Question: Comparing paying cash to taking out a loan, these circumstances end up > costing around 100 hours of work time more for taking out the loan compared > to paying cash. > However, most people don’t have $30k laying around (that’s why financing is > so common). So if you’re going to pay cash, you have to save up. For > savings, I assumed an interest rate of 5% (an “eyeball average” for my area > taken from Bankrate.com) steady over 4 years to save $30K, and assumed > putting the same amount into the account every month.
> Because 4 years ago you’d be earning a fair amount less than today (because > of that 4% annual raise), it didn’t make a lot of difference – the loan > “cost” about a couple weeks of work more than saving up in advance. > In dollar terms, it’s cheaper to pay cash. But since most people tend to > earn more per hour as they advance in their careers, and since the value of > a dollar tends to erode due to inflation (at 2% annual inflation, what you > can buy for $30K today would cost an additional $1,800 in four years – in > effect, that 5% interest rate on savings is only 3% in terms of purchasing > power), it’s not always the case that paying cash results in working fewer > hours to buy a car.
Answer: In the first month, the interest would be $200 (.08 x 30k / 12), implying that the average month over the life of the loan would have ~ $100 in interest charges, which is 3.33 hours for our $60k/yr buyer, or 160 hours over 4 years. Did you factor taxes into this analysis? I wouldn’t be unusual for someone making these kinds of salaries to have a marginal tax rate of 30-40% (fed, state and local), but an overall tax rate of only 20-25%. Any raises or interest rate income would be effectively taxed at the marginal rate, while that initial salary would only pay taxes at the overall rate.
And since the car loan is not tax deductible (unless taken out as some kind of home loan) the difference between receiving 5% interest and paying 8% is bigger than that. How hard would it be to work the same scenario for a lease? If the car costs $30k new holds residual value of $12k after four years, that’s $18k. Average interest per month would be $160. And you’d save sales taxes of ~$15/month on the $12k.
If my calculations are approximately correct, you’d save about $7,500 in payments over four years and then not have $12k at the end of those years. That seems an awfully high discounted rate for the present value of money just 4 years in the future.
Related posts:
- Car loans
- Car insurance claim question
- A house or a car?
- Least frugal for most people??
- Paying off house v. investing
- Would I qualify for a home loan?
- Need to build credit. Need car repaired. Mistake?
- Costs in a House vs. Renting
- Is positive cash flow possible?
- A house or a car?
- Home buying in a soon to be high tax area?
- Would you finance a car with an interest only loan?