Did I do the right thing fully financing my car?

Submitted by OkayestOfAllTime t3_10ofcda in personalfinance

I just recently bought a car, and at the time I thought I was doing something smart. I was quoted a simple interest rate of 2%, and I figured that between the time value of money and the fact that treasuries were at 3.75%, It would be better to take as much debt as possible and allocate the other money to compound.

Even though it is a short time horizon, I figured the compound effect over 4 years would greatly outway the penalty I am paying in interest. Then, I figured since inflation was at 4-5% (if not more) that 2% interest was essentially free money if I managed the extra cash well.

However, now that I am trying to think about it deeper, I'm not sure if my assumptions were correct. Especially when you take into account the depreciation and the fact that I am very likely underwater on the car, my grand plan might have been an oversight.

Also, I was watching "The Money Guys" and their rule of thumb on car purchases was 20% down, 3 years, and 8% of your annual salary. I obviously didn't do this (I did buy gap insurance which might have been a mistake as well)

Was my logic wrong?

Edit: I could have bought the car cash

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Dorkus_Mallorkus t1_j6e94if wrote

With 2%, it was absolutely the right move to fully finance, as long as you can comfortably make payments and are living within your means. Depreciation is irrelevant, as long as you plan to keep the car for at least a few years.

As for the gap insurance, probably not the best move, but if it makes you feel secure, it's a small price to pay.

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theoriginalharbinger t1_j6eaxhy wrote

> Then, I figured since inflation was at 4-5% (if not more) that 2% interest was essentially free money if I managed the extra cash well.

Inflation is never the right metric to use. You want to compare two things:

  • Risk-adjusted or risk-free rate of return elsewhere. If you can get 4% with your money somewhere else and are financing 2%, you can (mathematically) come out ahead. This only applies if you have the liquidity to invest, though.

  • Probability of self-discipline working in your favor. For a lot of people, "Invest" turns into "Buy better Starbucks once a week."

Inflation doesn't matter. If you can't actually get returns on your money and if your earning power isn't going up, then you shouldn't be financing. As an example, if you can finance at 6%, inflation is 8%, and your medium-term investments are returning 4%, should you finance? The answer is no - you'll end up paying more in interest than your investments are returning.

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OkayestOfAllTime OP t1_j6ecvd0 wrote

Definitely. I didn’t take into account “inflation” as part of the math. I just figured that technically there was a bit of arbitrage between the car loan and the treasury and that influenced my decision.

Also, to get ahead of poor cash management, I made a 1:1 investment for the price of the car in t-bills. I figured that was a good, conservative guarantee of growth against the note.

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nf19m t1_j6eg2hn wrote

One thing I’ll throw out there, not saying you didn’t or won’t do it, is that it’s only the right mathematical choice to take the financing if one actually puts the money that was to be used as a down payment into the investment. This means NOT spending it on something else.

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Stock-Freedom t1_j6e9ahn wrote

Not necessarily wrong. More of an opinion. A lot of people will make the down payment the amount of the loan time depreciation of the vehicle plus interest. But overall, financially, investing the money is a better turn out.

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linuxhiker t1_j6e92n5 wrote

I would have paid cash and I wouldn't have bought a new car.

Also gap insurance is one of those, it can be helpful but most people think it's a scam. Even my step dad who is a car dealer thinks it's a scam.

Well when I was in my 20s I was upside down in a car (by a lot) and then then my wife (at the time) totalled it. Without gap insurance I would have been screwed instead we just walked away because we had gap insurance.

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