Cash or Finance? The answer is obvious, just not what you expected. When Nick and I ran a medium dealership here in the Bay Area, almost 60% of customers preferred paying cash. While for most decisions (and for those without discipline) I think thats a good idea, for most good credit customers is actually not.

To make the point, let’s go through the same exercise we went through with many of our customers.

Scenario 1: You’ve got good credit – get a loan.

If you’ve got cash let’s take a basic scenario. You’re going to want to:

  1. Buy a vehicle for $25,000 including all taxes and licensing fees.
  2.  A normal loan term is 60 months, so we’ll use the same horizon
  3. A nominal credit union interest rate is 2.99% or less for excellent (720+) credit. Let’s use this as a starting point. (you can checkout complete current rates here)
  4. Any money not spent on a car payment is invested.

Obviously, the range of investment outcomes is unknown, but let’s use something fairly ordinary, like an S&P 500 index fund (let’s also use this since investment fees are minimal and won’t squeeze out incremental returns).

In this case, if you’d been prudent and invested in the S&P 500 for 60 months prior to March 2017, you’d end up with a nice $5,244 more than had you paid cash. Even in these cases its not a case of “best timing” either, while the S&P returns over this 60 month period were 67% in total, average returns over a 60 month window were 78% on average.

Why do you end up making more money by lending? Well a few reasons:

  1. Credit Union loan rates are typically barely above government treasuries. With rates for 60 month treasures at 1.88%, some credit union loans are a point or less .
  2. There are typically lots of other good investments that yield more than government treasuries and that have minimal fees (S&P 500 comes to mind).

Obviously “timing” is an issue, but in general there’s lots of more accretive, stable investments where you can out-earn your own loan.

Scenario 2: You’ve got not so good credit – pay cash

Now let’s say you’ve saved the cash, but have bad credit. Don’t worry, there’s still a lender that can help, it just takes a bit more work.

In these cases, let’s keep all assumptions the same, except in this case let’s make the interest rate 9.99% (assuming 570-630 credit). A couple things change for your $25,000 car – for one the payments go way up (more interest). And as a result … you end up

In the bad credit cases the interest outweighs the potential gains.

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