Cars - Pay Cash or Finance & Invest?

[Colin Smith]

My wife has finally ran her 1999 Volvo into the ground with the transmission going out and it would cost more to fix it than the car is worth at this point in time. 

Let's be clear that we are looking to buy a 3+ year old USED vehicle, looking to spend about $10,000. New vehicles are not part of this discussion as we have no interest in losing ~38% of the cars value in 3 years due to depreciation.

With auto loans being so low for used vehicles (~3%), it makes it hard to pass up, however, there is something to be said for owning your vehicles free and clear, as we do now. 

The questions is, would you pay cash and own your car free and clear, or would you finance the vehicle and invest the cash into RE?

[Brandon Hall]

@Scott Carder Unfortunately, statements like this are not as cut and dry as you may think. @Will Barnard is a business owner which provides him with the ability to deduct 100% of the car's lease payment as a business expense. Assuming Will operates out of an S-Corp (he's a smart guy so I'm positive he's doing this) and nets $350k, by deducting his lease payment he avoids 15.3% self-employment tax, a 1.5% CA franchise tax on net income, a blended CA income tax rate of 7.98% and a blended federal rate of 26.1% for a total of 50.88%.

This means for every dollar of his lease payment, he gets a 50.88% discount and his true cost is only $0.4912 per dollar. True, leasing does make someone else rich, but it can also make you rich given the right circumstances.

@Taylor Marvin I'd love to see your numbers that led you to draw the conclusion that you should always pay cash for depreciating assets (i.e. a car). Perhaps in a high interest rate environment, but I'm not sure that statement can be justified in today's environment (perhaps you will prove me wrong!).

Let's assume the car costs $10k and @Colin Smith puts 10% down leaving him with a loan of $9,000 at a 2.85% interest rate for 60 months meaning his monthly payment will be $314.82. Let's assume the car depreciates another 40% during the five years he owns it. At the end of five years, Colin will have paid $9,889.07 in interest and his car is now worth only $6,000. The true cost of the car to Colin is $13,889.07 (interest plus loss in equity).

Because Colin took a loan in the amount of $9,000, he was able to invest that money at a conservative rate of 8%. At the end of five years, his $9,000 has grown to $13,224. The net difference between the cost of the car to Colin and his $9,000 investment is only $665.12. But that cost is in future value terms so we need to discount it back to today. At a 3% rate (inflation), $655.12 in five years is really $573.74 today. So the cost of the car loan to Colin, assuming he can reinvest $9,000 at 8% (in real estate we often get 12%+) is only $573.74 in today's terms.

On the other hand, let's assume Colin pays $10,000 cash for the car. He doesn't have a car payment, but he also doesn't have $9,000 to invest. At the end of five years, Collin's $10,000 has lost 40% of it's value (depreciation) and is now only worth $6,000 (car's equity). So the car cost Colin $4,000. Again, that's the future value so we need to discount it back to today. Assuming a 3% rate (inflation), that $4,000 cost in five years is really $3,450.44.

In reality, paying cash for the car will cost Colin $2,876.70 ($3,450.44 - $573.74) in today's terms. And this is just a high level example which leaves out the real technical NPV and IRR analysis.

Put the numbers into Excel prior to making any financial decision. It takes the emotion out of it and will often expose you to the truth behind what popular bloggers may otherwise advocate.