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Thread: Financing a car the right way?

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    Default Financing a car the right way?

    I am going to be purchasing a gently used car soon. My current car is starting to become a money pit, and if I have fork over another $1000 for a huge repair then I will begin to approach that threshold where the car isn't worth repairing.

    I have budgeted $10,000 to use for a down payment + my trade in which should get me a monthly payment at about 10% of my income in the range of car prices I am looking at. With interest rates being so low....A friend has advised me to not blow such a huge chunk of money on a down payment and instead only use $5000 for the down payment and keep the other $5000 in the bank, and use it to offset the higher monthly payments while allowing that money to double as my emergency fund. Thus freeing up more of my other savings to invest more aggressively and keeping my cash flexibility over the course of the car loan. I keep my cars for a long time, well past their loan terms, and have near perfect credit.

    Example
    $10K down = $250 monthly payment
    $5K down = $350 monthly payment. Subtract the $100 difference from $5000 emergency fund over a 5 year loan. While still saving to keep E-fund topped off.

    I could afford the increased payments with out sipping from the Emergency Fund, but I just balk at the idea of having a car payment over $250 or 10% of my monthly earnings after tax. I like to keep my monthly obligations very low, which allows me to save save save and have my money working for me.

    Is this a good strategy for stretching my money and keeping my cash flexibility?

    I am drawn to this suggestion, Cash is King in this new economy, and part of me says it makes no sense to apply such a large amount of funds at one time to a depreciating asset. There seems to be a permanent level of uncertainty in the job market for everyone. Also the amount of extra interest is in my opinion not a big deal. I will probably be applying extra payments to pay this loan off quickly.
    You can't get champagne from a garden hose.

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    Jimmy did what Jimmy did Bball's Avatar
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    Default Re: Financing a car the right way?

    The idea of financing as little as possible always seems the smarter way to me in the bigger picture. Besides the freedom of less debt (which = less worry) it also gives you the most flexibility no matter what might happen.

    Before really even playing the game and comparing options that include financing more and tossing the rest into the bank, the question I'd have is can you really be disciplined enough to not start tapping that banked money for other things? Any perceived benefit would dwindle quickly if you start tapping that account. And lastly... the money you borrow IS costing you money... but money in savings is almost costing you (with the LOUSY interest rates paid these days)... unless you can play the investment game wisely.
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    Default Re: Financing a car the right way?

    Quote Originally Posted by Bball View Post
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    The idea of financing as little as possible always seems the smarter way to me in the bigger picture. Besides the freedom of less debt (which = less worry) it also gives you the most flexibility no matter what might happen.
    Generally I would agree with you, and that was my initial plan.

    Quote Originally Posted by Bball View Post
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    Before really even playing the game and comparing options that include financing more and tossing the rest into the bank, the question I'd have is can you really be disciplined enough to not start tapping that banked money for other things? Any perceived benefit would dwindle quickly if you start tapping that account. And lastly... the money you borrow IS costing you money... but money in savings is almost costing you (with the LOUSY interest rates paid these days)... unless you can play the investment game wisely.
    Being disciplined is not a problem or me. I was able to save up this large amount of cash in about 4 years even while having to take a 20% cut in pay due to a 1 day furlough for 3 years. If I put that $5000 into an Emergency fund that would be ear marked for offsetting the car payment and serving as an E-fund. I would not tap it for anything else other than emergencies, and i would contribute to it from time to time to keep it topped off and healthy. My friend suggested this idea as a way to keep my cash available to me, and not just lose it in one transaction. I also have another 5K separate in savings , and the plan would be to take that money and invest it to get better returns through mutual funds and ETFs.

    There will be definitely be unexpected costs to arise in the future, sewers will be installed in my neighborhood, starting a family, etc...So it would be nice to keep that money available for an emergency.

    My friends rationalization was that if I did have an emergency, its better to have that extra cash available to me thus avoid putting that emergency expense on my credit card or some other financing at higher interest rates. Having to pay an extra $100 dollars a month out of my monthly income to meet the car payment is more preferable than having to whittle down a large unexpected credit card balance.
    You can't get champagne from a garden hose.

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    Default Re: Financing a car the right way?

    What price range cars are you shopping in? I ask because about 20% down is the rule of thumb. That's just a rule of thumb, it's perfectly OK to use different percentages. This would put you in the neighborhood of a $50k car. If that's your price range that's fine. I only ask because if I had $10k that would buy the whole car for me used and I wouldn't have any payment lol.

    I think you'd be better served to apply a larger down payment. As Bball pointed out, savings interest rates are in the toilet to the point that you'd get the same effect by burying that extra $5k in a glass jar in the yard. If your loan is 4 years, you'd take that $100 per month you'd save on the lower payment and have your fund built back up to almost the original 5k by the end of the loan. If in the mean time you had an emergency expense that was over the amount you had saved, you could always do a 0% interest introductory credit card for the difference. If it was a very large emergency expense (disaster, medical issues), it's not very likely that having the $5k on hand would have helped you in any event.

    Your friend wouldn't happen to be a banker would he? I ask because banks advise lower down payments because the larger the down payment is, the LESS MONEY THEY MAKE!
    Last edited by travmil; 05-16-2013 at 10:32 AM.

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    Default Re: Financing a car the right way?

    With as low as interest rates are now and especially with how aggressive people are on cars right now (especially if you have good credit), I would absolutely keep your down payment low if you can. There is no reason to part with your cash if you don't have to.

    I recently helped a buddy of mine purchase his first car, a brand new Civic, and we were able to get his payment under 300/month with no down payment at all. His parents had to co-sign, but their credit got the payment pretty low and will help him build his own credit history.

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    Default Re: Financing a car the right way?

    Quote Originally Posted by travmil View Post
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    What price range cars are you shopping in? I ask because about 20% down is the rule of thumb. This would put you in the neighborhood of a $50k car. If that's your price range that's fine. I only ask because if I had $10k that would buy the whole care for me used and I wouldn't have any payment lol.

    I think you'd be better served to apply a larger down payment. As Bball pointed out, savings interest rates are in the toilet to the point that you'd get the same effect by burying that extra $5k in a glass jar in the yard. If your loan is 4 years, you'd take that $100 per month you'd save on the lower payment and have your fund built back up to almost the original 5k by the end of the loan. If in the mean time you had an emergency expense that was over the amount you had saved, you could always do a 0% interest introductory credit card for the difference. If it was a very large emergency expense (disaster, medical issues), it's not very likely that having the $5k on hand would have helped you in any event.

    Your friend wouldn't happen to be a banker would he? I ask because banks advise lower down payments because the larger the down payment is, the LESS MONEY THEY MAKE!
    I am looking at a car in the $24-27K range. I really have more than $10K to use as a down payment as I have a trade-in that should net me around $3K. So could potentially make a downpayment for half of the price.

    My friend is not a banker, but he does have a degree in Economics and has a CPA certification. He is pretty smart about money, but sometimes too smart for his own good.
    Last edited by graphic-er; 05-16-2013 at 01:40 PM.
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    Jimmy did what Jimmy did Bball's Avatar
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    Default Re: Financing a car the right way?

    Quote Originally Posted by graphic-er View Post
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    My friends rationalization was that if I did have an emergency, its better to have that extra cash available to me thus avoid putting that emergency expense on my credit card or some other financing at higher interest rates. Having to pay an extra $100 dollars a month out of my monthly income to meet the car payment is more preferable than having to whittle down a large unexpected credit card balance.
    But aren't you making a choice to HAVE to pay an extra 100.00 per month no matter what vs the idea of maybe having an emergency that would force you to have to borrow and maybe have that same payment?

    I'm just having a hard time of seeing the point of more debt but more cash when cash simply isn't worth anything to offset the cost of the debt. ...Unless you have a plan to put that cash to work for you somehow so that it's more investment with a real ROI versus just sitting there.

    Unless we're talking having NO cash on hand if you spend that full 10K....
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    Default Re: Financing a car the right way?

    Quote Originally Posted by Trader Joe View Post
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    With as low as interest rates are now and especially with how aggressive people are on cars right now (especially if you have good credit), I would absolutely keep your down payment low if you can. There is no reason to part with your cash if you don't have to.

    I recently helped a buddy of mine purchase his first car, a brand new Civic, and we were able to get his payment under 300/month with no down payment at all. His parents had to co-sign, but their credit got the payment pretty low and will help him build his own credit history.
    This is also what my Boss (who is also the owner) said. Do something better with your cash than spending it upfront.

    I think my biggest hang up is having a payment that is more than 10% of my income even though I could afford it. My friend's suggestion is essentially a way of playing psychology with myself. By keeping the 5K and using to serve as both supplemental funds for the increased car payment and as an emergency fund. I am still able to say that my payment is below that 10% income limit I want, and it will motivate me want to pay off the loan sooner because it would limit how much I would have to worry about keeping that Emergency fund topped off.
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    Default Re: Financing a car the right way?

    If the payment ends up bothering you that much in your psyche, you could always use your emergency fund to make a big bite out of the loan in a single payment.

    I don't like parting with big chunks of cash on cars unless I am going to be writing a check to own outright immediately. I lease my cars just so I don't do a down payment.

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    Default Re: Financing a car the right way?

    Quote Originally Posted by Bball View Post
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    But aren't you making a choice to HAVE to pay an extra 100.00 per month no matter what vs the idea of maybe having an emergency that would force you to have to borrow and maybe have that same payment?

    I'm just having a hard time of seeing the point of more debt but more cash when cash simply isn't worth anything to offset the cost of the debt. ...Unless you have a plan to put that cash to work for you somehow so that it's more investment with a real ROI versus just sitting there.

    Unless we're talking having NO cash on hand if you spend that full 10K....
    Having 5 grand sitting in a bank is better than having 5 grand sitting in a car even in this economy.

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    Default Re: Financing a car the right way?

    Quote Originally Posted by Bball View Post
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    But aren't you making a choice to HAVE to pay an extra 100.00 per month no matter what vs the idea of maybe having an emergency that would force you to have to borrow and maybe have that same payment?

    I'm just having a hard time of seeing the point of more debt but more cash when cash simply isn't worth anything to offset the cost of the debt. ...Unless you have a plan to put that cash to work for you somehow so that it's more investment with a real ROI versus just sitting there.

    Unless we're talking having NO cash on hand if you spend that full 10K....
    This is true, I would be making that choice vs using the full 10K I've budgeted and not having that $5K sitting in the bank available to me.

    If I spent the 10K I would still have other extra money in savings so no its not going broke, but I would probably designate those extra funds as my emergency fund and not invest them to get a better ROI. My friend is basically saying keep some of that down payment money and designate it as an Emergency Fund that you can also use to float some of your higher car payment and use your extra cash to invest more aggressively.

    Like I said I generally would tend to agree with you, but interest rates are so cheap, so its definitely causing me some pause.
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    Default Re: Financing a car the right way?

    Quote Originally Posted by Trader Joe View Post
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    If the payment ends up bothering you that much in your psyche, you could always use your emergency fund to make a big bite out of the loan in a single payment.

    I don't like parting with big chunks of cash on cars unless I am going to be writing a check to own outright immediately. I lease my cars just so I don't do a down payment.
    My Boss also said I should look at leasing, but generally you still have to make nice chunk of upfront payment on the lease. Which I am not comfortable with.
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    Default Re: Financing a car the right way?

    Quote Originally Posted by graphic-er View Post
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    My Boss also said I should look at leasing, but generally you still have to make nice chunk of upfront payment on the lease. Which I am not comfortable with.
    It all depends on lease deals, etc. I have never put a down payment on a lease.

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    Default Re: Financing a car the right way?

    Make sure you calculate how many miles you're going to drive if you lease. Otherwise you might NEED that $5k emergency fund at the end of the lease to pay the mileage overage.

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    Default Re: Financing a car the right way?

    Quote Originally Posted by Trader Joe View Post
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    Having 5 grand sitting in a bank is better than having 5 grand sitting in a car even in this economy.

    I just don't follow that reasoning IF the only way you got that 5K in there was by borrowing more for a car in the first place.

    Let's take the car out of the equation for a second. If the above is such a good idea then why not just go borrow 5K and bank it anyway to have 5,000.00 sitting in the bank?
    Nobody would do that would they? So what is different about the scenario if we put the car into the equation?

    Unless you can put that 5K to work as an investment with a good chance of earning more than the interest being paid out on the car then I just don't get the idea of banking 5K instead of using it on the car. Why is it a good idea to have that cash in the bank while now owing more on the car, and owing more interest due to that fact?


    EDIT.... Unless the car is somehow a business expense write off.... Which I assume it's not....
    Last edited by Bball; 05-16-2013 at 02:39 PM.
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    Default Re: Financing a car the right way?

    It's really all about how you want to spend your money Bball. I see what you're saying, but graphic-er already has the the 10 grand in his bank account. I would rather pay a little more in interest right now, especially with how low interest rates are if you have good credit, than part with 5 grand, especially on something like car which is going to result in you losing money either way, but it's really more of a personal choice.

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    Default Re: Financing a car the right way?

    Quote Originally Posted by Bball View Post
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    I just don't follow that reasoning IF the only way you got that 5K in there was by borrowing more for a car in the first place.

    Let's take the car out of the equation for a second. If the above is such a good idea then why not just go borrow 5K and bank it anyway to have 5,000.00 sitting in the bank?
    Nobody would do that would they? So what is different about the scenario if we put the car into the equation?

    Unless you can put that 5K to work as an investment with a good chance of earning more than the interest being paid out on the car then I just don't get the idea of banking 5K instead of using it on the car. Why is it a good idea to have that cash in the bank while now owing more on the car, and owing more interest due to that fact?


    EDIT.... Unless the car is somehow a business expense write off.... Which I assume it's not....
    Well, if the interest rate on that 5K was 2-3 percent that might be a good idea. Thats the case here. Banking the 5K instead of using to buy the car is gonna allow me to take another separate 5K that serves as my E-Fund and put it to work.

    Interest is the difference between a 15K Loan and a 20K loan. So I dont' think thats a huge amount. Like a couple hundred bucks.

    I'm not really sold on it yet. I already have a pre-approved finance check ready to use if I want to put the full 10K down. So this may just be an option I explore at the dealer, and end up using my pre-approved finance check in the end.
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    Default Re: Financing a car the right way?

    I live off my investments. The last car I bought was in 2007 and I paid cash for it because the bull market was long in the tooth and I had extra cash.

    I am considering a new car as well, and despite now being pretty much an income investor and well into my retirement years, will finance it. Here's why:

    1) I can easily make more on the capital than the 2-3% financing charge. But your mileage may vary.
    2) I intend to finance it for as long a period as I can. Interest rates are going to go up during the period of the loan, so I've locked in a low rate. When interest rates go up, so will inflation. We're already seeing inflation in energy and food now. So I will be paying back a loan at a very low rate with dollars that won't be worth as much as they are now.

    It wasn't very long ago that car loans ran 6-8%. Take advantage while you can.
    Another note: while it may make perfect sense to prepay your mortgage, it never makes sense on a car loan. On a mortgage, the loan is amortized, interest being taken on the unpaid balance every month. On a car loan, the interest is calculated and tacked on up front each year.

    The idea of having the $5k as your emergency fund is a really good one. Also consider that over the term of the loan, you will probably be getting raises so that the monthly payment will not be taking as big a % out of your income later on.
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