Is Paying Cash for a Car a Bad Idea?

When I was growing up, my parents taught me that if I wanted to buy something expensive, I should save my money until I had enough in the bank to pay cash for it. It was the old school, “Neither a lender nor borrower be” school of thought. Actually, that hasn’t been a bad school of thought for most of my life; especially when you look at the Great Recession that we’re slowly emerging from. Easy credit was a big part of the cause of the most severe recession since the Great Depression of the thirties.But today we’re experiencing interest rates that are lower than any time any of us can remember. We’re also experiencing a stock market that offers record high returns on investment and investing very conservatively can give you’re a return greater than the cost of borrowing money if you have good credit. The average transaction price on a new car today is about $35,000. If you invested that $35,000 in the stock market, you could expect to earn at least 10% compounded over the next four years. You would have $52,211 in your investment account at the end of 48 months, a total return of $17,211. If you have excellent credit and borrowed the money at 2% (there are even lower rates available), you would pay only $1,478 in interest over 48 months. You net profit, subtracting the interest from your investment return is $15,733!

Even if you’re ultra conservative and don’t want to invest in stocks, there are bonds, even tax free municipal bonds, paying higher than 2%, the cost of your car loan. There are many blue chip stocks paying dividend yields higher than 2%. For a person with good credit, it is “absolute insanity” to pay cash for a new or used car today. Interest rates will go up eventually and we should take advantage of these low rates because we may never see them this low again in our lifetimes.

But, remember that the only reason all of this is true is because of these historically row rates. Your car dealer will not offer you a low rate unless he has to. On the average, car dealers make more money financing your car than they do selling it to you. Car dealers get kick-backs from banks based on the interest rate they charge you. They call this kick-back finance reserve and it can amount to thousands of dollars on a car sales. Your sales person is paid on profits from the dealer’s finance department. You cannot get a complete and honest answer from your salesman if you ask him about interest rates. You should have already shopped for your interest rate with your credit union and bank before you began car shopping. By the way, credit unions usually have lower rates than banks because they are less regulated and have lower expenses than banks. If your workplace does not have a credit union, you can join one anyway. There is a small fee for joining, but it is well worth the savings you’ll realize on your checking account and borrowing money.

There are situations when the dealer, through your car’s manufacturer, can meet or beat even a credit union rate. This is rare, but worth looking into. Manufacturers will offer very low rates, even 0%, to stimulate sales of certain models. Rarely does it apply to all models and these low rates are offered as an “either-or” to cash rebates. Be very careful not to be misled by this “either or” of low interest rate OR cash rebate. Most dealers advertise prices including the cash rebate but they also offer in the same advertisement the low rate. This “either or” may or may not be disclosed in the fine print.

There is one more caveat to using the dealer’s (manufacturer’s) low rate. The dealer still has a trick or two up his sleeve offering a lower rate than a bank. Those tricks are add-on products like extended warranties, maintenance contracts, GAP insurance and a plethora of other products, many of which are overpriced and/or worthless.