Most financial advisors say not to finance a car if you can help it, pay cash if possible. But does it really matter?
Let's say there are two guys, Joe and Moe. Both work a day job and are middle class.
Joe takes an auto loan to get a new car and pays it off for five years.
Moe on the other hand spends five years saving an X amount of money every month until he has enough to go to the dealership and buy the same car outright.
Either way, they both paid the money for the car, and they both had an X amount of money earmarked for the car every month for five years.
Does it make a difference if you're Joe or Moe?
- AmyLv 79 months ago
(1) Joe pays more than Moe because he is paying interest.
(2) If Joe crashes his car, he still has to pay back the loan. If Moe crashes his bicycle, or the cheap car he paid cash for while saving for the expensive one, Moe does not owe anyone any money.
(3) If Joe loses his job and can't pay his car loan, he loses the car. If Moe loses his job after buying a car, he can keep the car.
(4) Moe's transportation for the first five years produces fewer greenhouse gas emissions.
- ron hLv 79 months ago
Joe pays rent on the money he uses to buy his car. As individuals / families we should ususlly avoid renting money. Sometimes though, you need to rent money to buy a car so that you can get to work,
- BLv 79 months ago
there is a time value of money spent, and you do get a better credit score by doing a car loan and paying it off (even if it is paid off super quickly). best bet is to take out the car loan, pay it off very quickly. you get the improved credit score and you have the money to invest in dividend paying stocks.
- CliveLv 79 months ago
You've forgotten the biggest difference. Joe has a car now, because the auto loan company has paid for it. Moe doesn't have one for 5 years, and how's he going to travel in that time? The dealer's not going to give him a car without the money.
This is why we borrow. I need the car now, maybe I need it to get to work, I can't wait 5 years and the only way is to be Joe.
It's even worse with houses. No way can I afford cash for a house so the only options are get a mortgage, rent, or be homeless.
To look at what financial advisers are getting at, let's say Joe and Moe both already have enough saved up for the car. So they're starting equal. Joe decides to keep his savings, get a loan and buy a car with that. Moe decides to buy a car with his savings. What happens?
Joe has to make repayments every month, and these include interest on the loan. Meanwhile he earns interest for 5 more years on the savings. Moe neither pays nor earns any interest on that amount as he's spent it. Now who is better off 5 years later?
I guarantee you that the interest rate the auto loan company charges will be more than what either of them can earn on savings. (It's one way banks make money. Get money in, lend it out for more, bank makes a profit.) Moe will no longer be earning interest on the amount of savings he withdrew to buy the car, Joe will, but he will also be paying out interest on the loan, and that will add up to more. And Moe can save for the next 5 years but Joe can't because he's spending that money on loan repayments.
Oh yes, it makes a difference! It's all about interest rates, which you failed to mention in the question.
On that sum of money each of them used to buy the car, Joe has paid out more money than Moe and will be worse off at the end.
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- PamLv 69 months ago
I lease my cars because I like having a new car every 3 years. It's a personal preference on what works with YOUR budget.
- SHIRLEYLv 59 months ago
If you finance it typically will also cost you interest.
- tiescoreLv 69 months ago
Joe pays interest on a declining balance for 5 years
Moe receives interest for 5 years on an increasing balance
Joe has less financial flexibility, he must make car payments.
Moe has increasing financial flexibility as he can change what he does with the money or even if he makes a deposit month by month.
I had to get a car two years ago, and I did finance about $5000 of the cost, I paid it off quick and have already started an investment fund for the next one.
- Anonymous9 months ago
I am generally a pay cash kind of gal, but I probably wouldn't for a car because I'd have to sell stock which would create a big tax bill that would cost more than a low interest car loan. I definitely wouldn't be paying interest on that loan for 4-5 years though. I'd have a significant down payment and have the loan paid off in 12-18 months.
But to answer your question, Joe is going to pay more than Moe because he's paying interest on the money he borrowed.
- JudyLv 79 months ago
Uh, Joe will pay a lot more since he'll pay interest.
- Donnie PorkoLv 79 months ago
Well yes. Joe has to pay interest and depending on how good his credit is, he could be paying several thousands more than moe.
Just to make it simple, let’s say joe buys a 30000 car with a 5% simple interest. That’s 30000(.05) = 1500. That’s how much more joe has to pay if he took out a loan. Keep in mind this is only simple interest. If it’s compound interest, it’s more than 1500. Moe pays his outright so he only pays 30000 while joe pays 31500.