Car Loan Payment or Pay Cash For A Car?

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When shopping for a new car one of the first questions a dealer will ask you is – what kind of car loan payments are you looking for?  If you answer that question, you just cost yourself thousands of dollars.  Instead, when you buy a pay cash for a new car.  In other words, you should look at total purchase price, not the monthly car loan payment amount.

Save Money On Your Car Loan Payment: Buy a Car With Cash

Let’s say you bought a used car for $10,000 and got a four year (48 month) car loan at 7.05% (car loan average at the time of this writing – see http://www.bankrate.com/auto.aspx)

The left column (below) represents your monthly car loan payment.

The right column represents the total balance you would have each month if you saved the money ($239.46 per month) at 3% interest.

Monthly Payment Total Savings
$ 239.46 239.46
$ 239.46 $ 479.52
$ 239.46 $ 720.18
$ 239.46 $ 961.44
$ 239.46 $ 1,203.30
$ 239.46 $ 1,445.77
$ 239.46 $ 1,688.84
$ 239.46 $ 1,932.53
$ 239.46 $ 2,176.82
$ 239.46 $ 2,421.72
$ 239.46 $ 2,667.23
$ 239.46 $ 2,913.36
$ 239.46 $ 3,160.11
$ 239.46 $ 3,407.47
$ 239.46 $ 3,655.44
$ 239.46 $ 3,904.04
$ 239.46 $ 4,153.26
$ 239.46 $ 4,403.11
$ 239.46 $ 4,653.57
$ 239.46 $ 4,904.67
$ 239.46 $ 5,156.39
$ 239.46 $ 5,408.74
$ 239.46 $ 5,661.72
$ 239.46 $ 5,915.34
$ 239.46 $ 6,169.59
$ 239.46 $ 6,424.47
$ 239.46 $ 6,679.99
$ 239.46 $ 6,936.15
$ 239.46 $ 7,192.95
$ 239.46 $ 7,450.39
$ 239.46 $ 7,708.48
$ 239.46 $ 7,967.21
$ 239.46 $ 8,226.59
$ 239.46 $ 8,486.61
$ 239.46 $ 8,747.29
$ 239.46 $ 9,008.62
$ 239.46 $ 9,270.60
$ 239.46 $ 9,533.24
$ 239.46 $ 9,796.53
$ 239.46 $ 10,060.48
$ 239.46 $ 10,325.09
$ 239.46 $ 10,590.37
$ 239.46 $ 10,856.30
$ 239.46 $ 11,122.90
$ 239.46 $ 11,390.17
$ 239.46 $ 11,658.11
$ 239.46 $ 11,926.71
$ 239.46 $ 12,195.99
$ 11,494.08 $ 12,195.99

Once everything is said and done, if you borrow money you will pay $11,494.08 for your $10,000 car – at $239.46 per month.

If, however, you delay your car purchase and make payments to yourself, you will have contributed $11,494.08 to yourself, but that money is now worth $12,195.99.  This person then proceeds to buy a card for $10,000.  If you delayed buying a car for four years and saved the money to pay cash when you buy a car you would have a $10,000 car and $2,195.00 in the bank.

How Much Can You Save On Car Loan Payment?

Now consider the difference if you did this over a life time.

Meet Sweet Sally Saver. She is a 30 year old who decides she will always make payments to herself of $239.46 per month and will always buy cars that cost $10,000.  She puts the money she saves into a high interest checking account that yields 3%.  She pays cash for every new car every four years until she is 64 years old.  During that time she will buy 9 cars.  Over the first four years she is creative – she drives an old beat up car and she uses public transportation.  She buys her first car at age 34 – with cash.

Meet impatient Larry Loan Lover. He is a 30 year old who decides he will always buy cars by taking car payments and he will always buy cars that cost $10,000.  At the age of 30 he goes out and gets his first car at a 7.05% loan with a payment of $239.46.  He buys a new card every four years until he is 64 years old.

In the chart below I’ll illustrate how much money Sweet Sally Saver is able to accumulate just by waiting an extra four years and paying cash for every vehicle she owns.

  Larry Loan Lover
Auto Account Balance
Sweet Sally Saver Auto Account Balance
Car 1 $0 used old car
Car 2 $ 0 $ 2,195.00
Car 3 $ 0 $ 4,665.49
Car 4 $ 0 $ 7,446.05
Car 5 $ 0 $ 10,575.59
Car 6 $ 0 $ 14,097.92
Car 7 $ 0 $ 18,062.33
Car 8 $ 0 $ 22,524.31
Car 9 $ 0 $ 27,546.31

At age 64 Sweet Sally Saver now has $27,546.31 in her auto savings account.  Poor Larry Loan Lover has nothing.  Most importantly, for all but the first car purchase (4 year period) Larry and Sally drove the exact same cars.

For a period of 30 years they drove the same make, same model, same price car – but Sally now has an extra $27,546.31.

How Much Should You Pay For A New Car?

Hopefully you already have and use a budgetDave Ramsey uses the general rule that your cars (including all motor vehicles) should not add up to more than half of your take home pay.  Another rule of thumb is that your total car costs should not exceed 15% of your take home pay. This amount includes everything from payments, to gasoline, to repairs, to insurance.  You vehicle cost should fit within the recommended percentage budget allocation.

Now you tell me. Do you want to go and buy another car on monthly payments?

Comments

  1. Infinion says

    The math is sound here; and I completely agree with your ideas. But you should note that most people that pay with cash do so for many more reasons other than pure finances. For one thing, people that pay cash tend to pay much less for cars than those that borrow. (what’s a few extra dollars a month matter? THOUSANDS, that’s how much!). Secondly, most people feel weighed down by the debt of a car. I’ve been there, and I won’t go back. I had to get out of it as soon as possible, and don’t plan to ever borrow again for a car. It’s very satisfying to purchase a vehicle and know you own it, and don’t have to send a check to the bank every month.

    Also, please, please tell me that people don’t really pay 7% on a car loan. Where are these people getting loans at, Vinnie the Shark? That’s the average? That’s just unreasonable.

  2. says

    I can’t wait to pay off my car and try Dave’s “Drive Free – Retire Rich” pattern. There is also a negotiating power that comes with cash. So chances are you’ll get that car for cheaper than if you were financing.

  3. Craig says

    @Infinion
    Thanks for your comment.
    I completely agree that there are also some non-financial advantages to paying cash for cars.
    I’ve heard that people pay less when they pay cash. I paid cash for my first car, financed my second, pay cash for my third and fourth. Honestly, I personally didn’t feel like paying cash gave me a much better deal. This could be because I bought cars through private owners and the form of payment was never discussed until the deal was set.
    7% – that’s the number. It is crazy.
    @Lakita
    Paid for cars do drive better than cars that are financed.
    @Ken
    Buying brand new cars is crazy expensive. There is a huge depreciation. Sounds like a good blog post for the future .

  4. Infinion says

    Actually, I wasn’t even considering getting a better deal with cash at purchase time. Although that may or may not be true. It certainly does change the tone of the purchase negotiations though. You can talk to the salesman in real numbers instead of payments, which as you know, he can set that payment at almost any number to make the customer happy. If you find a reasonably honest salesman, they’ll be willing to tell you just about how far they can go down while still making a profit. They’re usually willing to do this after a while, because when you have cash, they know you’re ready to buy today if the deal is what you’re looking for. I’ve found that being completely honest with the salesman *usually* results in better luck.

    But, as for the sale price, what I was really referring to was the ‘credit’ effect. Some people say that no one should use a credit card because you tend to spend a little bit more when you’re not handing over cash. I use credit cards everywhere almost exclusively (but I’ve never had CC debt), and I completely agree that I probably spend more than I would if I used cash alone. Obviously, you’re unlikely to hand over a wad of cash at the dealership, but the premise is the same. You know how much you have, you know what you want, and how much you’re willing to pay for it. It makes it easier to walk out the door if you can’t get the car for the right price; you simply can’t make money out of thin air after all! But when you go in with the intent of financing, sometimes it’s just so easy to pay a few more dollars a month to get that special vehicle. I know, I’ve done it before. So often i hear ‘I got what I wanted, and I only pay a few more dollars more a month that what I wanted to.’ Okay, sure, but how much more did the car actually cost that you were willing to pay? Did it end up costing more than it’s actually worth? Do you even know how much its worth? Do you even know how much it cost???

  5. FinancialBondage.org says

    My vehicle is my stupid tax. $900 to go and God willing, no more car payments for me ever again.

    Dave Ramsey says if you are not a millionaire you can’t afford a new car. I say if you have to finance the car, you can’t afford to buy it. Pay cash for forget it.

  6. says

    Good to know this information. This is a great HELP to all especially those in need of financial assistance for their loans. Good Article!

  7. Dylan says

    I don’t expect this to reach the site but if it does…I’ve studied finance…certain calculations have been conveniently left out and this article leads people to the wrong conclusion. e.g. A $10000 car today is not equal to a $10000 car tomorrow due to the effects of inflation – which are huge. There is no value placed on owning a car for 4 years. In this example there is no cost associated with NOT having the car (opportunity cost). There are a tonne of scenarios where a person will be better off to borrow instead of save. If you need to work it out just look up how to calculate net present value of an investment (car, house, anything). There is so many vital calculations left out – yes, if you leave them out, it makes it look like borrowing is a demon. Be sure though, it’s not. It can open you to new opportunities, you just have to take the time to learn and do it with sound judgement.

    • says

      Dylan,
      Welcome. I don’t edit comments just because I disagree. So according to your calculations borrowing money is cheaper than buying it with cash? Or are you just saying it’s not as big of a difference as this post indicates.

  8. says

    Thanks a lot for the information, i subscribed to your rss feed , in this time of crisis we really need to save money in our cars , credit cards etc.. or we will not reach the pay day !

    Thanks,.

    Ron

  9. says

    It is better to buy a second hand car for cash always. They can be sold for a smilar price withing 2-3 years and then upgrade again. Interest rates are just too high.

  10. Me says

    Once in a while, car companies have good financing deals like 0.9% for 60 months + no money down, etc… A typical saving account’s APR is around 1%. So, financing and not paying by cash can be a good thing. It happened to me last year. I have a saving account with Discover Bank for 1.5% APR. So instead of paying cash for my Honda Fit, I opted to finance for 0.9% for 60 months and pocket the difference

  11. Becky says

    A little different question. I agree that one should always pay cash which means paying yourself the interest. However, what if I have the cash but am earning more than the interest rate of the loan? Current Fed. tax rate of 33%. How do I calculate when it is better to pull the money out of the investment (pay cash) vs. keep the investment, pay a large enough down so you are not “upside down”, and take a 2 – 3 yr loan, with no prepayment penalty?

    • says

      Becky,
      I don’t do fancy footwork when it comes to my finances. If I had the cash to pay for a car I would. In this economy I think it would be hard to find a ‘guaranteed’ investment that gives enough interest.

  12. Ope says

    The math is a little off $10,000 loan with 7.05% is 239.69 for 4 years but the idea is there, However; if you pay monthly payments vs paying in full you will see that if you pay monthly then you will have more money to invest in but if you pay full $10,000 where is the money to invest in? also most people who pay off their car in full are more likely to take off full coverage on the car because they feel the need to save money.. When paying payment you are force to have full coverage. With a car loan you can also get Gap coverage to help you out..There is pros and cons to both but it all goes back to what are you doing with your time and money?

    • says

      Ope,
      The money you invest is not guaranteed, while the money you save by paying cash is. You mentioned that “Most people who pay off their car in full are more likely to take full coverage”. Have you seen any data on this? We have two paid for vehicles. On the first we have full coverage, but not the second. I usually determine if I should get full coverage or not based on the value of the vehicle, not my payments.

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