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Pay Cash or Finance: What’s the Difference?

Money PictureWould it surprise you to learn that paying cash for a car or any other major capital purchase may not always be the most efficient way to purchase?

We have all grown up in America with the dream to be debt free, which is a good financial position to be in. However, there may be some confusion on what debt is and what it is not.

Debt is a financial obligation to pay for something that we have no collateral or no possible way to pay for except with future income we have yet to earn. If we get hurt or a long term illness that prevents us from working, our income stops and we are in trouble. If we have money in our savings and investment accounts greater than the value of our loan, we could pay it off at a moment’s notice or we could have even paid cash.

If the cost was exactly the same whether we finance the purchase or pay cash, which is the most efficient purchasing strategy?

Here are the details–Assume you have $30,000 in an investment account earning 5%. You could drain the tank and pay cash. Had you left the money in your account earning 5% your account would be worth $38,501 at the end of 5 years. So what did the car cost you over the 5 years if you paid cash? That’s right, $38,501!

What if you kept your $30,000 in your investment account earning 5% and financed the car at 5% with the dealer. At the end of the 5 years, how much did it cost you? $38,501. It costs the same whether you pay cash or finance it assuming the same interest rate!

Obviously, if you could pay less interest to borrow than you are earning in your investment account that would be even more desirable. But, if it costs the same to borrow the money from another institution as it does to pay cash, why not pay cash? The difference is if you pay cash you have a $30,000 car in the driveway and your savings account is down $30,000. If you financed it, you would still have $30,000 earning interest, access to your $30,000 and a $30,000 car in the driveway.

What’s the difference? The difference is control.

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