I couldn’t find this discussed already, so adding a new topic.
Dear Wife and I recently purchased a new car and agreed to a 63-month loan since it is at 1.9%. This violates Clark’s number 1 rule on such loans: “The longest auto loan you should ever take out is 42 months.”
I don’t see how this can be a bad thing if one can make 4% interest as of now. I understand that may drop soon, but unlikely to go below 2% for some time. What is the drawback of just paying the minimum amount, even if the car value becomes far less than the loan? I don’t expect to sell the cars until it becomes more expensive to repair than it is worth, which should be well over a decade..
Granted, I am financially prepared to increase the payments substantially as soon as bank interest goes below 1.9%, but it seems to me that this is superior than taking a shorter loan with higher payments to begin with. I’m literally making money this way compared to a 42-month loan.
I must be missing something, since Clark is adamant about this rule.
I think a 63 month, 1.9% loan is fine… but I wonder, did they boost the price of the car they sold to you in order to compensate for the below-market financing, or did you get a decent cash price?
You could now purchase the remaining loan balances in Treasury bills/notes and lock in returns in the 3.5% range for the duration of your loan. Make sure you have a failsafe system to avoid late monthly payments.
p1g1 - That’s quite an interesting option to consider. I can handle the monthly payments from income, but don’t have that kind of cash outside of my emergency funds to buy the bills/bonds. Most of my net worth is tied up in retirement accounts.
It is a winning strategy since you are collecting interest at a rate higher than your loan interest rate.
Example: Assume that someone has $50,000 in an account earning 4% and is offered a 5-year loan $50,000 loan at 2%. For simplicity keep the account interest rate at 4%
Pathway A- Use all the account money to pay for the car. This pathway results in no money in the account at 5 years.
Pathway B- take the $50,000 loan paying it off monthly at the 2% rate while the remaining balance in the account is growing by 4%. This pathway results in money in the account at the end of 5 years.
Pathway C- Buy a vehicle you can afford (versus one you have to take over five years to pay off) and then take the extra money and save and/or invest it.
Pathway C- Buy a vehicle you can afford (versus one you have to take over five years to pay off) and then take the extra money and save and/or invest it.
I certainly did not take pathway C. This is a pure pathway B play. I could have pulled the cash out of my Roth without harming my future retirement plans. This way, however, doesn’t rock my retirement boat at all, and the car will be nearly paid off before I retire, meanwhile that invested capital will certainly return more than the 1.9% borrowing cost just by holding a TIPS bond with 2.125% interest plus inflation adjustments. In addition, inflation itself will mean that each subsequent fixed payment will be using less valuable future real dollar amounts.
If you don’t have the dry powder to buy a $50k car, then it’s too expensive for you. Do people get $50k or more expensive vehicles? Sure, but they shouldn’t if they can’t afford it. If you must work a scheme so you have something reliable, do it on a more reasonably priced choice.
Yes, in addition to your scheme, you could take a mortgage against a paid-off house or a cash advance at 0% interest with an origination less than you might get in high-yield savings; but all this tomfoolery exposes you to additional risk for minimal gain.
If you don’t have the money liquid for a $50k vehicle, then make a more reasonably priced choice.
I could pay the loan off today if I wanted to. In fact, I got a lower price for my last (used) car by taking a three-year, high-interest loan instead of paying cash, then paying off the entire loan amount the following month.
My whole point of this post is that sometimes folks in this situation can work a scheme (Jolly’s wording) which results in paying less than the cash or short-loan methods would cost. My question was simply whether this “scheme” had some hole in it which I was overlooking, or was Clark’s advice really for those who must borrow money for a car.
If you want the cash to do something else with it, you don’t have it “in hand.” If you need a “scheme” to pay for something over many years, you don’t have the money “in hand” either.
As far as holes which scheming with the money versus using it to just pay for a car? There are few, not the least of being that when you “set aside” money for something, it often gets used for something else.
And by the numbers? There are a few gotchas there too; for instance you’re paying tax on the interest the “saved” money is making. You’re also hurting your credit score some by having the outstanding loan which reduces other opportunities (for instance that 0% credit card with $1200 sign up bonus) and may increase insurance and other costs.
If you NEED a 5 year loan to afford a modest car, I would be more likely to recommend that versus take a 5 year loan on a more expensive car where there is a “scheme” for not paying it. My answer is situational.
What’s the value if you car in 24 months? Then compare that to the principle balance on your loan. It could be thousands different. Your Insurance will only pay Actual market value which could be way less than what you owe. The car could be totaled and you are still responsible for the loan. That’s what Clark is talking about, not the rate. The depreciation is faster than you are paying the loan down. And, heaven forbid if you got a Rule of 78’s loan.
Thank you Joe! I figured there was a valid point that I was missing. Of course, if I had already paid for the car, I would also be out nearly the same amount, with the interest paid being the extra loss for having had the loan. I can live with that, since the interest rate I have is rather low, 1.9%.