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Here's my current dilemma: should I buy the new car I'm looking at with cash or have 0% financing for 72 months?

For reference, here is some info about me: I am currently living at home. My plan is to move out in the spring of 2019. I currently have 90k saved in my bank account, ~115k in my 401k, ~40k in my Roth IRA, and ~3k in my company's HSA. When I move out, I plan to buy a house. I currently don't have a car, so this is the perfect time for me to buy. My credit score is in the 760-790 range. I am debt free.

The car I'm looking at is a new car (25k), but it has incentives attached to it. Its either a 2.5k cash back or 1k cash back with 0% financing for 72 months. My options are:

Option A) Buy with cash (Total price of car is 22500)

Option B) Finance with 0% interest (Total price of car is 24000). Monthly payments (for next 6 year) would be $333.34

The benefit of Option A is that I own the car immediately. If I take Option B, I won't own the car until I am done paying it off. I know that if something terrible happens, this could end very shitty for me. Keeping that in mind, maybe it's the arrogance talking, but I think I'll be fine to continue car payments - the plan is to always have enough spare money to pay off the car in the event of an emergency. Option A is also enticing because I "save" 1.5k compared to if I finance it ($333 * 72 ~= 24k)

The benefit of Option B is that I don't have to sink 22.5k into the car immediately and I could invest that money in the next 6 years (more than likely making more than the 1.5k difference). I also think the monthly car payments would help my credit score (?).

A concern that I have is that if I take Option B, buying a house may prove to be more challenging since they will more than likely see my monthly $333 car payments and hold it against me.

What would you recommend?

  • 5
    Why buy a new car? – Hart CO Oct 13 '17 at 4:07
  • 4
    So, the actual question isn't cash vs. 0%, it's cash-1500 vs. 0%. Those are very different questions. – Kevin Oct 13 '17 at 5:00
  • 2
    You own the car either way immediately; it is incorrect to assume the loan giver owns the car, they just have a lien on it. – Aganju Oct 13 '17 at 11:03
  • Be clear on the terms of the loan. The cash value of the car is $22,500, because that's what it costs to buy it with cash. If you finance it, you'll be paying the dealership an extra $1000 up front for the privilege of financing it. The loan effectively has a 0% rate, a term of 6 years and a 4.25% origination fee. I'd buy with cash and put keep the $1000 for your house. – DSway Oct 13 '17 at 23:13
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Some things you missed in your analysis:

  1. How will financing change your insurance costs? I.e. what is the difference between the insurance that you would buy for yourself and what they require?

    Note that it is possible that your insurance preferences are more stringent than the financing company's. If so, this isn't a big deal. But what's important is to consider if that's true. Because if you'd prefer to drive with only the legal minimum insurance and they insist that you have full coverage with no more than a $1000 deductible, that's a significant difference.

  2. Remember that you don't have $22.5k for six years. You have an average of $10.5k (($22.5k + -$1500)/2) for six years. Because you make payments ($24k) throughout. So you start with $22.5k and subtract $333.33 a month until you reach -$1500. That neglects both investment gains and potential losses.

  3. It's not the $333 payment that will freak out mortgage companies. It's the $24k debt. But that's offset by your $22.5k in assets at the beginning. And the car of course counts as an asset, albeit at lower than its sale value. I.e. from the bank's perspective, paying $22.5k for a car out of savings is almost as bad as borrowing $24k for a car. Both reduce your net worth.

  4. Watch out for hidden fees. In particular, 0% interest can often change into higher interest under certain circumstances.

  5. If we assume a 7% return for the six years, that's about $1400 the first year and less each year after. Perhaps $4500 over six years. But you aren't going to get a 7% return if you keep $24,000 in a bank account in case you have to pay off the loan. Instead, you'll get more like 1%, less than inflation. Even five year Certificates of Deposit are only about 2%, right around inflation (1.9% for previous twelve months).

    You can't keep the $24,000 in a securities account and be sure that it will be there when you need it. If the market crashes tomorrow, your $24,000 might be worth $12,000 instead. You'd have to throw in extra money from elsewhere. Instead of making $4500 at the cost of $1500, you'd have paid $25,500 for $12,000. Not a good deal. So for your plan to work, that $24,000 needs to be in an account that won't fall in value.

    You either need to compromise on the idea of a separate account that is always there when you need it, or you have to accept rather low returns.

Personally, I would prefer not to have the debt and not to pay extra on the insurance. But that's me. The potential investment returns are not worth it to me. If you give up the separate account, you can make a few thousand dollars more. But your risk is higher.

3

I'd finance the car (for 60 or 48 months), but stash enough money in a separate account so to guarantee the ability to pay it off in case of job loss.

The rationales would be:

  • to retain liquidity, and
  • show the credit bureaus that I can pay loans on time.

Note that I'd only do this if the loan rate were very low (under 2%).

  • 1
    With 90k in his account, unless the OP spends massive amounts of money there's really no reason to literally put it in a separate account. Setting the amount aside in a budget is quite enough. – Kevin Oct 13 '17 at 5:02
  • @Kevin you're right: there's no need. But it can be really convenient for many people. – RonJohn Oct 13 '17 at 5:04
  • Anyway, this is what my wife and I did (@0.9%) and why, though we didn't have the $1500 extra discount for cash or we may well have taken that. – Kevin Oct 13 '17 at 5:05
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There is a 3rd option: take the cash back offer, but get the money from a auto loan from your bank or credit union.

The loan will only be for. $22,500 which can still be a better deal than option B. Of course the monthly payment can make it harder to qualify for the mortgage.

Using the MS Excel goal seek tool and the pmt() function:

  • 3.2% for 48 months or
  • 2.57% for 60 months

will make the total payment equal to 24K. Both numbers are well above the rates charged by my credit union so option C would be cheaper than option B.

  • What APR would OP need for the net interest on a $22,500 loan to be less than the $1,500 difference? – Kevin Oct 13 '17 at 5:07
  • I updated the answer with numbers. – mhoran_psprep Oct 13 '17 at 10:11
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If you don't have other installment loans on your credit report, adding this one could help your credit. That could potentially help you get a better interest rate when you apply for a mortgage. There are positive and negative factors.

Positive:

  • Installment loan with a history of on time payments.
  • More cash available for the house down payment. Helps if you would otherwise have less than a 25% down payment, and really helps if you would otherwise have less than a 20% down payment.

Negative:

  • Debt to income ratio. The monthly payment may lower the amount of monthly mortgage payment the mortgage lender will allow you to take on (to keep the total of the mortgage and car payment below a certain percent of your income).
  • The initial "hard pull" inquiry when opening the loan, however this will no longer have an affect after about 12 months.
  • Credit utilization. I am not sure if this applies to car loans or not.
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Cash price is $22,500. Financed, it's the same thing (0% interest) but you pay a $1500 fee. 1500/22500 = 6.6%. Basically the APR for your loan is 1.1% per year but you are paying it all upfront.

Opportunity cost: If you take the $22,500 you plan to pay for the car and invested it, could you earn more than the $1500 interest on the car loan? According to google, as of today you can get 1 year CD @ 1.25% so yes. It's likely that interest rates will be going up in medium term so you can potentially earn even more.

Insurance cost: If you finance you'll have to get comprehensive insurance which could be costly. However, if you are planning to get it anyway (it's a brand new car after all), that's a wash.

Which brings me to my main point: Why do you have $90k in a savings account? Even if you are planning to buy a house you should have that money invested in liquid assets earning you interest.

Conclusion: Take the cheap money while it's available. You never know when interest rates will go up again.

  • "Why do you have $90k in a savings account?" I was planning to move out in the next year, so I didnt want to invest much money in the stock market - just in case I did poorly. – Jon Oct 17 '17 at 20:19

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