I’m looking at buying a new car sometime in the next year or two as mine is over 10 years old and not as comfortable as I’d like. In fact, my partner and I have started doing more road trips and camping and our current cars just don’t make the cut.
This has led me to some thinking, and calculations. Is it better to save up and buy a car for cash, or does car finance make sense? In fact, is there an argument for using car finance, and if so, what would it be?
This post is not meant as financial advice, and my situation is different to yours. But take what you read, look at the calculations, give it some thought, and let me know in the comments whether this makes sense.
Assumptions and background to this article
This first thing to note is that my partner and I both have fully paid off cars. We currently pay for insurance each month, fuel costs, and maintenance. I’m writing this from the perspective of already owning a paid-for car, and now replacing it with a newer one.
In total I am willing to set aside R4,000 per month towards a car. This is either towards monthly saving or an instalment.
I am only looking at the cost of the car in my calculations, not fuel nor insurance. That just overcomplicates things for me.
I can probably trade my car in for around R70,000. We’ve looked at perhaps selling a car and sharing one, but that is a whole different discussion. In fact, I’ve written about it before.
I also have R20,000 set aside that I can use as a cash deposit.
Saving for a new car
First off, let’s see what we can do if we save the deposit that I have, as well at R4,000 p.m. for 5 years. I can’t obviously sell my car now as I need it. So this is just saving.
I am using a slightly conservative interest rate of 5% as I don’t have access to a home loan to stash my money, and I don’t currently have an account that earns better. I could potentially get 7% or 8% interest, but I prefer a conservative take as one cannot predict the future.
As you can see, saving my R20,000 deposit over 5 years, as well as R4,000 pm will get me to just over R297k. That’s not bad.
But, 5 years is a long time!
Vehicle Price increases
Now comes the interesting part (well, one of many interesting bits); vehicle prices increase each year. Although there is not precise report or index to account for this, TransUnion publishes a Vehicle Price Index (VPI) each quarter which looks at financing costs and gives a fair indication. The increases vary each quarter and year – sometimes drastically. It feels fair to use an average vehicle price increase of 5% pear year but this is an assumption.
So if we have R297k saved in 5 years time, what kind of car can we buy? If look at it in todays money it equates to a vehicle that today costs around R230k. Not so great necessarily, but at least we know and we know how to do the calculations.
We can also add the future value of my current car that I could use as a trade-in. Thus, the kind of car in todays’ money that I would be able to buy is around R281,000.
Note – this type of vehicle may not be suitable for my needs so I may need to relook at my budget. Let’s keep looking at this scenario though. It gets interesting.
Making sense so far?
This is fun!
What car can I afford with financing?
Being fastidious and saving for 5 years will get me a car for cash, and one that’s around the R281k mark in todays money. But what about if I trade in my car for R70,000, use my R20,000 deposit, and get an instalment of R4,000 pm. What car can I buy then? (PS – also look at this post on how much car can I afford?)
Important note: This calculation excludes balloon payments, residual, or any other nonsense. You can make your money stretch with these loans, but that adds to the calculation complications! They also end up costing you so much more! Like loads more!
Let’s assume that I can trade in my car for R70k, use my R20k deposit, and finance the vehicle at 10% interest over 5 years.
Looking at the above simple financing calculation I can buy a car now for R278k, pretty much the same as what I could buy if I saved for 5 years.
But I can get it NOW! I mean that’s cool isn’t it? Why wait for 5 years?
Also, in my scenario of saving monthly, I am saving R4,000 pm and a deposit of R20,000. When buying a car with finance, I have the exact same out-of-pocket expenses. So it feels like it’s the same.
But is buying a car for cash or using finance the same?
Buying a car for cash vs using car finance
The thing with any kind of loan is that you can buy something now without having the actual money. That is cool. But what’s the catch? In the case of buying my new car, I can either save R4,000 pm or use it on an instalment. There is no extra money out of my pocket. So then why not use car financing?
I’m please you asked!
The difference is in fact where you are left in 5 years time.
In the scenario of buying a car for cash
In 5 years time I will
- be able to sell my current car for R51k (assume a 6% depreciation each year)
- have cash to buy a new car for R297k
- have a total of assets worth R349k
In the scenario of financing the car
In 5 years time I will
- have no cash available from my current car (I used it as a trade in)
- own a 5 year old car which has depreciated by say 6% year year, thus worth R204k
- have assets worth R204k
That’s close to R145,000 less!
That is the difference. What you have at the end of 5 years!
In fact, the difference is even worse when you do the calculations with say a R5,000 instalment per month, thus a more expensive car. Then you’re R180,000 worse off.
And interest rates, depreciation rates, and additional finance costs will all add to the numbers.
Flaws in my logic
There are a number of assumptions, things ignored, and flaws in these types of calculations.
- The increase in the price of the vehicle, and the general depreciation are very much based on the specific make and model. And mileage and condition you leave it in. So it’s hard to predict.
- One cannot put a value on peace-of-mind for your families safety.
- A new car will generally mean higher insurance premiums and more calculations.
- One could get a better interest rate for your savings, and one may get a better interest rate on financing. Or not.
- You may be in a position where you can structure the financing of a car to your benefit with a tax benefit. Possible but out of my realm of calculations.
- You have no idea what the future may bring.
Is it better to buy a car for cash?
The answer is a definite maybe.
Firstly, your circumstances may dictate that you need a car NOW. So if you don’t have the cash on hand, you will need to use car financing. As simple as that.
It’s not always about the number although you really should look at the numbers.
Generally speaking, car finance always leaves you worse off. Especially if you add on a balloon or residual payment, if you pay the car off over more than 5 years, and if you have a high interest rate and financing costs. Debt is expensive! Don’t be fooled!
In the financing scenario above where we buy a car for R278k, the interest portion totals R51,738 over the 5 years. That’s money you’re paying purely for convenience. There are also likely to be other fees. A monthly admin fee, insurance for your outstanding debt, an initiation fee, etc.
I often hear the argument about buying a car in a company, using financing, and expensing it to the company. Saving tax in the company and potentially saving VAT (if you are VAT registered).
This is very dependent on the company, what it does, the current financial state of the company, and whether a vehicle a truly a valid expense for said company. There is no guarantee that it will work out better doing this, you’ll need to ask an accountant who is familiar with this type of situation.
If you have the cash or are able to save up, it is generally better to buy a car for cash. You just need to be patient.
What do I do when buying a car?
Well, my previous 2 cars were bought cash. I generally keep a car until it’s falling apart and almost embarrassing to drive. My current car is certainly not at that state yet but it would be nice to have a bigger car.
Financial decisions are tough. Personal and emotional.
Right now, I’m still doing calculations.
Does this make sense? What have I forgotten? I’d love to hear your comments.