Frugal Shopper: Should I Pay Cash For My Next Car?

September 13, 2010
At a time when credit isn't taken for granted the way that it was just a few years ago, some are rediscovering the idea that new cars don't have to be financed.

If you've been good at saving money, you know that it hasn't been earning much interest anyway. But does taking out that bank check or fat wad of bills make you look like a smart high-roller, or just stupid?

As we've found in looking at the numbers, and some potential situations, it's a complex decision, and you really need to run your own numbers and consider whether paying cash is even an option.

Cash gets no love at the dealership

If want to pay cash for an affordable car, you're likely to be given alien stares around the dealership. That's because some dealerships expect to earn hundreds—in some cases thousands—of dollars per loan written. In any car, make sure you talk about financing after a price has been agreed upon.

As Jesse Toprak, vice president for industry trends at the pricing-intelligence firm TrueCar, points out, if you're not careful and accidentally disclose that you'll be paying cash, you might end up paying hundreds more for the vehicle.

And paying cash for a mainstream vehicle is quite rare. Among mass-market brands, well under ten percent, typically, pay cash on a new car. The brands least often bought with cash include Chrysler, Kia, Ford, Nissan, Dodge, Toyota, and Chevrolet. For each of those brands, less than six percent of all buyers pay cash.

Honda stands out among full-line, mass-market brands in that 12 percent of its buyers pay cash.

Luxury shoppers pay cash much more often

Among high-end luxury and performance vehicles, a much higher percentage pay cash. About a quarter of all Porsche buyers pay cash for their vehicles—some of them, like the 2011 Porsche Cayenne Turbo, costing more than $100,000. Sixteen percent of Mercedes-Benz buyers plunk down big cashier's check, while Jaguar and Cadillac follow at 14 percent, and 13 percent of those buying a BMW skip the financing.

Money, money, money

Money, money, money

For some luxury brands like Mercedes-Benz and BMW, where half or more of their vehicles are already moved on leases, that means good old-fashioned new-car loans don't make up that much more than a quarter of all sales.

So why do the high-rollers—who you would assume, in many cases, got where they are because of smart money management—pay cash more often?

Toprak says that most of the people who pay cash can be summed up in two types: Older, wealthier customers who simply do not finance anything; and those who are financially ready to buy a new car—perhaps even a luxury car—but can't get financing.

For those affluent buyers, it's not necessarily the sound financial decision, as in some cases they could do better investing the money in such large amounts elsewhere. "But it's difficult to make an argument with these customers," said Toprak, who used to manage dealerships.

Resurgence in those bucking the bank

While the total portion of the new-car market paying cash has declined for the past 20 years, and especially over the past ten years, Toprak reports a resurgence of those paying cash over the past year or two due to the unavailability of credit.

Among those customers who can't get financing—or those who don't like the terms being offered to them—paying cash is sometimes seen as the only way. And increasingly so, whether it be immigrant families who haven't yet established enough credit, or those who have a foreclosure in their not-so-recent past, paying with a huge wad of cash is the only way—especially if you know to avoid certain unsavory subprime credit terms.

But some experts insist that you can almost always do better paying cash. "As long as your finance rate exceeds what you could receive from an alternative investment, it will make sense to pay cash for your vehicle," argued David Wurster, the president of Vincentric, a company that provides vehicle cost-of-ownership data.

The logic? With financing, you spend potentially thousands of extra dollars on interest, over time. On the other hand, handing over the full transaction price has its cons—namely, that those funds aren't available to invest or gain interest.

Right now, however, with low interest rates and low rates of return for other types of investment, there's about a 0.78-percent opportunity cost (about what you'd get with the money to be used toward the loan in a savings account), so it makes paying cash for a vehicle a much better deal than, say, five years ago.

Running the numbers: Cash makes more sense than a few years ago

Wurster calculated out the numbers for us (see the chart below) on a couple of models likely to be shopped by families watching their wallets: a 2010 Ford Fusion SE four-cylinder sedan, and a 2010 Hyundai Elantra Blue four-cylinder sedan. Using a typical 60-month loan at the going rate, about 6.13 percent, the results are surprising: Over five years, all else the same, you'll end up paying about $2,000 more on the $21,775 Fusion or $1,300 more on the $14,145 Elantra over the long run, just by financing rather than paying cash.

But of course, if you're a smart investor, you might be able to earn a lot more than 0.78 percent on the funds you have available.

Put simply, as long as your auto-finance rate exceeds what you could (or at least might) receive from an alternative investment, it will make sense to pay cash for your vehicle.

Of course there are lots of exceptions to the rule. Would you rather have that money free just in case? And what if interest rates or earnings on investments suddenly become much more attractive during the course of your loan? Not likely, but possible. And then there are other sweetheart incentives that knock money off the price only if you finance through an automaker's captive finance company. In that case—if there's a $1,500 incentive, for instance—it could pay off.

Although some will insist one way or the other, there's no single answer to whether paying cash is smart or not. Run your numbers thinking about what we've discussed, and decide for yourself.

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See below for Vincentric's comparisons on financing for five years versus paying cash:

Ford Fusion SE and Hyundai Elantra Blue - cash vs financing - from Vincentric

Ford Fusion SE and Hyundai Elantra Blue - cash vs financing - from Vincentric

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