Word is finally getting out to my friends that I am working at Dick Hannah Volkswagen as a sales and leasing consultant. I haven’t really been spreading the word as aggressively as I should, and my circle of friends is very wide, so it makes sense that its taken so long for people to catch on. It’s pretty awesome getting calls about cars.
Recently a long-lost friend of mine asked me if he should pay for a car outright with cash or purchase it through some sort of financing.
This gentleman served in the military for about 8 years. He was Navy, and I assume spent a lot of time on tour, billeted, on the government’s dime. He had had a steady income, fairly low expenses, and was able to save up some money. He’s now a civilian trying to figure out what’s best for him and his family financially.
He has an aging car. He knows it’s time to upgrade his vehicle to avoid the potential expense of keeping his old car running. On top of that, his car still has some inherent value he wants to use in the purchase of a new vehicle.
In the future, he wants to keep his monthly expenses down as well as limit the amount he will pay for the new vehicle by avoiding paying interest. Also, he thinks that the dealership might a prefer selling cars for a for the car and would prefer it?
Dealerships do not actually prefer to receive cash/check for cars anymore. In fact, the dealership would probably rather finance the cars. Why would they give you a discount to do something they don’t want you to do? (Don’t get me wrong, people with cash often make good clients, but it has more to their willingness to do the deal now as they have been planning for it.)
Did you know that banks will often pay the dealership to underwrite through them? Banking was once a very risky business. (To all the bankers out there, yes- I know banking is still very risky… but not as bad as it once was.) But now we have fairly accurate credit scores and high-tech methods to validate and track people, making it much safer to loan money.
That safety allows for banks to accurately gauge and manage risk. Having an accurate gauge of creditworthiness allows the banks to offer very competitive interest rates to customers.
Here’s where things get interesting. My friend has to gauge opportunity costs of spending his money on a vehicle all at once. Opportunity costs are the loss of potential gains from choosing one alternative over another.
For example. What if he can get a loan for 5 years at 2% interest? The money would be free to invest. Say he is very lucky and gets an average of 8% a year for 5 years. That would be of benefit to him, no?
But what if he takes a loan, and lacks discipline? Spends the money elsewhere, and then ends up not being able to afford the car. What if he can’t keep a job. What if the market crashes like it did back in 2008, and the US economy lost trillions and the investments he put his money into all go sour. What if you want to buy a house and your debt to income ratio is too far off to get it?
It all comes down to a matter of preference, and risk management. I personally believe he should buy the car using financing if the interest rate is low. I assume he can manage his money well enough if he is asking for advice on the topic, and also managed to save enough money for this to be a question. He must try to keep his loan from being underwater by putting enough of a downpayment to allow for flexibility in the future if something comes up. A car’s value tanks like a rock after the purchase. Should he need to get rid of it, it’s good to have a smaller loan balance than amount owed.
Why would you invest into something that is a liability? Keep the money, be wise with it. Having cash that you can invest in your future goes a long way. There is a phrase in business, “Debt is cheaper than equity.” Read the article to see what I mean.
Another great article gives you some good advice: Here