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I was involved in an interesting chat on Bogleheads a while back.  There was a new attending who had a $12,000 car loan at 5% he was considering paying off.  I told him this:

Quit buying cars on credit. Pay this one off ASAP and then keep putting the payments into a “car account.” When it comes time to buy your next one, you can use cash. There’s no reason for anyone, much less a physician, to buy a car on credit.

Another poster responded:

I disagree with the “no reason for anyone… to buy a car on credit” advice. Rates are currently low enough that some people could get a car loan, pay a relatively small amount in interest for the car, but end up saving much more come mortgage time because they were smart enough to build credit history. Since the OP [original poster] has no student loans, he probably has no other installment accounts, so the car loan is probably benefiting his credit score.

In response, I came up with 15 reasons why buying a car on credit probably isn’t a great idea.

1) You buy too expensive of a car

Basic transportation is available very cheaply. You can get a 10 year old economical commuter for less than $2K. The availability of credit encourages too much consumption.

2) Interest costs

Given that cash-equivalent investments are paying 1% or worse these days, even financing at 2 or 3% is costing you something, especially after-tax.

3) Finance charges

Cash buyers don’t pay them.

4) Smaller selection of cars to buy from

Guess what? If you want to come buy my car I’m not going to finance it nor wait while you dink around with a credit union. You better have cold hard cash. So that leaves you to go deal with those who are willing to either finance it or mess around with whoever you’re going to finance it through. That’s fewer cars to choose from.

5) Higher price

On the same reasoning as above, you can get a great deal from me if you wave twenty $100 bills in front of my nose. If you have to go down to Low Book Sales down the street, you’re going to pay more.

6) Credit Scores Are Stupid

A good credit score is so easy to get without doing dumb financial things that it is no reason to take on debt. How about buying your gas on a credit card and paying it off at the end of each month? That’ll give you a credit score you can get the best mortgage rates with after a year or two. Not enough credit lines? Get two cards and alternate them.  Too many of us worry about our credit scores anyway.  I hope to never need mine again.

7) Cash Flow Constrained

So you decide to borrow the money to buy your car so you can leave your cash invested. Guess what? You still have to service the debt. You’ve got to come up with a few hundred bucks a month. If your income drops or another opportunity comes up or whatever, that cash flow isn’t available. It’s best to have low fixed expenses and high variable expenses. Buying things on credit reverses that.

8) Living On Credit Mindset

If you finance your car, why not your TV, and your furniture, and your house, and your vacation and your kid’s college and borrow from your 401K etc etc etc.

9) Screw-ups

One missed payment not only hurts your credit score, but also tacks on additional fees. It might not even be your fault. Maybe your employer sent the paychecks out a day late.

10) Satisfaction of Living Without Debt

You don’t get to call in and scream “I’m debt-free!” on the Dave Ramsey Show.  Seriously though, talk to someone who has paid off their mortgage and ask if they’d take out another mortgage on the home at a very low rate.  Most won’t because it is so satisfying to live without debt in this world.

11) Insurance costs

If you own it you can go liability only. The bank wants you to fully insure it. And a more expensive car has higher insurance too. That cheap beater you could have paid cash for is dirt cheap to insure.

12) Registration fees

More expensive cars (the kind you go into debt for) cost more to register each year.

13) Sales Tax

Same drill. Paying cash encourages you to buy less. Less car, less tax.

14) Cars depreciate

It’s one thing to buy a house that you expect to keep up with inflation on credit. The longer you wait to buy a car (while you save the money) the cheaper that car gets.  In fact, the terms on auto loans are getting so long these days (5-8 years is not uncommon) that many buyers actually find themselves upside down on their loan.

15) Leverage Goes Both Ways

Many argue that they prefer to keep low interest loans and invest and hopefully earn on the spread.  It’s great when it works for you. But it works both ways. Here’s what Warren Buffett says about it:

By being so cautious in respect to leverage, we penalize our returns by a minor amount. Having loads of liquidity, though, lets us sleep well. Moreover, during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008.

Now I’m not a Dave Ramsey-esque extreme anti-debter.  I do understand that forgoing 401K contributions to pay off your 0.9% student loans might not be that wise.  But far too many people who plan on investing the money they would have used to pay down loans or buy a car never get around to it.  It’s a behavioral finance thing, and it’s an easy trap to fall into.

If those 15 reasons aren’t enough to convince you, feel free to buy your cars on credit. There are dumber financial things that most Americans do every day. But for a physician, who likely makes $10-30K a month, to have to take out a loan for a car, is what I call a negative status symbol. It tells me he has no idea how to manage money. He should be able to save up for an average used car in the same amount of time it takes to shop around to buy one.

What do you think? When is it okay to buy a car on credit and when is it folly?

Photo Credit: Stephen Hannafin, Via Wikimedia, CC-BY-SA