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.
Related: 7 Ways to Save Money on Gas: Pay Less at the Pump
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.
For example:
- 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.
I mean, obviously, you know which side of the coin I land on…but yeah, I think that’s the worst part about personal finance. We forget that it’s personal. There are these Rules That Cannot Be Broken, but in some cases, following them actually doesn’t make much sense.
If/when I finally knuckle under and agree to my husband getting a new car (SUV. ugh), we will likely finance again. We just made sure that our down payment was enough that the payments fit comfortably in our budget. And there’s no penalty for paying it off in full, or at least there wasn’t with mine. So it worked well for us and hopefully will again.
@Penny- That sounds like a good option- finance and then aim to pay it off in full. Yeah, just by posting this on twitter there were some strong opinions from personal finance “Rules That Cannot be Broken” people 😉 Sometimes people can be very black and white and they forget to see the grey in life.
Long time lurker, first time commenting! Keep up the good work, I really enjoy reading your blog and the down-to-earth considerations instead of specific rules (the PF Bible is sacred…) that cannot be applied everywhere and by everyone.
On the subject, it all depends on how you look at it, like much of the PF. 214$ is indeed 0,9% annually (213.42$ of interest on 24 months with 954.73$ monthly payments), remember that from day 1 you paid mostly capital, unlike a mortgage, so the balance dropped quite fast. I personally think that the main point that should be underlined, bold, flashing if possible is: “If you have the money to pay for it 100% in cash”. The cost of opportunity for someone that does not have the cash to begin with, getting a 0.9% rate vs 1.5% in a HISA and around 35% marginal rate (around 50k$/yr salary in QC) would be a meager 370$. 185$/year! Most people could save that by switching credit cards, skipping a family restaurant meal, calling their phone/internet provider, or basically anything that does not include opening the door to “taking credit for liabilities”.
Cheers!
@Kams- Thanks so much Kams for commenting and reading. Yes, if we did not have the money to pay for it 100% in cash I don’t think I would finance. Thanks for crunching the numbers Kams!
I hate monthly payments so I don’t think I’d do it again! I took out a loan at 4.99% for a year to build credit the first time with a 50% down payment. But next time, I would just use our cash reserves even if we could get a 0% loan because I don’t like monthly payments. I think we are 8-10 years away from a new car though. That said, I like your logic and I don’t think car loans are inherently bad. They are simply a product, like Desirae says.
@Leigh- I think if I were into budgeting then I wouldn’t do it, but since we don’t budget, it doesn’t really affect us too much. Would be nice to see the cash build up without this expense though.
I’ve paid cash for both my cars, but they were both seriously cheap ($3500 and $5000+ trade in of previous car). At the point I someday get another car (hopefully many many years in the future), I’ll be open to the idea of financing if that sort of rate is available. A definite maybe 😉
@Angela- Steal of a deal! Yeah, if it was under $8000 would just pay cash outright I think.
I went through two car purchases, one where I financed my first ever car(Honda Civic) and our current car(Prius C) where we bought it with cash. Personally I would prefer to pay cash every time just to get it out of the way but if a dealership was offering 0% interest rate or maybe 1% I would definitely consider financing it. If I wanted to use my cash for other purposes and had a 0-1% rate on the table I would go for it. I would also make sure that the payment plan would only be for 1-2 years and the payments would be low, like your reasoning. Don’t want to drag financing it for too long.
Later this year we may look into trading in our Prius C for a bigger car, probably a SUV with the arrival of baby #2. We plan on paying it cash but if we run into a dealership like what you got offered, we would really think about financing it.
@Kris- 0-1% is a good rate for financing and to keep the financing short. Yeah, definitely not more than 3 years because it would suck to keep paying for the car past the longevity of the car. Prius C (I was going to get one too) but it was too small even for me (and this was before kids or even meeting my husband!). We have a CX-5 SUV and love it, very roomy with those pesky strollers. Now you’ll need to fit two car seats in there.
I hate car shopping. Could my 10 year old Camry last another 10, please? I have never financed a car. But on the other hand, I almost always have bought a new car (4 out of 5). Which is breaking another golden rule. But I keep them for on average 10 years (much longer if I take out the one I had for only 3), so why not start fresh? Oh well. Who knows, if you make a good educated decision about financing that’s okay versus, just doing it to do it. Tom
@Tom- I hate car shopping too- car salesman are too schmoozy for my liking. I think your 10 year Camry will likely last another 10 years. Toyotas are built to last!
If a dealership is offering 0% on an open term loan for say 72/84 months and you have the capital to pay it off 100%, what is the downside to take up the offer at $0 down?
@sam- I think a 6 to 7 year car loan is too long- so many people end up trading their cars in after a few years, but yeah, if it is open and it’s 0% and you have 100% cash to pay it off, guess there’s not much of a downside!
Hi GYM, good points about financing a car. Yeah, when the rate is very low, it makes good sense to get it financed. I don’t like debt, and feel it’s a hassle to deal with the monthly payment. So, I would rather pay cash to make it simple.
In terms of new car versus used car, I like a brand new car. As Tom mentioned above, shopping a car is not fun, and I never enjoyed it either.
@Helen- I love the brand new car smell, I must admit!
We paid for our last car in cash in 2010. I think the interest rate wasn’t that great back then. I’m not sure, though.
I just didn’t want a car payment because I was trying to keep our monthly expenditure down so I can quit working. 🙂
Now, I’m not sure. I might finance if the interest is less than 1%. I hate car payments, though. It’d screw up our budgeting…
Hopefully, self driving car will be here by the time we need a new vehicle. We don’t have a parking spot at our new place anyway. Street parking…
@Joe- Ugh street parking. I hate scraping the windshield and getting rid of the snow- but you won’t have a commute to worry about so you don’t need to rush to do that every morning, not bad!
We bought our first car in a private sale and paid for it with a credit line because we were young and dumb. It ended up costing an arm and a leg because it was about 100 years old. It took YEARS to pay down the credit line. Not my best financial decision.
We financed our second (current) car. The interest rate was low (not as low as yours – I think it was like 2 per cent or something silly) and we had a five year term. We ended up paying it off about 14 months earlier.
While I don’t think I would ever do another five year term, I could see a scenario where we would finance again with the right interest rate. Of course, we would likely do a bigger down payment in that scenario, too.
Glad to see more people talking about the uh, personal side of personal finance lately. I think sometimes that gets lost in all the “rules”, you know?
@Tara P- Hah, 100 year old car. Congrats on paying off your car term 14 months earlier than 5 years! Some people have 7+ year terms- I can’t imagine paying off a car term for 7 years, that’s too long, some cars don’t even last that long.
Another great article GYM! Like you, I’m always trying to think outside the box with my personal finance strategies.
This is one that very much appeals to me. Thanks to your article, I’m definitely going to look into financing strategies when it’s time to replace our cars.
BTW, Tom: my in-laws have our old Toyota Rav4, which we bought in December 2000. It’s had no major issues in 18+ years and is still going strong. So I’m 100% sure your Camry will likewise run for at least another 10 years!
@Chrissy- We bought it in April but I’m sure there are lots of good offers if you shop around. I think at the end of the month the used car salesman have quotas to make so they try their best to get the sale.
There usually is a cash price on a new car that’s different from the advertised price – what was the cash price?
The difference between retail and cash price is the upfront interest payment ask by the dealer. No business would survive with 0% interest, it’s all a marketing trick. The lower the rate, the higher the cash discount is.
@Dividend Earner- I remember asking what the cash price was and it wasn’t a significant difference, I think maybe $100-$200 difference? That’s why we ended up financing. I thought it would be a huge difference, but maybe it was a different deal/ offer at the time.
Without a cash discount, a 0%-like interest is a no brainer. Take the financing and be diligent with your money.
I have been amortizing my mortgage to 25 year with 2% like interest and I invest the difference because I get over 10% annual return on my investment. My investments make money and continue to make money, my house makes no money … (Please note that I am in a position to pay off the mortgage as my assets far outweighs the mortgage amount)
@Dividend Earner- I like your disclaimer in brackets- true financial independence! Your scenario makes perfect sense to me.
Planning to buy our brand new car, and still thinking if we should choose financing or pay cash. But, yeah this post is really helpful! Thanks
i financed my last brand new car in 2014 at 0.9%. i think the car cost 22k total and i financed about 20k or so. i just kept putting the extra cash i could have paid toward the loan into savings and then put that to a brokerage and bought stocks. i basically knew i could pay it off any time and that’s what i did when our cash flow changed with mrs. smidlap’s job loss in ’17. people on the internet have some real gall with their dogmatic commentary. financial independence has “independent” right in the name but they’re just sheep following a different flock…but sheep nonetheless.
here’s to doing things your own way!
@freddy smidlap- Yahh! Yeah, I think financing or borrowing money triggers a lot of people, especially personal finance enthusiasts. I think it’s very different when you know you can pay it off but you choose not to- you still feel financially independent in that respect.
I don’t know… the numbers speak for themselves! *sarcastic tone haha*
I would be comfortable taking on that loan especially all things considered – low financing interest, the fact that you plan to keep this car for 10+ years and decent monthly payment over a short 2 years. I’d rather use the money to pay higher interest debt or invest than a paid off vehicle!
I would’ve done it your way too. *shrug*
@Jaymee- It wasn’t too decent, lol over two years for $20K+, it was $1000 a month almost. Quite a huge cash flow suck.
Oh! Yea $1k a month hurts! Well glad you powered through it! =O
I loved the comment “the beauty of personal finance is that it is personal.” We finance our vehicles because of the interest rates. If we can get a rate of 0% or .9% which is pretty standard and our savings is even at 1.5% it makes sense to finance the vehicle.
The only comment I would make is try to find out how much extra you would get off from paying cash. As they usually have some sort of cash discount. I hate car shopping as well and agree, I could not be a car salesmen. If they do have some sort of cash discount include that when you think about how much you are paying in interest. As they have just worked the interest rate into the price of the vehicle. In the two times we have done this we found what they told us the cash discount was wasn’t worth enough to pay cash.
Thanks for sharing!
@Financial Fred- Yes, good point! We tried to see if there was a cash discount on our car purchase and there wasn’t really any- it was surprising to me.
I am reading this blog in August-2022 when the Bank of Canada Prime rate is 4.70%. I think those 0% are probably will be very last ad or blog you will see till next 20 years atleast or when Americans go head on war against China or Russia or worse both together. I wonder even next pandemic (if government will ever let it realize) will not impress the Fed to budge these interest free rates as it has costed much economy, to business and those in Canada reading this, the ever increasing overasking offer you have now put for 30 year old structure for the shed space in Toronto downtown you paid for.
I recently bought a big size SUV with 6.29% loan despite I had certified cheque in the name of the dealer. There are many reasons you can go for car loan even if you are coming to this blog 5 years down the line when this interest rate seems “wow” to you. This is my understanding but I could be wrong
1. When you buy a car loan for a used car or even new car(did I say atleast 2 years of wait for junk cars and 3 years or unknown for those buzzing electric ones? wait till it gets more exciting when your boss wants to see you in office (hybrid we call it) and you cannot take transit anymore), the financing agency has something call cashback reserve in next 6 months. What it means if you pay this loan back in 6 months the dealer get a hit and no commission as the financer takes all money to its institution. Indirectly, I told my dealer you are on the hook if something goes wrong for next 6 months, I will not wait a sec to pay it back
2. Negotiation plays: I know some don’t like it but what did you do when you wanted that raise at work so you can pay for your Hawaii trip? Its just flipping the game of becoming the boss of car asking “can you give more stuff, warranties and yeah can you take that setup fee on the top of Doc fee”
3. Dividend investing: Put the same money in 7-8% dividend paying ETFs you are still ahead in game and your car interest will be pretty much -2% or 2% realized discount after loan pay off
4. Risk hedge for a Car asset: Imagine you buy a car and you or somebody totals it (and ICBC blames you by default 50% liable, the new rule if you don’t know), if you had paid full cash for it what it feels like? compared to paying 2 more loan installments before the insurance company can cut you the cheque for full car cost you incurred.
5. Pay back the loan: The other step you always have is to pay back the loan anytime. You don’t need to worry, if car acts up or you want to sell it as you just saw how Tesla or Ford electric truck can make the little one sleep in the car you got choice as now you can used that saved cash as downpayment and in the meantime tradein/sell your previous car.
@Shaz- Thanks Shaz for sharing your thoughts.