Help a Reader: Buying a Car

Here's an email I recently received from a reader:

So, we paid off our car and we have a growing 'Auto' savings account where we're sending the payments we were making on the car. The idea is that we'd be able to pay cash for our next car when the time comes and our current car falls apart underneath us.

In the meantime we've been able to borrow from the fund for car repairs that keep the car running longer.

Question is: While I love not having the payment and I love saving the money, when the time comes should I invest the saved money if I can get a sufficient return and borrow the money for the car if I can get a low enough rate?

What are your thoughts for him?

Comments

[The Warrior]

Personally, I do not borrow for cars anymore. I only would if what I could afford was not safe enough for my family. Our family despises debt and we are very close to finally being debt free.

The question to ask yourself is, "Would I sleep better at night knowing I have a paid off car or debt on a car?"

Hope that helps...

[Mike B.]

My Credit Union has decent (maybe 2.75?) interest up to 25K if you meet certain criteria. Since the missus and I both have paychecks we can meet the criteria on two accounts, so I don't feel too bad keeping the money we save for the car there. If you don't have this option for reasonable interest savings, it kind of depends how much time you have until your next car purchase. If it's not-too-long, you definitely wouldn't want to subject it to the ups-and-downs (well, ups maybe, but downs not) of the stock market. If it's over 5 years, then I'd take the risk. I think there is no great answer here in today's reality (of low interest savings/CDs).

As for financing the purchase, some places will give you either a low-interest loan OR cash back, so then it's obviously best to just take the cash back if you have cash-in-hand. My last two car purchases I intended to pay cash, but the dealers gave 'cash back' only if I financed through them. So, I double-checked there was no early re-payment penalty, and financed them both for a month and then paid them off. If you can get 0%, it is obviously best to take the loan and keep the money in even a crummyy interest-bearing account. Run the numbers through a spreadsheet and see if the few hundreds dollars benefit over the life of the loan is worth your peace of mind of not having that stupid car payment. For a lot of us, it isn't.

[No Waste]

We're a cash for cars household, but these rates are so low that I can see why people are tempted to borrow.

As long as you don't over-buy as a result, I don't see anything wrong with financing a portion of the purchase, as long as you get an extremely low rate.

[Michelle]

If the rates are low, then I personally would invest the cash and get a loan. There are so many cases where you can get anywhere from 0% to 2%!

[Retire By 40]

Why don't you invest the fund right now? It sounds like you are keeping it in a saving account.
When you need another car, just cash out some investment to buy it cash.
That's what I'd do anyway.
I hate monthly payments.

[BH]

I'd keep investing and buy a car with cash when it becomes absolutely necessary, simply because I'm philosophically opposed to consumer financing, even if it is at 0% interest, I don't like the idea of having a lender. Additionally, if you are sufficiently judgment proof, you can purchase much less expensive insurance if you don't have a lender. I'd recommend buying a nice car when the time comes that you are proud to drive for a long time (bought a 3 year old lexus that is now 11 years old and I feel no desire to replace it prior to its death). :)

[Mc]

I'm also a person who likes to pay cash for my cars. By which I mean that I finance around 1/3 of a car purchase and then pay it off a couple months later, to get the benefit for my credit report. But I dont do this very often because a car will easily last 10 years or more. I am in my mid 50's and I have only bought 2 new cars in my life. Cars are useful, but you spend a lot for new and fancy which isnt actually needed and which is basically money flushed down the toilet.

I think in general you should think of the money you are saving as "savings", not "for a car". I would invest it and keep growing the amount you put into this savings. If you need emergency money for anything, take it out of this account, otherwise let it grow for all your future needs. When you think you need a new car, sit down and list all your other needs too like retirement, or kids' future college that will all need to be paid by your savings. You may decide that spending a lot on a new car is not as important as the other things you want to do with your savings. The danger of having an account designated for a new car is that you can then just spend that account on the car without considering whether it makes sense in your larger financial plan for your life.

[JNEW]

From a strict investment point of view--

you would finance if you could obtain a fixed/safe return on your invested cash that exceeded your proposed auto loan rate. And vice- versa.

But finance is not always so simple. If it makes you sleep better to pay cash. Pay cash, if you can afford to do so. A side note to that is never buy a car that is beyond your means. I have heard the rule of thumb that you should not pay more than 10% of your gross pay for a car. Remember, they are truly disposable items-- liabilities---not assets.

Personally, I always pay cash for my cars. I feel that financing a depreciating asset just makes no sense anyway you slice it.

I am debt free (and loving it). The only loans I feel are prudent are those that are intended to allow you to make money in excess of the loan interest rate. And that is easier said than done as well. It works for mortgages when property is appreciating (not so much when home values have been sliding) and it can work for margin accounts if your portfolio is on the rise. It works to finance a business if the business is successful as well.

My advice--- get debt free. Then use the excess cashflow to increase your net worth substantially. At that point, loans will be truly optional products. That is when they work best.

The best loan is one you can pay off any time you want. That gives you the leverage and NOT the lender.

[SR]

If you finance a car at 0%, you're going to pay much more than someone who pays cash. Negotiate a cash price, then ask to finance at 0%. If the price is increased - PAY CASH!

[jim]

"should I invest the saved money if I can get a sufficient return and borrow the money for the car if I can get a low enough rate?"

If you can get a guaranteed fixed return that beats the interest rate on a loan then OK. But thats not very likely. Most places you can invest/save your money is going to have risk and won't guarantee you won't lose money. I would not take a risk with the money in an investment while borrowing.

The only real exceptions here are if you qualify for a discount low interest rate loan like the 0% interest deals that new cars sometimes have and then can get a CD for 1% or something. Or maybe you can get a fairly high return in a rewards checking account.

Otherwise, no, I wouldn't invest your money in stocks or buy bonds or buy real estate etc. because all those kinds of things have risks of losses. Don't borrow money to invest when theres risk. About the only thing that doesn't really have risk is a savings account or CD and they pay fairly low interest.

[Tommy Z]

If your current car is falling apart as defined by more than $1,500/year in repairs bills ($125/mo average), then it's time to buy something different.

My general rule is never buy a car you cannot afford to pay for with cash. So, consider a used car that you can pay cash.

[Funny about Money]

Not so long ago I asked my financial adviser the exact same question!

The money I've saved for the next car is in a money market fund. Alternatively, I could use the cash value of a whole life insurance policy whose premiums I've quit paying.

He felt it was not a good idea to take money earmarked for a major purchase and invest it in the market. He also pointed out that the interest returned by both instruments is less than the cost of borrowing the money to buy the car on time. So, he said, he thought it was better to cash out one or the other of them (using the cash from the money market fund would not be a taxable event, whereas cashing out the policy would) to buy the proposed car.

On reflection, I realized that even though the jalopy is old, it runs like a top and the mechanic thinks it will keep running that well to about 200,000 miles -- at the rate I'm racking up mileage, that will be about another eight years. In my state, registration costs drop dramatically as cars age...which means the cost of registering a new car will be absolutely blinding in terms of my monthly budget -- to say nothing of insurance on a new car.

Decided to keep the tank and keep the money.

I may invest the cash value of the insurance policy, but maybe not: it still has a death benefit, payable to my son, of almost twice the cash value. And whereas I would have to pay income tax if I withdrew the cash value, if my son got the death benefit as an insurance payout, he would pay no taxes on it.