Paying Cash Versus Going Into Debt: Looking at the Numbers

Recently, I’ve had discussions with several readers about the concept of paying cash versus taking out a loan for medium-sized purchases, such as an automobile. In order to demonstrate how cost-effective it truly is to pay cash for an automobile rather than taking out a loan, here’s a clear example that you can calculate at home.

Let’s say you just bought your first automobile with a loan. It’s a cheap one with only a small monthly payment, and your plan is to drive it for four years, then replace it with a car that costs $11,000. After the trade in, you’re planning to spend $10,000 on a car in four years.

You have two options here. First, you can just wait until then and buy the car with a 48 month loan. If you get this loan at 8%, the payments will be about $244.13 per month for 48 months. You can run the numbers yourself using the handy auto loan calculator at bankrate.com.

On the other hand, you can start paying for the car now by putting money into a savings account. If you put $188.90 each month into a HSBC Direct savings account (which earns a 5.05% APY), you’ll have almost exactly $10,000 (actually, just a few cents over) after 48 months, with which you can buy the car by writing a check instead of taking out the loan.

With the second plan, you literally pay $55.23 less per month by saving up the money and then buying than buying and then paying off the loan.

What if you made a full equivalent payment into the savings account all 48 months? Instead of putting in just $188.90, you put in the $244.13 you’d have to pay for the loan. After 48 months, the account balance would be $12,924.27. You would have an extra $2,924.27! This could either mean a nicer car or a start on the car you would purchase after that.

Simply put, there is no better way to buy a car than to make the payments to yourself first, then write the check to buy the car. It doesn’t matter how good of a negotiator you are or how good of a rate you get, you can’t top a payment that’s 20% less.

Some people will argue that you have to get a car loan or else you’ll never get a car. This is arguably true for the first automobile that you own, but your first automobile should be just good enough to get you back and forth to work for a few years until you can afford to write a check for your next car.

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14 thoughts on “Paying Cash Versus Going Into Debt: Looking at the Numbers

  1. Mark says:

    Love the website, but not all debt is bad and a spending your own money should be the last thing you should want to do EVER !

    Here’s how we bought our car (btw I’m from the UK)

    My wife & I paid £6000 for your current car a little over 3 years ago.
    £3000 paid in CASH by wiping out our saving account.
    £3000 paid by maxing out our first credit card that offered 0% on purchases for 13 months.
    Every month we paid the minimum 2% payment and (by generally tighting our belts) started rebuilding our savings account.
    After 13 months we could have reduced the debt but,we hadn’t saved enough to fully pay off the balance and we didn’t want to start incurring interest so we transferred the debt to credit card No. 2 (costing a 2.5% transfer fee) with 0% for 9 months and kept our savings growing.
    At the end of 21 months we could on payed the remaining debt off. ……. but we didn’t. Quite the opposite.
    Card no 3 was 0% on transfers (again 2.5% fee) & purchases for 12 months. So we purchased on the card (earning points) and banked the CASH we would of spent into our savings account.
    In December tranferred our debt of £3700 (our max credit having risen to £5500) to Credit Card no 4 offering 0% on transfers for 12 months (again a 2.5% fee) WE WILL NOT SPEND ON THIS CARD, but will repay the minimum by 2% ever month and review in 11 months time !

    The car is still going strong.
    We’ve paid credit card transfer fees but NOT A PENNY in monthly credit card interest.
    We’ve tranferred £3000 into a tax free cash ISA (IRA) at 5.4% and the remainder is currently in our savings account at 6.1%
    This money isn’t really ours, but hey we’ll take the interest on the money every month thankyou very much.
    We’ve enjoyed spending the points earnt on the cards and the cards purchase protection was nice !

    CREDIT CARD used in this way offer the best loans EVER ! IMO

    Let the Credit card companies put a smile on your face and money in your pocket.

    We currently haven’t received picked our new card for purchases … so are VERY, VERY reluctantly having to spend our own CASH again ooch,ooch,ooch …………

  2. Jim Lippard says:

    “Not a penny in monthly credit card interest”–but you paid a 2.5% balance transfer fee three times, which is no different than paying interest.

    If you purchase a car from a dealer, they may let you put part of the purchase price on a credit card (for the points, cash back, or just the month float) if you’re paying cash.

  3. Gaya says:

    Nice theory. But what will happen if
    the price of the car goes up than the
    amount we can save?

  4. Trent says:

    Your car would have to jump in value almost 30% for this to matter. Given that inflation in the United States has stayed in the 4% range for a long time, that’s likely not going to happen.

  5. ro says:

    Don’t forget about the taxes paid on interest :-(

    Also a call to the CC company can increase your max.

  6. Inflation compounds over time as well. That 4% over four years is equal to about 17% overall. Thus the price of the car should be 17% more expensive, but you are saving 20%. Hmmm, that looks closer.

    I got an interest rate of 4.9% when I bought my car. I could earn more on my money by putting it in the HSBC account. Paying cash is not always a good blanket rule. If people are going to me more money elsewhere, I’m going to take it.

  7. Chris Noto says:

    “I got an interest rate of 4.9% when I bought my car.”

    You sure didn’t get $4.9% on a used car, LMaM, and a new car, which you had to buy to get that rate, depreciates between 50% and almost 75% in the first three years of ownership. Believe me. I know. I just spent seven months in new car sales, and now do customer service in a new car dealership service department.

  8. formul8 says:

    You have a couple of other options here:

    -Buy a new car that has 0% financing and drive it until the wheels fall off (they are still out there)

    -Take that $10K saved, write a check as a down payment on a new or used $20K car. I would rather drive a Honda Accord for many years than a Civic.

  9. Jeremy S says:

    You can buy a 5-6 year old Toyota or Honda for about $5000. Based on my experience with these cars, that should last you at least 5 years. (Plus, they will save you alot of $$ on gas.)

    Meanwhile, if you save up $1000 a year ($84/month), you can buy your next car when that 5 years is up.
    That sounds alot more affordable to me than a car note.

  10. tomi o/ says:

    like my economics prof. once sed, “if you can’t afford a new pair of shoes, wear the old ones longer”.i am not american, but I live there.I’ve noticed AMerican’s just love to be in debt jst cos der are credit facilities available. I am planning to get a car before the end of this year, and since I do not have any credit report cos I do not own a credit card, I have to pay in cash, hopefully I get a lot of discount for paying cash at once.

  11. LC says:

    I have paid cash for all my cars, and I believe this by far the best way to go. However, when I got married, mu husband had a car loan with a 3% APR, so in that case, it would pretty dumb not to finance it. Although I am amazed when people tell me their car payment is more than my mortgage!

  12. Kevin says:

    Why would you ever pay cash for a depreciating assest? Saving money up over time or simply writing a check is crazy. Financing rates are down around 6% or less now. If you finance a $30,000 vehicle for as long as 6 years and keep you money in the bank growing at 3.5%, you will earn over $1,200 in interest. Verses paying $30,000 in cash for a vehicle that you’ll be lucky if it is worth $10,000 in 6 years. That is like throwing away $20,000!

  13. Allen says:

    Kevin, it makes more sense to pay cash for a depreciating asset that you could bargain on much better than cash, AND you don’t have to pay finance charges on it. Best part about paying cash…you actually own the car. If you pay with a credit card, your car will depreciate anyways and now you’re stuck paying finance charges.

    “That’s like throwing away $20,000!”…could you imagine how much more you’d throw away with a 3.5% finance charge tailing you?

  14. ksk says:

    the finance charges are the issue and i cant forget about the higher car insurance when you finance

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