Rich people don’t finance automobiles. If you don’t have the cash, you can’t afford the car. Save for a couple of months if you need to.
Recently a lawyer friend told me about a new car purchase. On a five-year loan, he locked in a 2.84% interest rate and felt pretty good about it. After all, you can make more money in the market right? This is one of those no-brainer decisions. Not so fast.
14 reasons to pay cash
I suggested he pay cash for the car and came up with 14 reasons why it makes sense to pay in cash. Actually, I came up with less reasons at first but then had a great Twitter conversation with a reader recently and decided I needed to develop a few more reasons before posting.
1. Simplicity. Buying a car on credit means one more payment to track. Even if you set it on autopay, you still have to monitor the payment, budget the payment and otherwise make sure the payment is made on time. Pay for a car in cash and that problem evaporates. Don’t underestimate cognitive load and the associated cost. Less is beautiful.
2. Cars Depreciate. Cars are not assets. The value decreases as soon as you drive it off the lot and eventually a car will be worthless. Why finance something that will be losing its value? I’d rather stick with financing actual assets that I expect to appreciate over time, even if only keeping pace with inflation (like a house).
3. Interest. Obviously! Why pay interest when you don’t have to? A $30,000 car is going to generate $852 in interest a year. That’s a new iPad every year. I’d rather have the iPad than pay a bank.
4. Finance Charges. Buy in cash and you won’t pay them.
5. You’ll Buy a More Expensive Car. This is simple human nature and backed by many studies. We humans spend more money when making a purchase on credit than we do when paying with cash. Why put yourself in that situation to buy more car than you want just because it’s on credit or because you can afford the monthly payment?
6. Higher Sales Tax. Buying more car than you intended? You’ll also pay higher sales tax.
7. Higher Insurance Premiums. More car also means higher insurance premiums to protect the car.
8. Higher Registration Costs. That’s right – the fees just keep adding up. A more expensive car could lead to higher registration costs, depending on how your state calculates registration fees.
9. Cash Flow. If you’ve decided to leave a certain amount invested to beat the return on financing the car, you still have to come up with the monthly payment to service the car loan. That means adjusting your budget and restricting your cash flow. I prefer to have as much flexibility with cash flow as possible.
10. Mistakes. Accidentally miss a payment? Doesn’t even matter if it wasn’t your fault. One mistake and you could ding your credit score or incur a late payment fee. Why take the risk?
11. Less Buying Options. Buying a used car? Good luck finding a private seller who is interested in waiting around for you to get your credit union on board with the sale and wiring the money. If I’m selling a used car, I’m expecting you to show up with cash.
12. Living Debt Free. If you have student loan debt and a mortgage, you know what it feels like to live with debt. That means you probably value the time before all those things when you were debt free. Why turn back the clock? It’s liberating to live debt free and you don’t get that feeling with a car loan, even if you have the money in savings to pay off the loan.
13. Making the Spread Isn’t as Clever as It Seems. So you’re making the difference between your return in the market and the 2.84% you’re paying on the car loan. Let’s say you’re making a 5% real return (8% total return, but losing 3% to inflation). On a $30K loan that’s $1,500 a year. Nice. But wait, it’s in a taxable account, right? So you have to pay taxes on that interest. Your actual return is more like $900 after taxes. Suddenly that $852 in interest you’re paying to bank doesn’t look like such a good deal – you’re only really making $48 a year!
14. Finance Everything. If it makes sense to finance a car, why stop there? The logic should extend to everything – you should be financing your next vacation, home furniture, iPhone and kid’s education.
I get it, sometimes financing does make sense
I’m not suggesting that debt is so evil that financing never makes sense. Forgoing contributions to your 401K to pay down a 1.9% car loan is not a smart move. The problem is that the behavior economists are all over this – financing leads to greater expenses and it’s an easy trap to fall into.
If these reasons don’t convince you, there are worse things to do than finance a car. A young lawyer making $100K+ a year should be able to save up for a car pretty quickly. It’s likely you can cobble together the money within the time it takes to research and finance a car anyway.
Once you buy that car in cash, start making monthly payments to a car savings fund and you’ll be ready to buy the next car in cash once you’ve driven the current car into the ground.
Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Empower keeping track of his money. He’s also maxing out tax-advantaged accounts like 529 Plans to minimize his taxable income.
I’m a cash for cars guy, and I think #5 is the best reason on this excellent list.
Many car shoppers only think in terms of affording the monthly payment. If you force yourself to afford the entire vehicle in one transaction, you suddenly become much more cost conscious.
Shelling out $10,000 or $20,000 in one check is something, but it’s not nearly as difficult as spending $50,000 or more.
Best,
-PoF
I think it’s a big step to look in the mirror and realize that yes, each of us is actually subject to human psychology and human behavior patterns. It’s like when you’re at a dinner party and someone says, “Advertising is such a waste a money. I’m not influenced by it all” and you know right away that they’re the ones most influenced!
Hey, Josh
I love it that you’re so smart about money. Years ago I paid cash and got my old Victorian house on two acres for $24K. I’m glad I did that or I’d be living in Section 8 housing today. I’ve figured out some
money-savers in dealing with the bank that are perfectly legal(that the tellers don’t even know about!).
Your mother must be very proud of you.
Best wishes,
Diane
It’s accumulated knowledge that matters. Anyone can learn, just read a few good books a year and some blog posts. My aunt did something similar to you. She owns a home in East Cleveland that is beautiful but not necessarily in the best area. It’s a smart decision to make sure your base level living costs are low.
Thanks for the comment Diane!
Hey BI,
Completely agree with all your points. One of our main thoughts is making interest work for us (income) rather than against us, compounding is great when it’s on your side!
We’ve only bought 1 car, which we did with cash. No regrets and that’s the approach we’ll take with all our future cars.
Tristan
Interest is something someone pays you, not something you pay to someone. I love it!
I’ve always been a new car guy and then would drive it until it was on its last leg. That said, I was always financing them for 5 years and paying them off in around 3.
My wife and I were actually talking about this a couple months ago and both of us are going to drive our current cars (2009 and 2011) until they die and then buy used from now on. I’ll still probably only go 1-2 years used, but it’s hard to justify paying so much more for a new car, especially if you finance it.
It’s a great feeling when you get a brand new car, but that wanes much quicker than the car payment usually does! 🙂
— Jim
All great points BL! We purchased both of our current cars with cash and will never have a car loan again! The car payment is going into an investment account each month so we will be good to go the next time we need to buy one!
Love, love your blog. I have one tiny constructive comment.
Word Fact: Fewer vs. Less. … According to usage rules, fewer is only to be used when discussing countable things, while less is used for singular mass nouns. For example, you can have fewer ingredients, dollars, people, or puppies, but less salt, money, honesty, or love. If you can count it, go for fewer.
From dictionary.com
Agreed! The site’s editor messed up on this post for sure. 🙂
Here is one – having payments in your credit profile reduces your flexibility when taxing future debt that you may need, like buying your next home. Banks ding your maximum loan amount substantially for all debt payments you Carry. Having a car loan will mean the bank will certainly lower the bar for your next home loan.
On the flip side of that, having a car loan that you pay off consistently can help you raise your credit score.
Yes, that’s true but around here we’re trying to play at the level where your credit score doesn’t matter. Keep that in mind!
I completely agree with you. I don’t want to buy a car with financing like you. But what can I do when I have not enough money to purchase a car. Can you let me give any idea so that I can afford a car with pay cash?
Josh,
Conventional wisdom says “don’t lease a vehicle.” What are your thoughts?
I have purchased six used cars in my lifetime. Despite my best research efforts (and having the cars inspected by mechanics before purchasing them), five of the six turned out to be lemons or needed substantial work within a year of the purchase date. These experiences have left a bad taste in my mouth when it comes to used cars, and I am wondering whether the peace of mind that might come with a cheap lease is worth the cost and downside of leasing vs. purchasing.
Appreciated.
– JH
I totally agree that you should not finance a car. The reason the dealers push it is because in some cases they get a kickback from the lending company on each loan.
We paid cash for a car in January 2020 and they tried to sweeten the deal by offering to pay our first 3 payments and we could pay the rest off in 6 months. 6 months was the shortest term we could talk them down to. Sill paid cash, when someone is so desperate to sell you on something you should figure it is to their benefit not yours. Last month my neighbor bought a new car. HE told the salesperson that he wanted to pay cash all the way through the transaction. They got down to the final paperwork and when they presented the out of state check from a credit union the manager said “oh we can’t accept that check”. They went ahead and financed it and the manager said “oh so sorry, we will give you free tire rotations and 2 other no cost free services” and my neighbor thought they got a great deal. I said told them I would have walked away from the deal right then.