Most people don’t have any choice except to finance their cars. However, if you are reading this column, the chances are you are in that fortunate higher demographic category and can afford to pay cash for your next car. People who read Op Ed columns in newspapers tend to be more intelligent and affluent. But, just because you can, is it the right move?
Many people think they can get a better deal on a car if they pay cash. This was true 40 years ago before dealers discovered the new profit center referred to as the Finance and Insurance Department. Today this is not true. In fact, paying cash may even make the actual vehicle cost you more! The reason for this is that car dealers make money when they handle the financing with the bank or with the manufacturer’s lenders like GMAC or Chrysler Credit. A dealer typically averages about $700 on every car he handles the financing on. Therefore, if the dealer’s minimum acceptable profit on a car was $1,000, he may sell it to someone who he could make $700 finance profit on for less than someone who he knew was a cash buyer. Dealers will sometimes sell a car for zero profit on the car because they can make a good profit on the financing.
One argument in favor of financing a car is being able to keep your money invested and earning a greater return than your interest cost of financing. The often overlooked fallacy is not making the comparison realistic by understanding that when you pay cash you are really “borrowing money from yourself”. If you have a 3 year CD paying you 6%, on $25,000, you will earn $4775.40 at the end of 3 years. If you finance a $25,000 car for 3 years at 6%, you pay only $2,379.80. But, to compare apples and apples you would have to pay yourself back for the $25,000 you “borrowed from yourself” to pay for your car. When you paid yourself back with interest monthly over three years, the interest you earned would equal the interest paid on the car loan. If you can earn more than 6% with your money, than financing the car for 6% would be a good idea.
One argument against paying cash for your car is that it becomes an asset of your estate and your net worth. This means that someone who won a lawsuit against you could seize your car for payment. If you had to declare bankruptcy, you could be forced to sell your car to settle your debts. If you owed the IRS money and could not pay, they could take your car. None of these things could occur if you had a loan on your car which offset the equity.
There is one very important intangible reason why some people should pay cash for their car. That intangible is called “peace of mind”. My older brother, Doug, grew up during the Great Depression. When he built his new house, he paid cash for it. I couldn’t believe this and was severely critical of him. It was entirely illogical for him to pay cash when he could get a very low interest rate and home mortgage interest is tax deductible. His investments earned him far more than the interest rate on his mortgage would cost. After a while I finally realized why Doug was right and I was wrong. He paid cash for his home because it made him feel better. Growing up in the thirties, like many of my customers did, made an indelible impression on his emotions. Owning his home with no debt made him feel happy and secure and what could be more important than that?