Would you borrow at 1.8% and invest in a guaranteed 10% investment? It seems like a silly question. It’s kind of like when USAA offered me a 3% cadet loan and was also offering 5% CDs. An FDIC guaranteed 2% spread: a no brainer right? I took the cadet loan and invested it in CDs, the S&P 500 (SPY), and paying down higher interest student loan debt.

At the time, I just had too much of my monthly paycheck going towards servicing my student and cadet loan debt. After 3 years of committing 50% of my pay towards my debt, I paid off the cadet loan two years early. I’m still working on my student loans. Only $23,000 to go! My goal is to be done in the next two years, before my 30th birthday.

Trading the 2002 Saturn for the 2015 Mazda 3

That was 2010-2013 and now it’s 2015. A few promotions later, I’m now a captain (O-3) with a wife also working. Being DINKs (Dual Income, No Kids) is the perfect way to accumulate a stack of Benjamins for financial independence. It also allows us to start looking at getting rid of the 140,000 mile 2002 Saturn L300 that always seemed to cost us about $1500/year in repairs and didn’t get great gas mileage (24 mpg three year average).

We were putting away $300/month to cover auto insurance and repairs, and also to save for a new car. After three years, we had $1000 to show for it. Not very impressive. The Saturn sucked up a lot of the money in repairs and gas. This is what convinced us it was time to start looking for something better. (If you’re still living paycheck to paycheck, not maximizing your Roth TSP contributions, or haven’t gotten your financial house in order, don’t even think about a new car! Start with used and start saving.)

Before my last deployment, my wife and I were out car shopping. After looking at a few new and used cars, we decided on the new 2015 Mazda 3 i Touring hatchback. Taking a break from used cars for a bit made sense to me only if I drove this car for the next 10-15 years. The car comes with lots of fancy standard features. Some reasons we liked the Mazda:

• Bluetooth, HD radio, fuel economy monitoring, fog lights
• Blind spot monitoring and backup camera. Definitely a luxury, but nice to have backup on crowded highways and tight city parking spots.
• 30 mpg in the city and 40 mpg on the highway
• Comfortable and minimalist interior
• Small size which makes it easier to park in the city
• 5-star crash test safety ratings, lots of airbags, and a very survivable vehicle

“My Wife Looked At Me Like I Was Crazy…”

After test driving the Mazda 3, my wife and I started talking about how we were going to pay for the car. I said we should save up over deployment and pay cash for it when we get back. My wife looked at me like I was crazy:

“Let me get this straight,” she said, “You want to take $20,000 out of our investments and put it into a depreciating asset. Alternatively, you could invest $10,000 in the stock market and make about a 7% return and $10,000 into the SDP and make a guaranteed 10% return. How does borrowing money not make sense?”

I tried to argue for a while about the benefits of never having a car loan but I realized I was being illogical. I had been brainwashed by Dave Ramsey. She was right. When USAA is offering auto loans at 1.79% and I can get a 10% guaranteed return in the SDP, I really shouldn't be paying cash for a new car. I could essentially borrow at less than 2% (below inflation!) and invest my money and pocket the spread.

After negotiating a great out the door price (better than TrueCar) of $20,880, we decided to go with a 3 year loan resulting in payments of $600/month for 36 months. If we take the full 3 years to pay it off, we’ll pay $581 in interest. If we keep our SDP going for the same period of time, we’ll earn $3000 in interest, resulting in over $2400 of spread. If I miss a 90 day period in a CZTE (Combat Zone Tax Exlcusion) area, then I’ll have an extra $10,000 payment to make on the car.

Advantages to Financing a Car

1. You keep your money working for you. This is the best reason I can come up with. Instead of dumping $11,000 in a depreciating asset, you can instead max out your Roth IRA accounts for you an your spouse, max out your SDP, or get over 50% of the way to maxing out your Roth TSP.
2. You can get dealership rebates to decrease the out-the-door-cost of your new car. Most dealerships offer some kind of rebate if you finance through their lending service. While their rates are normally awful, most loans have no early payoff fees, which means you can refinance at any time to a better rate. I’ll get more into refinancing an auto loan in a future article.
3. Many car companies offer 0% financing, zero money down, or a few months of no payments. If you have 0% financing, it’s pretty easy to find an investment that will return more than that. If you have a few months of no payments, this will give you time to build your savings to invest or to make a large initial payment on the car. Don’t squander this time! If you’re not disciplined enough to save for your upcoming expenses, you’re probably not financially mature enough for a car loan.

The One Rule You Must Follow When Buying a Car on Credit

While I normally abhor consumer credit, especially for depreciating assets, I make an exception for car loans. My new one rule for car loans is:

You must have the cash readily available to pay off the car loan and you must be making a decent return on that cash.

By readily available I mean in a CD, SDP, or Treasury bond. Not in stocks or bonds because their return is too fickle as we have seen in recent economic crises. It must be in a government secured investment. By decent return I mean whatever spread above your auto loan you feel is worthwhile.

For me, a 10% guaranteed return in the SDP is worthwhile. If I was getting 5% in a CD, that may be worth it as well. A 3% return on a Treasury bond? Probably not worth the 1.2% spread, at least to me. You’ll have to decide what’s a worthwhile return for yourself.

In the right financial situation, borrowing money for a car can make sense. But always leave yourself an out. Don’t take on too many payments at once. My new rule should keep you from getting into too much trouble. I always highly recommend paying cash for a used car until you’ve got your financial house in order, especially if you’ve just recently joined the military. If you do buy a new car, plan to drive it for the next 10-15 years.

Reader: Do you think you should pay cash for a car or do you finance it? Any proponents of leasing?