Oct 13

The Finance Maze – Cash vs Finance

Finance buying a car, car finance, cash vs finance, finance maze

Buying a motor vehicle whether it is new or used can be a time consuming and frustrating adventure. In this article I will look at the everyday person buying a family car and some of the things to consider.

The act of purchasing a vehicle and funding it are two very separate parts of the process. The negotiating of a price or change over figure is one transaction and the funding a totally different transaction.

Once you have completed the buying of the vehicle it then comes down to how is the most effective way to pay for it. Most from the old school would say that if you can’t pay cash then don’t buy it and to some this is still the way they buy things.

Now if you have the cash to pay for a vehicle outright then this may not be the best option as you end up with no cash and a depreciating item.

There is a way that you can retain your cash and purchase the vehicle under finance and at the end of the day you are better off.

How Does This Work?

The following assumption is based on the fact that you can afford a monthly payment from your income.

Let’s look at the scenario that you wish to buy a new vehicle for say $30,000 and that you were going to pay cash. You pay the dealer the money and you end up with an asset worth $30,000 day one and no cash.

What do you think your car will be worth in 12 months and again in 5 years?

Let’s be unrealistic and say that your vehicle is worth $25,000 in 12 months and say $20,000 in 5 years and you still have no cash reserves.

This is how it works:

If you invest your $30,000 in the bank on a term deposit over 5 years with compound interest at 5.1% and you finance the $30,000 car purchase over 5 years at 9%.

Year	Amount	Annual	Total	Car Value	Total Assets	Loan
1	30,000	1,530	31,530	25,000	56,530	7,417
2	31,530	1,608	33,138	24,000	57,138	7,417
3	33,138	1,690	34,828	22,000	56,828	7,417
4	34,828	1,776	36,604	21,000	57,604	7,417
5	36,604	1,867	38,471	20,000	58,471	7,417

At the end of 5 years:			38,471	20,000	58,471	37,085

At the end of the five years, your cash investments will be worth $38,471, and your outgoing repayments will have been $37,085. This means you have an extra $1,386 in your pocket at this time.

Why Does This Work?

When looking at the interest rates in the above example, it may seem counter-logical that you end up with a positive cash position, given that you are receiving 5.1% on your funds and paying out 9%.

The simple answer to this is the power of compound interest.