Cash Vs. Financing Vs. Home Equity Line Of Credit
Before we get into the question of cash versus financing, a little background is in order for shoppers who haven’t had much experience buying a new vehicle.
If that sounds like you, here’s the deal: When it comes to buying a vehicle, you generally have two ways to go about it. You can either finance the car, which means you pay it off over time, or you can pay cash, which means you buy the vehicle outright as if you’re picking up a new book at the bookstore and handing the clerk a $20 bill.
The advantage to financing is that you’ll usually end up with a better car than you can if you’re paying with cash. For example, if your car budget is $8,000, you’ll buy a used vehicle if you pay in full, but if you use that $8,000 as a down payment on a new vehicle, you can expand your horizons greatly. If you have good credit, you can easily afford many new models.
The only drawback is that you’ll need to make monthly payments in order to pay off the loan that allowed you to buy the newer, more expensive vehicle. Included in those payments is interest, which is a fee you pay the bank for allowing you to borrow the money in the first place.
Isn’t Cash Better?
The common thinking is that buying a vehicle with cash is better than financing because you won’t have to pay interest. After all, when dealing with cash, you pay exactly the price shown and no more. When you’re financing, you have to pay off the car with interest, and that means you’ll end up paying an additional amount on top of the vehicle’s purchase price. So, is this thinking correct?
Our answer is: Not Always.
While we agree that buying a vehicle with cash is generally preferable to financing, there are many situations in which that’s not the case. The best example is if you qualify for a favorable interest rate. In that case, paying with cash may not be the smartest thing to do because you’ll lose very little money by financing; you get to keep your cash for other projects or investments.
For example, say you want to buy a $25,000 vehicle and you can afford to purchase it with cash. If you want to spend your cash, that’s great: It means you won’t have a payment or another care about the car’s financing. But let’s say you shop around for a good interest rate and end up with 5.99 percent financing for 60 months (5 Years) after a $5,000 down payment.
In that case, you’ll keep your leftover $20,000, and while you have a car payment, the total interest comes to just $3,193.78. The question you must ask yourself is whether it’s worth $3,193.78 to have that $20,000 in your bank account rather than tied up in your car. Most people would rather have the money in the bank or invested, where it’s likely that they’ll quickly earn back the entirety of the loan’s $3,858.16 cost. Well most people do not realize that in this case you only need to earn at least 2.99% on your investments to pay for $$3,193.78 back in the same time! what makes it more profitable for you is when you register it in a RRSP you would get back more cash at tax time!
Where can you find an investment that will pay more than 2.99% you may ask. Well let’s look at how the banks that would loan you the money have done in the last 5 years.
*Stats taken from MorningStar.ca
Are you really saving money by paying Cash?
Let’s use your home line of credit typically it would be Prme+0.5% (As of November 27, 2018 Prime Rate is 3.95%).
If you just pay the minimum (2%per month) and DO NOT ADD any more money on the LINE OF CREDIT throughout the life of a loan this is what it would look like.
In this case even though the rate is cheaper it would vertually never be paid off. By the time you have paid the same amout back on the line of credit it would have taken you 15 years and you would have a balance still. This also takes in to effect that Prime rate doesn’t chage in the 15 years.
Well what if you take the payments you would have paid on the vehicle loan and just pay the line of credit down that way.
You will save 2 months of payments but this will only be true if Prime Rate does not change
Other factors to consider are how much room you acctually have in the Home Equity Line of Credit?
*Sources – Autotrader.com | MorningStar.ca
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