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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.
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.
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.
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.
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?