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In this article we are going to help you determine whether
you should buy or finance your car. Since we
don't all have degrees with finance as our major, this
decision is not always the easiest. However, making the right
decision here can save you a pile of money in the long run.
Before we begin it is important to understand the principle
called the Time Value of Money. This means a dollar today is
worth more than a dollar tomorrow. We can all agree that if
someone offered you $10,000 today or $10,000 one year from now,
you would choose to have the money today; the reason for this
is interest. If the interest rate was 5% annually and you took
the $10,000 today, in one year it would be worth $10,500 ($10,000
+ $10,000*5%). It is evident that choosing to have the money
today would, one year later, leave you better off by $500. This
same principle can be applied in the reverse direction. $10,000
a year from now is worth $9,524 ($10,000/1.05) in today's dollars.
In other words, if you were to take $9,524 and invest it at
5% you would have $10,000 at the end of one year. When the Time
Value of Money is applied to purchasing a car, you can see that
if you do have enough money to purchase the car out-right it
may be best to finance and invest the rest
of your money.
Financing is offered from many different sources so there are
lots of options available to you. The following list outlines
the pros and cons of some different options:
- Car Dealership - On the plus side, this is your most convenient
option as your entire car purchase is done through the same
company. However, in most cases you do not receive competitive
interest rates and they tend to use high pressured sales tactics
to get you to sign on the dotted line.
- Home Equity Loan - This option can be done through most
financial institutions and it is here that you will receive,
by far, the most competitive rates. For more information about
home equity loans visit our home
equity loans help page.
- Financial Institution - You will receive a competitive interest
rate from a bank or a credit union and they should be able
to give you an idea of whether or not you're getting a good
deal on your car. However, the convenience of dealing with
your dealership is lost. In the vast majority of cases the
extra effort of making an appointment with the bank and reviewing
their offer will pay off. Another plus is some banks offer
you free life and disability insurance with your financing
package.
Whatever source(s) you are considering you need to apply the
same financial concepts to determine the cheapest option. We
are going to think of the cost of the different options in terms
of today's dollars (also known as the present value). This will
give us a common measure for which to compare the different
financing options and see which one is the best or even if you
would be better off buying the car out-right.
If you were to buy the car out-right it is very simple to determine
the amount in today's dollars for this financing option; it
is simply the amount of money you will have to pay the dealership
in order for them to hand over the keys so you can drive off
the lot. However, the financing options are a little more difficult.
Using the Time Value of Money theory, as discussed above, the
payments you will make over the course of your loan need to
be converted into today's dollars. There are many financing
calculators available online to help you with this.
Once you have determined the amount (in today's dollars) of
all the different options, the rest is simple; the cheapest
option is your least expensive option for buying/financing a
car. Notice how we didn't say best. Even though buying the car
out-right may be the least expensive option, you may not have
the money to do so. Or you may find the additional cost of financing
the car worth the flexibility of paying for your car over a
longer period of time.
Kepping the above in mind, you will be much better prepared
to make the smartest decision when your next financing opportunity
presents itself.
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