A loan or a self loan: Is there any reason I should ever take out a loan when I have that money in saving?
Is there any reason I should ever take out a loan when I have that money in saving?
Example: I have 20k in a house fund, and I want to spend 8k to buy a car?
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I maintain a strong bias against taking on any debt, of any sort, and I feel it serves me well. This is not to say I would never take on a debt, like a car loan, mortgage, or educational loan. It's just that there is a built in bias against it.
The reason that bias is good is that, in my view, taking on (unforced) debt presents the following problems:
Paying interest is paying money to someone when you really don't have to. (The obvious factor).
More to concern oneself about in life (for me, this matters. I like to keep my radar screen as clear as I can).
Possibility for problems (the lender acts in bad faith; computer error; human error, lost checks; credit dings; misunderstanding of terms; etc)
Danger of a debt crater developing if the future me acts irresponsibly. I don't think I'd do that, but I also don't know what other life factors might influence me or whether some challenge will weaken my future self.
Therefore, the standing no-debt bias.
That said, if there is a very compelling reason to take on unforced debt, it could override the bias. The best example I know is that my mother bought a house with a mortgage when she had the cash, because CDs at that time were paying far more than the mortgage interest rate (this was back around the 80s when CDs hit an absurd 18%!). To not take on that debt would be refusing free money! But that's a rare case. Today, CDs and other guaranteed interest streams are at historical lows, so this factor is really not in play.
There is no correct answer. It all depends on you.
If you have a fund dedicated to a purpose (house, car, daycare, vacation, etc), in my opinion you are best served by keeping it dedicated to that function in most cases.
Say that you find a home that you want to by in two years. If you have good credit and appropriate debt/income ratios, your car payment will not pose a problem to getting that home. But not having enough money for a down payment will.
I would use that money to buy a car instead of taking out a loan to buy the car.
It does however prompt the question: What do you want more a house or a car?
The way I usually make this decision is to answer the following question:
Do I think that I can earn a better
return on my savings than the interest
rate I would get on the loan?
Yes= Get a loan
No= Use the savings
If you have your savings in a fixed income investment like a CD or bond, then it is just simple math to answer the question, for more volatile investments like stocks you just have to make an educated guess based on the direction of the markets and past performance.
It depends on what your plans for the future are.. Taking out a loan is not a bad thing if it is at a good rate and under good terms and you are sure you can handle the payments. If you buy the car with cash you may be giving up the opportunity to later get a great rate on that k. However, you are probably not utilizing that k to make as much interest as you'd then be paying if you did take the k on loan.
Since you say "house fund" I assume you are saving to make a down payment on a new house. If you plan to buy that house within the next 6 months the hard pulls on your credit report from applying for the car loan will probably ding your credit score for the next 6 months which might cost you on your mortgage rate. However, if you don't plan to buy for a few more years and if you've never had a car payment before then the auto loan would actually be adding diversity to your credit history and in the long run would help your score.
Another factor to consider is the loan-to-value ratio you are shooting for. LTV affects the interest rate, requirements for private mortgage insurance, etc.. Mortgage rates are at an all-time low and lower than auto-rates, so depending on the terms of the house purchase that k might be better spent on the car than the house.
In short, if you want to buy the house soon (rates are loooow, market is a buyer's market), and you need that k to get a better mortgage rate or prevent you from being required to buy PMI you should probably put it toward the house. Otherwise you should probably put it toward the car.
Last piece of advice. If you absolutely must buy a house and a car in the same short time-frame, do them both on the same day so that your credit score is not dinged before applying for one or the other. With mortgages this may be difficult considering the longer closing procedures, but try to time it so that your credit is getting checked by the mortgage broker and the auto lender on the same day.
If you need / want the car, I would get the car. Without car payments you can save your money again to get the house. Moreover, I wouldn't want to be saddled with payments to the mortgage and car loan at the same time.
Lastly, a car is a more temporary possession (10 years) vs a house (30+) years so shopping around for the house longer while you save money is a good thing. I know you want to buy while prices are low, but I personally think it is more important to get a house that you want to live in later than settle for a cheap one you get a deal on now.
The only time it makes sense to take out a loan is:
You want to establish credit history.
You are able to get a better rate of return on your investment vs. the interest charge on the loan.
The drawbacks of these 2 points are:
The loan will most certainly have an interest charge unless you put it on a line of credit and pay it off immediately.
Most investments today do not pay rates of return better than the interest charges on most loans.
Otherwise it's better to pay for the car up front. You have not mentioned whether you need the car to earn income. A car will incur other costs such as insurance and maintenance.
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