained cars can have a life much longer than that, but this is about the average and the rule of thumb I use. People with 6 or 7 year loans are still paying for their car when the value is next to nothing. I have a Honda Civic which I bought in cash that is 7 years old and worth about $4K now on KBB. Imagine how much money would be thrown away on payments after 3 years, let alone 7.

    Plus, I have heard that banks are combining auto loans into investments in the same way they bundled mortgages into mortgage backed securities in 2010. We all saw how that ended, so it’s much better to pay cash and sleep well at night. Great post!

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      Author

      Good point! I think it’s telling that the average price of a new car and it’s loan terms has continued to increase substantially over the past few years. Thanks for stopping by!

    2. Well if you are going to sale a truck for $70,000 you gotta offer some long terms I suppose. Like I said in the article paying $500 a month for a brand new car doesn’t seem so bad but paying $500 a month for a car that is basically worthless sucks. It sucks so bad that most people then decide that if they are paying $500 a month anyway why not have a new one and the cycle continues.

  10. Preach!

    I got a car loan on my first car, but paid it off aggressively (about 18 months) and am never financing a car again. The folks who say financing a car is a good idea typically are never in a better financial position than I am, so why would I listen to them?????

    You’re right – normal is broke. Sometimes you’ve got to go against the grain in order to succeed.

    I’m definitely saving up some cash for my next car when we need it (a few years away still most likely unless our work situation changes significantly). Great post!!

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      Nice work paying the loan off quickly! I wish more millennials would think that way and stop taking out huge care loans!

    2. Hey Dave, Paying off debt always feels amazing. It is funny how people in horrible financial situations will still give advice. I was trying on a suit recently and balked when I heard the price. The man helping insisted that nice clothes simply cost that much and I would be happy to have such a quality piece. Not judging but I seriously doubt the person at the mall was better suited to tell me how to spend my money.

      Start paying yourself those car payments if you want to get a jump on your next car.

      http://www.lifeprepcouple.com/pay-yourself-a-car-payment/

  11. Great post! I always prefer to buy cars for cash! But there an exception here. It makes sense to pay a loan for the car when it will be used to earn money and it will pay the loan itself! The profit can be easily counted.

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      Author

      So true. I think there’s also a good argument for financing at 0% interest. Thanks for stopping by!

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