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Buying a Car With Cash May Not Be the Cheapest Way to Go

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author photo by Russ Heaps September 2015

Buying a car with cash could mean leaving money on the table. That's the opinion of the San Francisco-based consumer-advice firm NerdWallet. These experts suggest you might be hundreds or thousands of dollars better off using that cash to make a 20 percent down payment on a loan to purchase the vehicle and invest the rest.

How It Works

Here's how it could work, according to NerdWallet. Say you saved $25,000 toward buying a car. You go to your local Ford dealer and negotiate a good deal on a Ford F-150 XL pickup for a total of $25,000. Rather than writing a check for the full purchase price, use $5,000 of your savings as a down payment for a $20,000 loan over five years. Take the rest of your $20,000 and invest it somewhere, like an index fund with a history of high returns. Draw your monthly loan payments from the investment account.

If all goes according to plan, you would own your F-150 and still have some money left in your investment account at the end of the loan term, which in this case would be five years. The leftover money is the net return on your investment. You'd have never seen this money if you paid cash for the truck. You can think of it as found money or money saved on your vehicle purchase.

In a best-case scenario, NerdWallet's example has the buyer borrowing $20,000 at a 2 percent annual percentage rate (APR), while investing in an index fund with an annual average return of 7.7 percent. This would leave the buyer with $2,723 in his index fund at the end of the 5-year term of the loan. Even at 3.5 percent APR, the reward could be $1,784.

What It Takes

For this to work in your favor, you must qualify for a no-interest or low-interest loan. If you have $25,000 in savings that you can earmark for a vehicle purchase, then you have rock-solid credit, allowing you to borrow $20,000 for a 3 percent or lower interest rate. Some carmakers have their own lending subsidiaries, such as Ford Credit, which often offer low- or no-interest loans on their vehicles. Credit unions are another source of loans with below average interest rates.

Another must-have for this strategy to work is finding an investment that returns at least 4 or 5 percent more than the interest you're paying on the loan. NerdWallet recommends beginning an investment search with exchange-traded funds (ETFs) or index funds.

The Catch

There's always a catch. In this case, the return on investment isn't guaranteed. Just like investing in stocks, no matter the historic return of the investment you pick today, it could lose money tomorrow.

What It Means to You

Before following NerdWallet's advice, carefully research potential investments. Unless you're prepared to pay some of the loan payments out of your own pocket if things go wrong, this isn't a strategy for you.

This image is a stock photo and is not an exact representation of any vehicle offered for sale. Advertised vehicles of this model may have styling, trim levels, colors and optional equipment that differ from the stock photo.
Buying a Car With Cash May Not Be the Cheapest Way to Go - Autotrader