2789: Should You Pay Cash For a Car by Paula Pant of Afford Anything on Personal Finance Decisions

[00:00:00] This is Optimal Finance Daily, Episode 2789. Should you pay cash for a car by Paula Pant of AffordAnything.com? And I'm your host and personal finance enthusiast, Diana Merriam. Now let's get right to it and continue optimizing your life.

[00:00:47] Should you pay cash for a car by Paula Pant of AffordAnything.com? Should you pay cash for a car? That question isn't just a hypothetical anymore. We need to buy a car, and that means we need to make a five-figure decision.

[00:01:04] It's been almost two months since Will's car got stolen, and it's time to buy a replacement. His last car, as you may recall, was a 16-year-old Honda Accord with 275,000 miles on it. This time he decided to shoot for something nicer.

[00:01:21] I've been thinking of buying a well-made Japanese car between 5 to 7 years old with 50 to 90,000 miles on it, he told me. Hey, what a coincidence! That's my dream car too! He set a budget of $10,000 for his car purchase. And obviously, he planned to pay cash.

[00:01:41] Because taking out a car loan is stupid, right? Right? That's what I always assumed. Until three finance bloggers told me I'd be nuts to pay cash. It began with a podcast. You see, it all started one night while I was recording a segment for the Stacking Benjamins podcast.

[00:02:00] I'm one of four people on this podcast segment. The group of us are chatting one evening, and I mention that Will and I are planning on buying Will's next car in cash. The podcasting guys reply, why? The question caught me off guard. Why wouldn't we pay in cash?

[00:02:18] Cars are supposed to be purchased with cash. We're not raiding an emergency fund or shortchanging retirement to make the purchase. We have plenty of savings for home repairs, car repairs, health savings accounts, travel, and quarterly taxes. We have cash reserves for all of our rental properties.

[00:02:37] Our retirement accounts are maxed out. On top of all that, we have some extra money floating around. We've been scratching our heads, trying to figure out what to do with it. Then Will's car got stolen.

[00:02:49] So why wouldn't we use a small portion of that $10,000 to buy him a seven-year-old replacement vehicle in cash? Here's why, the podcasting guys reply. Car loans are going for 2% APR. You could take out a loan at 2% and invest the $10,000 cash for a better return, they said.

[00:03:11] I tried to imagine what that would look like. First, I would make a lump sum $10,000 deposit into an investment account so that I'd know that I was actually investing the cash rather than frittering it away. Then I could invest the money into an S&P 500 index fund.

[00:03:28] Historically, those have a long-term annualized return of 7% to 9%. That's substantially greater than the 2% APR that a car loan costs. In other words, I could borrow at 2%, invest at 7% to 9%, and pocket the spread. Huh, the idea made sense. I floated it by will. Are you smoking crack? He replied.

[00:03:52] What do you mean? You want to borrow money and put it in the stock market? He explained, slowly placing the emphasis on borrow. That's the worst idea I've ever heard. I'm talking about a broad market index fund, not Facebook stock, I offered. He shook his head.

[00:04:10] You've lost your mind. How about paying off the mortgage? Okay, so that wasn't going to work. I brainstormed that night about how else to optimize the cash and came back to him the next day with an alternative.

[00:04:24] What if we borrowed money for the car and put the $10,000 towards paying off the mortgage? I figured that idea would get him listening. He loves chatter about paying off the mortgage. And our highest bank-issued mortgage rate, 5.25%, is substantially higher than the interest on a car loan.

[00:04:43] It's also early in its amortization schedule when a large paydown would really move the needle, saving us a ton on interest payments. Because it's a rental property, a refinance isn't in the cards. We'd forego some tax savings, but the math still works out.

[00:05:00] Strangely though, Will didn't seem interested. I don't believe in car loans, he said. I don't believe in consumer debt. I only believe in cashflow-positive mortgages, and even those I want to pay down aggressively. He was touching on a contentious topic.

[00:05:16] I prefer to shovel money into retirement accounts and acquire more rental properties. He prefers to pay off our mortgages. It's the old pay off the mortgage or invest dilemma. I take a Robert Kiyosaki view of money. He favors the Dave Ramsey approach.

[00:05:33] Then don't think of it as a car loan, I replied. Think of it as refinancing $10,000 of your mortgage into a lower interest rate. He looked at me suspiciously. Any time a financial explanation is that complex, something's wrong.

[00:05:48] Look, all I'm saying is, who cares how the loan is secured? I replied. At the end of the day, your total liabilities are X, and their cumulative interest rate is Y%. Who cares whether a car or a house secures those loans?

[00:06:05] Car loans are being offered at less than inflation, I added. Think about that, less than inflation. We have a clear exit strategy, I continued. It was my last pitch. If a worst case scenario unfolds, we have the cash to pay back the loan instantly.

[00:06:21] Why not put that money to work rather than parking it? Will shook his head. I just want to go to my grave knowing that I've never had a car loan, he replied. At that point, I realized two things. One, financial nerds, that's us, have weird deathbed ambitions.

[00:06:38] Who aspires to look back on their life and say, I never had a car loan? Finance nerds, that's who. Second, this issue was clearly a non-starter. We were going to buy the car in cash. In the end, that's precisely what we did.

[00:06:54] Will bought a seven-year-old Acura with 90,000 miles on it. I bought a car as well, a five-year-old Honda Civic to replace my 15-year-old Camry. We paid cash for both and vowed to keep them for at least a decade.

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[00:08:35] I think there's a lot to consider when it comes to how one pays for a car. I've only done it three times, so I'm no expert, but I've been on both sides of financing or buying in cash. My first car in high school, I bought used for $7,000 cash.

[00:08:51] My second car in college was a big mistake. I financed a brand new $20,000 car with a monthly payment of about $450. I didn't need a new car. I just wanted it. I kept it for a couple of years and then sold it for what I owed on it.

[00:09:09] My current car I bought in 2018 for $6,000 cash. And I anticipate buying all future cars in cash. While financing at a low interest rate has a compelling argument, I think I would be

[00:09:23] tempted to buy a more expensive car if I didn't have to pay for it all at once. Also when you have a loan, you're required to have more insurance coverage than if you own the car outright. So I'd be paying more there.

[00:09:36] I've read that because dealers make more money from financing than they do from actual car sales, you might be able to get a better overall price if you agree to financing. In that case, why not take the loan as long as there are no early payment penalties and

[00:09:52] then pay it off immediately. But that should do it for today. Have a happy rest of your day and I'll see you tomorrow where your optimal life awaits.