Why do some people finance cars instead of investing that money and buying them with earned interest?
I've never financed a car, so correct me if anything I say is inaccurate.
Personally, I've always paid cash for cheap and reliable cars. But if you really have to have a monthly payment, why not invest that money in someplace like a mutual fund or treasury bonds, earn interest, and buy the car with that earned interest instead of paying interest?
Just last week, I went to the dealership to buy a used Accord. I overheard someone who traded in his $3k car and bought an $18k car at 7.5 APR for 60 months, which comes out to be about $300/mo for a $15k loan.
Why not continue driving that $3k car, invest that 300/mo for 60 months in something with very low risk, like 10 year treasury bonds, earn 2 percent or so interest, and have about $19k+ in the end (not even including the trade in), and just repeat?
Because then you'd have to wait 60 months :D I understand your point, and trust me, I wouldn't take a loan to buy a car. But for some people, owning a super sexy car is very important, so they are willing to pay for it.
Why pay cash upfront when you can generate returns on it in excess of your financing cost?
0% financing
My general rule is to keep my fixed expenses as low as possible, so I'd rather pay cash for the car than finance it.
That is one way to go about it, but that that's an approach with a short term focus.
Another approach is to go for the option that makes you wealthiest in the long term (in this case, at the end of the 5 year life of the loan).
On a absolute cash flow basis, for a $15k loan at 7.5% APR, you'd only need to be make north of 2% p.a. on that $15k of cash you would have used instead, to be better off taking the loan than spending the cash.
In other words, you dont even have to make returns above your financing cost to be better off taking the loan, and naturally, the higher your returns on the cash are the worse off it makes you spending the cash upfront.
I am thinking long term, which I guess is different for everybody. Keep in mind, you're assuming a guaranteed return with 0% portfolio volatility, and in the meantime you're paying interest on a depreciating asset.
That 3k trade doesn't necessarily mean the car is worth that value. My 2002 Camry was due for inspection, and it had some significant problems that outweighed the KBB value of the car. So, time to get a new car imo.
0% APR is obv ideal, but if you get a good rate (I got 2.9%), and they provide particular deals that expire (recent college grad down payment bonus, in my case), you net more in deals than investing your spare cash.
Also, the deal i got on a new Acura ILX seemed to outweigh interest I would earn on invested cash. Approx. 6k off MSRP, which for sure wouldnt last once the quarter ended, seems like a better long term bet of value.
I took your advice with student loans in a way. Dumped two truck loads of cash on the loan company's doorstep within 14 months of graduating. 6.8% was too steep to not pay off aggressively. In a way, I paid for school in cash as opposed to eating the financing rate over 10 years or more
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