Pay cash or finance a car?
Paying cash avoids interest, but the cash stops earning. Here is the total cost of each choice, and the return your money would need to earn for financing to come out ahead.
Financing only beats paying cash if your cash earns more than
7.23% a year
At 5% a year, paying cash comes out $2,328 ahead after 5 years. That is what a 7.0% loan really costs once monthly compounding is counted, so the deposit, term and period do not move it.
- Total cost, financing
- $61,583
- Total cost, paying cash
- $59,255
- Car value after 5 years
- $17,748
Your numbers
Total cost over 5 years
Everything each choice costs you, including what the cash would have earned had you not spent it on the car. Lower is better.
- Down payment $5,000
- Repayments $41,583
- Running costs $15,000
- Car price $40,000
- Running costs $15,000
- Opportunity cost $4,255
Where the money goes
| Item | Amount |
|---|---|
| Down payment | $5,000 |
| Loan repayments, 60 months$693 a month on a $35,000 loan. | $41,583 |
| of which interest | $6,583 |
| Maintenance and running costs | $15,000 |
| Total cost of financing | $61,583 |
| Item | Amount |
|---|---|
| Car price | $40,000 |
| Maintenance and running costs | $15,000 |
| Opportunity cost: growth the cash would have earnedFinancing keeps $35,000 invested at 5% a year, with each repayment taken out of it as it is paid. | $4,255 |
| Total cost of paying cash | $59,255 |
The car is worth an estimated $17,748 after 5 years whichever way you pay, so depreciation does not change which option is cheaper, and nor do running costs, which are the same on both sides. Tax, registration, insurance and dealer fees are not included.
How this calculator works
How does this pay cash vs finance calculator work?
It compares two ways of buying the same car with the same money. Paying cash spends the full price on day one. Financing spends only the down payment and keeps the rest invested, then pays each loan repayment out of that invested cash as it falls due.
At the end of the period, the cost of financing is everything paid to the lender plus the down payment and running costs. The cost of paying cash is the price and running costs plus what the cash would have earned had it stayed invested. Whichever total is lower is the cheaper choice.
What does the break-even investment return mean?
It is the return your cash would need to earn for financing and paying cash to cost exactly the same. If you can reliably earn more than that, financing comes out ahead; if not, paying cash does.
It works out to the true annual cost of the loan, which is a little above the quoted rate because interest is charged monthly. A 7% car loan costs about 7.23% a year. That is why the deposit, term and comparison period do not move it: financing only wins if your money earns more than the lender charges for it.
Why is the break-even return higher than my loan rate?
Because loan rates are quoted as a yearly figure but charged monthly, and interest on interest adds up. Investment returns are usually quoted as what you actually earn over a year, so the fair comparison is against the loan’s effective annual cost rather than its headline rate.
What is the opportunity cost of paying cash?
It is the investment growth you give up by spending the money on the car. If you finance instead, the part of the price you did not pay up front stays invested, but it shrinks every month as repayments come out of it. The opportunity cost is the growth that shrinking balance earns, compounded at the return you enter.
Counting growth on the full amount for the whole period, as some calculators do, ignores that the repayments have to come from somewhere, and makes financing look cheaper than it is.
What if the loan runs longer than the comparison period?
Whatever is still owed at the end of the period is treated as paid off then, and added to the cost of financing. Leaving it out would make financing look cheaper the shorter the period you chose, simply because less of the loan had been repaid.
How is depreciation calculated, and does it matter?
Each year the car loses the stated percentage of the value it has left, so it loses the most in the first year and less after that, and never drops below zero. The result is shown as the estimated value at the end of the period.
It does not change which option is cheaper. You own the same car either way, so it is worth the same at the end whether you paid cash or financed it. The same is true of maintenance and running costs.
Does it include tax, insurance or fees?
No. There is no tax, registration, insurance, stamp duty, dealer or loan establishment fee, and no balloon payment. Fees on the loan would make financing more expensive than shown; tax on investment returns would lower the return your cash really earns.
Are the figures adjusted for inflation?
No. Every amount is nominal, and running costs stay at the same amount every year rather than rising. Both options are affected the same way, so the comparison between them still holds.