We chose to finance our car even though we could pay for it in cash.
We all hear about the difference between good debt and bad debt. Good debt is usually something like debt you go into for education, or a mortgage. Bad debt is usually something like credit card debt or a car loan.
Generally, there are personal finance recommendations that EVERYONE SHALL FOLLOW (haha) such as avoiding bad debt and saving 10% of your income. One such personal finance advice that most PF bloggers will recommend is to not finance your car. The beauty of personal finance is that it is personal, and even though people may be very debt averse, everyone is different when it comes to figuring out what will work for them or not.
I love scrolling on Twitter but am limiting it to 15 minutes a day (trying to, at least).
I stumbled on a tweet by Penny from @picksuppennies about how she got a car loan that was 0% for five years so she could use the money to invest or work on other goals. Then someone on Twitter basically told her it was a dumb idea and she was being irresponsible, or something to the tune of that.
Financed my car at 0% for five years to work on other goals and invest.
Could have paid for it outright but why?
10/10 would recommend. https://t.co/qqCuWIhIBs
— Penny (@picksuppennies) January 31, 2019
I thought this was interesting since the commenter was basically following the tenets of personal finance, like ‘thou shall not get a car loan’ even though it is a 0% car loan.
This flavour of black and white thinking, all or none thinking doesn’t fly as much in my own personal finance world.
When we were used car shopping (by the way, car shopping is the worst, I could never be a car salesperson, it would just rip me apart at the soul), I initially thought my husband would not want to have a car loan at all, because he is completely debt averse. Well, even though we could have paid for our family car (it is a used SUV) in cash, we ended up financing the car with 0.9% financing. We paid a large down payment and financed the rest for two years. We plan to drive the car and run it to the ground (or at least drive it for over 10 years).
Next month will be our final payment of the car loan, hurrah!
Here are the reasons for financing a car and on the other side of the coin, the reasons for paying for a car in cash.
Reasons For Financing a Car
One of the reasons we chose to finance the car is because of lost opportunity cost with the money we would have dumped into paying for the car outright with cash. Even though we didn’t maximize the money we had access to (instead of paying for the full amount of the car in cash), we still earned at least at 1.5% rate of interest with it in our joint high interest savings account. Of course you have to subtract the marginal rate income tax we had to pay on this interest. Nevertheless, this is higher than the 0.9% interest rate we paid to finance the car.
If we were to maximize it the opportunity we saved from not putting it into the car right away, we could have invested it in the market and earned a decent return from 2021 investment gains.
For more compelling reasons why you shouldn’t buy a car in cash, check out this The Motley Fool post on why you shouldn’t buy a car in cash.
Reasons for Paying a Car in Cash
I have also paid for a car in cash (my own personal car) because there wasn’t a 0.9% interest rate offer when I purchased my car back in 2014. I purchased a new car (again, another personal finance golden rule broken!!) because the new car purchase price was only about $1000 or so more than the used car purchase price. I also tried to negotiate for a discount because I did not have to finance and could pay for the car in cash, they did knock another few hundred dollars off the purchase price because of the cash purchase.
Therefore, paying for a car in cash would make sense if the interest rate were much higher than the high interest savings account rates available at the time. It would also make sense if there was a large discount because the car was paid for in cash instead of financed. To me, these are the reasons that I would pay for a car in cash.
Our Car Financing
What did we do for our own car financing situation?
Our car in total cost $29,200. After adding our beloved tax friends, GST and PST, the total cost was $32,700.
We put down a $10,000 down payment (even better putting a portion of the downpayment with a 10% cash back credit card and paying it off) and the remaining balance was about $22,700.
We took at two year term at 0.9% financing. The total cost of the 0.9% financing was $214 (this seems like 0.9% over two years instead of annually). This was added to the total cost and then split on a monthly basis for two years.
The opportunity cost of $22,700 invested in 1.5% is $340 per year, or $680. If this $22,700 were to be invested in a conservative 5.5% yield, you could get $1249 per year!
Therefore, even though a car loan is typically considered a bad kind of debt and something that you should avoid at all costs, there are ways when it might make more sense to take out a car loan.
- If the balance is not very high
- If you have the money to pay for it 100% in cash
- If the interest rate is under 1% or even better, 0% financing
- If you keep your car loan term on the short side (I am thinking under 4 years)
There are the scenarios when I think financing is okay. What are your thoughts?
Did you pay for your car with cash or did you finance or lease your car?
GYM is a 30 something millennial interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for blog updates, a free dividend yield spreadsheet, and the free Young Money Bootcamp eCourse.