Buy or finance using borrowed money?
June 22, 2010 11:29 AM   Subscribe

Math nerds, help! I need to figure out what's the better option for acquiring a car using borrowed money.

So, I'm looking to buy a car. For argument's sake, let's say it's priced at $10,000. I have a line of credit at a very low rate of interest, 2.5%, and no cash otherwise. Does it make more sense to buy the car outright for the purchase price, or finance it (let's say at 2.9%) to avoid accruing more interest charges on the LOC? My intent is to totally pay off the LOC in 2-3 years using investment income.

I love math, but I can't quite wrap my head around this one...
posted by greatgefilte to Work & Money (9 answers total)
So your choices are:
Borrow 10,000 at 2.5% from the LOC, or
Borrow 10,000 at 2.9% from the car financer?

It's dead simple, choose the lower interest rate LOC. Unless I'm missing something.
posted by PercussivePaul at 11:33 AM on June 22, 2010 [1 favorite]

Yeah, from a math POV if the only variable in your decision is the APR (principal and length remain the same) then go with the lower rate. However you should consider if using up your LOC would eliminate all your emergency funding or not. If you're relying on having that LOC available if there was a high priced emergency then it may be worth the extra 0.4% you will be paying to have the LOC available.
posted by msbutah at 11:39 AM on June 22, 2010

Response by poster: Sorry, maybe I wasn't clear, but whichever way I do things, the money will be coming from the LOC. My question was whether it's better to buy the car up-front and start interest charges immediately, or to finance it using the LOC to make the payments.
posted by greatgefilte at 11:44 AM on June 22, 2010

You will be paying interest either way, so you should choose the lowest rate, which is the line-of-credit.

My question was whether it's better to buy the car up-front and start interest charges immediately, or to finance it using the LOC to make the payments.

You will start interest charges immediately no matter what you do. The question is, are the interest charges going to accrue against the balance on your line of credit, or against the balance on this hypothetical car loan? If you get a car loan, and pay it off by drawing on the line of credit, you will simply shift the balance from a higher percentage rate to a lower one, which just means that you will be wasting slightly less money over time. If you have the choice of starting with a lower rate from the beginning, that's what you should do.
posted by Mars Saxman at 11:51 AM on June 22, 2010

If it was me, I would definitely take the financing. It's money being lent to you at a very low interest rate.

If you max out the LOC, a) your line of credit is maxed out. If an emergency comes up, or you just want to buy something else, you may have to borrow at a higher rate. and b) Your credit score will take a not-insignificant hit from using that much revolving debt.
posted by drjimmy11 at 11:51 AM on June 22, 2010

(In my own experience, real-life financial decisions like this are almost never about pure math, because you can never anticipate when something unexpected will come up.)
posted by drjimmy11 at 11:53 AM on June 22, 2010

The only advantage I can see is that if you default on a car payment, they come and get the car, and that's it, where if you default on the LOC payment, things will be worse. Also, what guarantees do you have that the LOC will not change in the future? Betting on the investment income is fine, but what happens if you don't get it?

Further, car dealers will often change the base price depending on how you plan to pay for it, for just this reason -- make it more attractive to go through their service. Use that against them during the negotiation. "I can give you cash right now, or you could drop that interest rate to 1 percent, or knock a grand off the purchase price."
posted by Etrigan at 11:55 AM on June 22, 2010

Best answer: Using $10,000 as the amount, and paying it off in two years, I calculate the following total interest payments for the two cases:

1) Borrow $10k from LOC @ 2.5% to purchase car, make no payments for two years, then pay all at interest $512

2) Finance at 2.9% with $0 down, make payments from the LOC for two years, then pay down the LOC at end of two years. Interest on car financing $305, interest on LOC $273, total interest $578.

So it looks like it would cost you $65 more to use case 2.
posted by dabug at 11:59 AM on June 22, 2010

Option C, none of the above. Save up $1000 or $2000 and pay cash for a clunker. When you get the income from your investments you can upgrade...with cash of course.
posted by MsKim at 3:10 PM on June 22, 2010 [1 favorite]

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