05 Jul Should I take a car loan or pay cash?

Q. If I’m purchasing a new car and can pay cash, especially since bank interest rates are so low, would it be to our advantage to take a zero percent five-year loan from the dealership and lose the additional $1,000 discount? We are currently earning 1 percent interest on our funds.
— Driver

A. Let’s do a little math.

First, you said you have the money available to pay cash but do you truly have a sufficient cash reserve?

Michael Maye, a a certified financial planner and certified public accountant with MJM Financial in Gillette, said he usually recommends individuals have six months to one year of emergency cash reserves. Your appropriate level of cash reserve will depend on your personal situation.

He said assuming you truly do have a sufficient cash reserve, it is better for you to take the $1,000 cash back.

That’s even with knowing that with the cash back offer of $1,000, you will still pay the New Jersey sales tax on the gross price of the car before the rebate is deducted, Maye said.

Therefore from a sales tax perspective, the sales price is the same whether you do the cash back or five-year loan.

So how does the cash back offer become the better option?

Maye said you need to compare the $1,000 versus the potential interest income you could earn over the five years on your money in the bank.

He said if you buy a $15,000 car with five-year zero percent loan, your monthly payments would be $250 month. In the first year, you’d earn roughly $135 of interest ($13,500 avg. balance x 1%) on your money in the bank.

“Over the five years, I project you would earn a grand total of $375 in potential interest income,” he said. “Remember as the loan balance declines, so do the funds you have an opportunity to earn interest on.”

He said the comparison of the $1,000 vs. $375 over a number of years is even worse if the time value of money is considered.

Bottom line, Maye said, is that if you really do have the excess funds, go for the $1,000 cash back.

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This post was first published in July 2016.