Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Low interest loan instead of paying cash from investments?
Old 11-05-2013, 10:38 AM   #1
Recycles dryer sheets
 
Join Date: Oct 2013
Posts: 64
Low interest loan instead of paying cash from investments?

Hello, I've posted several things lately but I'm new and have a lot of questions. You guys are a great resource and I really, really value your advice.
I often go with my sister when she visits her finance adviser.(I understand a little more of the lingo than she does and I always learn something when I go.) Last time she mentioned having used cash to buy a car. He said he thought taking out a loan and letting her investments pay for it overtime would have been the better way to go. What do you think? I know the more money she keeps invested the more wrap fee he gets. But is it good for the investor? Say you took out a loan for 5 years and let investments pay for it slowly. Would this be the withdrawal side of dollar cost averaging? Good idea?
__________________

__________________
HappyOutsourced is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 11-05-2013, 10:52 AM   #2
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jul 2006
Posts: 11,017
My understanding is that the math shows that paying cash is generally the most cost effective way to pay for a vehicle. That said, interest rates and cash flows have some bearing on the situation. For example, if the cost of borrowing for the car is 1% and the cash that is not spent remains invested with an ROI of 8% it makes sense to borrow. That reflects current conditions. However if the cost of borrowing were 8%, that would be another story. If the buyer has tons of cash sitting around in a savings account earning 0.01%, it makes sense to buy in cash. In times of high interest rates, cash may get you a better price. Not recently though!

Disclaimer: I bought a car in 2012 with 0.99% financing for 3 years. I have had 4 cars in my lifetime and I have paid cash for two and financed two.
__________________

__________________
Meadbh is offline   Reply With Quote
Old 11-05-2013, 10:54 AM   #3
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
Mulligan's Avatar
 
Join Date: May 2009
Posts: 7,369
Interesting question. Anytime I need money like for example getting a roof which I am doing soon, I get an access credit card check and pay it back out of my monthly pension check. Just cashed one that is 3% with no advance charge and does not have to be paid off until June 2016 which is plenty of time. I am sure the most prudent way for me would be to take it out of my low interest bearing accounts and pay myself back. But I for some reason do not trust myself that I will pay it back. So I go this route. When it comes time for me to get another car and if I buy used, I will do it this way. Way easier than going to get a loan, and cheaper too. I get offers in the mail daily, so I can always roll it over onto another one if I don't get it paid off before offer expires.
__________________
Mulligan is online now   Reply With Quote
Old 11-05-2013, 11:07 AM   #4
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,406
It's really the same play as the pay off your mortgage debate. If she is willing to take the relatively minor risk that her investments underperform the loan interest rate she comes out ahead. One difference is that mortgage loan interest is deductible and car interest is not so if the gross interest rate were about the same then the economics would not be attractive. It might help her credit score if she cares about that.

That said, I pay cash for my vehicles and have for years.

On my last new vehicle, I got a $500 credit towards the car by financing with the manufacturer's finance arm and then paid off the loan a few months later. It worked great - you just need to make sure that there are no prepayment penalties.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
pb4uski is offline   Reply With Quote
Old 11-05-2013, 11:21 AM   #5
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
NW-Bound's Avatar
 
Join Date: Jul 2008
Posts: 19,391
Even in low interest environment like we are in now, it's not difficult to find a place to get better returns than the 0.99% interest on car loans. My brother got a 0% deal when he bought a Honda for his daughter. No reason to pay cash when you get deals like that.

For these deals to be real bargain, I assume that they do not jack up the price to make up for that low interest rate, but I have not been shopping for new cars to know.
__________________
NW-Bound is online now   Reply With Quote
Old 11-05-2013, 11:29 AM   #6
Thinks s/he gets paid by the post
 
Join Date: Jul 2005
Posts: 3,862
I've done it frequently, home mortgage, HELOC, and car loans, all of which we could have paid off long ago or paid cash. As long as the interest rate is less than what you are expecting for your normal AA you can grow your portfolio higher by taking out the loans. Of course, you are taking on the risk that your portfolio might go down. Particularly with short-term car loans, you don't have much time to invest the loan balance. That will make them much riskier than something like a 30 year mortgage loan. Our two car loans were taken out in 2002 and 2009, both times I felt a several year investment would be a reasonable risk. All the loans have been worthwhile.
__________________
Animorph is offline   Reply With Quote
Old 11-05-2013, 11:38 AM   #7
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jul 2006
Posts: 11,017
Quote:
Originally Posted by NW-Bound View Post
Even in low interest environment like we are in now, it's not difficult to find a place to get better returns than the 0.99% interest on car loans. My brother got a 0% deal when he bought a Honda for his daughter. No reason to pay cash when you get deals like that.

For these deals to be real bargain, I assume that they do not jack up the price to make up for that low interest rate, but I have not been shopping for new cars to know.
That is a generalization. My 0.99% loan is from Honda financing. I could have gotten a 0% loan on a Civic, but I did not wish to buy a Civic. I could have gotten 0% on a Toyota Corolla too, but I did not wish to buy one. The best deals are on the highest volume cars and you will usually not get them on cars that are at very high demand (which my CRV was).
__________________
Meadbh is offline   Reply With Quote
Old 11-05-2013, 11:50 AM   #8
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
NW-Bound's Avatar
 
Join Date: Jul 2008
Posts: 19,391
Quote:
Originally Posted by Meadbh View Post
That is a generalization. My 0.99% loan is from Honda financing. I could have gotten a 0% loan on a Civic, but I did not wish to buy a Civic. I could have gotten 0% on a Toyota Corolla too, but I did not wish to buy one. The best deals are on the highest volume cars and you will usually not get them on cars that are at very high demand (which my CRV was).
My post was not clear, hence was misunderstood.

What I meant was whether the loan was 0% or 0.99%, one could find a place to get a better return for the cash than these low rates. And with the car makers being competitive as they are, there would be a reason why one would offer 0% compared to 0.99% as you explained.
__________________
NW-Bound is online now   Reply With Quote
Old 11-05-2013, 11:54 AM   #9
Recycles dryer sheets
 
Join Date: Apr 2011
Location: Castro Valley
Posts: 400
I'm not a big fan of the idea for several reasons:

1) Investment returns are not guaranteed. Also, you cannot use a 75 year average Rate of Return to predict the next 5 years.

2) In order to compare apples to apples, you should use guaranteed returns like Banks/CD's for the next 5 years. Your after tax return will probably be 1/2 to 1%. Is your car loan lower than this?

3) You add a human element to it, maybe you cash out the investment and spend the money.

4) The intangible effect. Some people sleep better with no debt.
__________________
jkern is offline   Reply With Quote
Old 11-05-2013, 12:04 PM   #10
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
NW-Bound's Avatar
 
Join Date: Jul 2008
Posts: 19,391
A quick look on the Web shows that one can get 2% on 3-yr and 5-yr CDs, the length of a car loan.
__________________
NW-Bound is online now   Reply With Quote
Old 11-05-2013, 12:06 PM   #11
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jul 2006
Posts: 11,017
Quote:
Originally Posted by NW-Bound View Post
My post was not clear, hence was misunderstood.

What I meant was whether the loan was 0% or 0.99%, one could find a place to get a better return for the cash than these low rates. And with the car makers being competitive as they are, there would be a reason why one would offer 0% compared to 0.99% as you explained.
Sorry, yes, I did misunderstand your post. You were referring to the opportunity cost of not having the cash to invest if one chose to pay cash for the car. In my case the difference (so far) between portfolio returns and the cost of the loan has been ~8%, so the car loan has been a good deal.
__________________
Meadbh is offline   Reply With Quote
Old 11-05-2013, 12:16 PM   #12
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
HFWR's Avatar
 
Join Date: May 2005
Location: Lawn chair in Texas
Posts: 12,964
I intended to pay cash for my Prius, but Toyota gave me a three-year loan for 0.9%. My j*b depends on grant money that is subject to drying up at any moment, so I thought that having that $25k in my pocket was better than having it sunk in a car. One more year and the car will be totally mine, and it was worth the $300 or so financing cost to have access to that cash if I'd needed it. The flexibility was worth it for me, under my special circumstances. YMMV...
__________________
Have Funds, Will Retire

...not doing anything of true substance...
HFWR is online now   Reply With Quote
Old 11-05-2013, 12:19 PM   #13
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
haha's Avatar
 
Join Date: Apr 2003
Location: Hooverville
Posts: 22,380
Quote:
Originally Posted by jkern View Post
I'm not a big fan of the idea for several reasons:

1) Investment returns are not guaranteed. Also, you cannot use a 75 year average Rate of Return to predict the next 5 years.

2) In order to compare apples to apples, you should use guaranteed returns like Banks/CD's for the next 5 years. Your after tax return will probably be 1/2 to 1%. Is your car loan lower than this?

3) You add a human element to it, maybe you cash out the investment and spend the money.

4) The intangible effect. Some people sleep better with no debt.
+1. Using an investment portfolio to fund a car loan is huge maturity mismatch. There are exceptions too- for example taking the low interest car loan to avoid breaking a CD that you might have used to pay for the car.
Essentially time shifting
__________________
"As a general rule, the more dangerous or inappropriate a conversation, the more interesting it is."-Scott Adams
haha is offline   Reply With Quote
Old 11-05-2013, 12:43 PM   #14
Thinks s/he gets paid by the post
2B's Avatar
 
Join Date: Mar 2006
Location: Houston
Posts: 4,330
If the amount of extra return you would make on the interest rate/investment return spread is worth worrying about, you are probably buying a car that is way to expensive for you. I'm personally not going to worry about a few percentage points difference in potential spread on a $30,000 loan. The loan balance is continuously falling so it would only average out at $15,000 over the course of the loan. Even at a 5% spread, it would only be worth $750/yr for the potential risk of not making the spread or the annoyance of another bill to pay.

I would have a different opinion if taking the loan got an increased rebate and you could pay off the loan without penalty.
__________________
The object of life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane -- Marcus Aurelius
2B is offline   Reply With Quote
Old 11-05-2013, 12:51 PM   #15
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jul 2006
Posts: 11,017
Quote:
Originally Posted by 2B View Post
If the amount of extra return you would make on the interest rate/investment return spread is worth worrying about, you are probably buying a car that is way to expensive for you. I'm personally not going to worry about a few percentage points difference in potential spread on a $30,000 loan. The loan balance is continuously falling so it would only average out at $15,000 over the course of the loan. Even at a 5% spread, it would only be worth $750/yr for the potential risk of not making the spread or the annoyance of another bill to pay.

I would have a different opinion if taking the loan got an increased rebate and you could pay off the loan without penalty.
Oh really? What you are implying is that if someone like me wants to get a good deal that will ultimately save several thousand dollars, it means she can't afford the car, despite the fact that the price of the car is ~ 1.1% of her NW. Just because someone is FI doesn't mean money should be wasted.
__________________
Meadbh is offline   Reply With Quote
Old 11-05-2013, 12:56 PM   #16
gone traveling
 
Join Date: Sep 2013
Posts: 1,248
Quote:
Originally Posted by NW-Bound View Post
A quick look on the Web shows that one can get 2% on 3-yr and 5-yr CDs, the length of a car loan.
I think if I pay cash I will be able to negotiate better deal with a dealer.

Also where do you see 2% 3-Year CDs?
__________________
eta2020 is offline   Reply With Quote
Old 11-05-2013, 01:18 PM   #17
Thinks s/he gets paid by the post
OAG's Avatar
 
Join Date: Jun 2006
Location: Central, Ohio, USA
Posts: 2,598
Quote:
Originally Posted by eta2020 View Post
I think if I pay cash I will be able to negotiate better deal with a dealer.

Also where do you see 2% 3-Year CDs?
Pentagon Federal Credit Union (insured by NCUA).
__________________
Vietnam Veteran, CW4 USA, Retired 1979
OAG is offline   Reply With Quote
Old 11-05-2013, 01:22 PM   #18
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
clifp's Avatar
 
Join Date: Oct 2006
Posts: 7,450
I normally pay cash for cars, but this last one Penfed was offering 1.74% for a 6 year loan. Considering that I have CD with Penfed at 3.5-5% and then just offered me 3 year 2% CD it seems like a now brainer to borrow the money.

Now I would think that if you are paying an adviser a 2% (gasp) or even 1% wrap fee that any modest savings you gain by interest rate arbitrage would be more than wiped out by the hidden fees.

Also taxes matter while the interest on mortgages and HELCOs are deductible, those on car loans are (although the 1.74@ even for a 50K car loan interest is only ~$450 a year on average and the lost tax deduction is small.)

The flip side is if you have a 3% 15 year loan and you have much of the money in dividend stocks say @ 3.5% the interest is deducted as ordinary income but the dividends are taxed at 0 to 15%.
__________________
clifp is offline   Reply With Quote
Old 11-05-2013, 01:28 PM   #19
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
NW-Bound's Avatar
 
Join Date: Jul 2008
Posts: 19,391
Quote:
Originally Posted by eta2020 View Post
I think if I pay cash I will be able to negotiate better deal with a dealer.
Perhaps.

Does it make a difference if the low rate comes from the car maker, who's willing to take a cut on profits to compete? I have not been shopping for new cars for years, so do not know.

Quote:
Also where do you see 2% 3-Year CDs?
Quote:
Originally Posted by OAG View Post
Pentagon Federal Credit Union (insured by NCUA).
Yes.

For 5-year CDs, there are more choices for people not having access to the above CU. You can check at bankrate.com.
__________________
NW-Bound is online now   Reply With Quote
Old 11-05-2013, 01:30 PM   #20
gone traveling
 
Join Date: Sep 2013
Posts: 1,248
Quote:
Originally Posted by OAG View Post
Pentagon Federal Credit Union (insured by NCUA).
Not everybody can join it. I can not. Show me place that pays 2% CDs and is available to everybody.
__________________

__________________
eta2020 is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


 

 
All times are GMT -6. The time now is 08:45 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.