Quote:
Originally Posted by silverlegacy
It is all in time value of money. A 3% inflation rate (slightly below average historically) makes your money worth less and less as time goes on. So in effect, a ~3% interest rate is offset by the fact that the present value of the car payment is nearly 16% lower 5 years in the future. Investing that money protects against the inflationary drop (CDs are ripoffs, there are better ways to invest your money that are extremely safe, liquid, and can still get a 4-6% return).
Don't get stuck on CDs here. That is the wrong way to look at the issue. The issue is sticking your money in something that loses 10% a year or putting your money in something that gains __% a year and pay off a loan that costs $X in interest per year. There is a crossover point where one is more advantageous than the other. It can vary greatly through the percentages and the years involved. So one person that gets a 1% interest rate on the loan for the car and can get 4% return on investment has a different answer than a person who gets a 6% interest rate on a loans, but can only get a return of 2%.
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Agreed, if you can get a return on your money that's higher than the rate at which you're borrowing, it's a no-brainer. I thought the original question was phrased based on crappy CD rates... If you've got a safe place (FDIC insured) to stick money that will yield better than 4%, go for it!!
I still don't see what the rate of inflation has to do with this calculus though... Can you show me the actual mathematical formula that shows where you're money ahead? I understand that the payment will be relatively less in 5 years due to inflation, but how it actually impacts your return is beyond me.
For example, here are my formulas (I used the 1.25% return, just to keep it simple). Perhaps you could add in the missing variables.
Option 1: I purchase the car with cash and every month, instead of making a payment, I deposit an equivalent amount into an account yielding 1.25%. At the end of the 5 years, I have a car worth say, $10,000, and I have $27,728 in cash.
Option 2: I borrow on the car, and invest my $25,000 at 1.25%. At the end of the 5 years, I have a car worth $10,000, and I have $26,608 in cash.
Add the inflation to my #'s, so I can see what I'm missing...