If I were purchasing a new car today and had the option to either pay cash or finance the car at 1.99% or less, I would seriously consider financing it. For the record, I doubt you will find many 1.99% car loans at the time of publication. According to Bankrate, the average 48-month new car loan APR was 4.80% as of October 17, 2018.
Although the risk of default is presumably lower if you have the cash on hand to pay off the loan at any time, things could still happen. You could, for example, become incapacitated and stop making payments.
My friends' cash-first mentality is the product of years of conventional wisdom telling them to avoid debt whenever possible. And in this case in particular, why would they want to pay interest to get access to an amount of money that they already have?
But when it comes do debt, as with many things, you need to learn the rules early so that you can break them once you've established good habits. Because the reality is that there is a cost to making a big purchase in cash, and it's a lot bigger than the interest my friends might pay on an auto loan they don't need.
Let's say that instead of buying in cash, they decide to put roughly 20% down for the car and finance the rest. We'll round the down payment here to $3,000, so they'd be looking for an $11,000 loan. Someone with good credit looking for a loan that size with a 60-month term would likely qualify for an APR -- or borrowing cost -- somewhere between 3.25% and 4.5%.
If their money earned closer to the historical stock market average of 7%, then their decision to finance the car and invest their cash on hand would net them several thousand dollars more by the time they paid the loan off.
So in the short term, there's a benefit to not buying the car outright in cash. But when you look at the long term, the numbers become staggering. That $11,000 figure I landed on before wasn't exactly arbitrary; it's enough for two people to max out their annual Roth IRA contributions for 2017.
I mentioned optionality before, and that's a luxury of having cash on hand. Building up thousands of dollars in savings isn't easy, so when the time comes to do something with it, it's always worth weighing the options.
Investing is just one way they could use they could use the cash. If they have existing credit card or student loan debt with higher APRs than the auto loans they'd qualify for, it might make sense for them to finance the car and pay down those other accounts with the money they've saved.
Before cashing out your 401k, we suggest weighing the pros and cons, plus the financial habits you could change to reduce debt. The right move may be adjusting your budget to ensure each dollar is being put to good use. Keep reading to determine if and when it makes sense to cash out your 401k.
Deciding to cash out your 401k depends on your financial position. If debt is causing daily stress, you may consider serious debt payoff plans. Early withdrawal from your 401k could cost you in taxes and fees as your 401k has yet to be taxed. Meaning, the gross amount you withdraw from your 401k will be taxed in full, so assess your financial situation before making a decision.
Having a 401k is crucial for your financial future, and the government tries to reinforce that for your best interest. To encourage people to save, anyone who withdraws their 401k early pays a 10 percent penalty fee. When, or if, you go to withdraw your earnings early, you may have to pay taxes on the amount you withdraw. Your tax rates will depend on federal income and state taxes where you reside.
There are a few ways to become debt-free without cutting into your 401k. Paying off debt may not be easy, but it could benefit your future self and your current state of mind. Work towards financial freedom with these six tips.
To avoid early withdrawal fees, consider taking out a 401k loan. A 401k loan is money borrowed from your retirement fund. This loan charges interest payments that are essentially paid back to your future self. While some interest payments are put back in your account, your opportunity for compounding interest may slightly decrease. Compounding interest is interest earned on your principal balance and accumulated interest from past periods. While you may pay a small amount in interest fees, this option may help you avoid the 10 percent penalty fee.
"Cash value in a life insurance policy can really come in handy," says Matthew Grove, who was senior vice president of New York Life at the time of this interview. "Our clients use cash value to pay for everything from household repairs to weddings to retirement. Unexpected health or household emergencies are where the benefits of the fast access to cash value really prove important."
Life insurance policies that build cash value can be complex, but many allow the policyholder to borrow against the policy or to withdraw cash permanently (a "surrender"), or to use the cash value to pay premiums, Grove says.
A surrender is a return of a portion of the premiums paid to that point, says Mark Teitelbaum, vice president of advanced markets at Equitable. Loans and surrenders are generally tax-free so long as the cash value is less than the total premiums paid to that point.
"Usually the ability to tap life insurance cash surrender values is built into the contract design itself when the life insurance company develops the product," Teitelbaum says. "Some products such as universal life have considerable flexibility. You might be able to withdraw cash values from the policy even when the contract is very young. Some types of contracts such as whole life may be less flexible and require a longer ownership period."
"When cash is taken out of a policy it will reduce the amount of death benefit, and if too much cash is taken out of a policy it might eventually not be able to remain intact, or "in force," in life insurance language," Teitelbaum says. "If that happens and there was any positive appreciation in the policy, where the cash value had grown to be larger than the premiums paid for the policy, it could result in a tax bill to the client."
Taking the funds as a loan can leave the policy undamaged, as the loan and interest can be repaid. Interest rates are typically lower than on other types of loans, and the interest payment adds to the cash value.
"If an individual is retired and withdrawing money from a qualified account (like an IRA or 401(k) to cover living expenses, it may make sense to minimize those liquidations in a down market by tapping cash value and allowing other assets to rebound in value," says Dave Simbro, vice president of risk products conviction with Northwestern Mutual Life Insurance Co.
A policy with cash value can be a major asset in the overall financial plan. If there's any chance you'll need to take cash from a life insurance policy, it's best to read the fine print and talk to the issuer and broker before your need is acute, as the wrong move can be costly down the road.
You may be able to supplement your emergency fund with a personal loan, especially if you have excellent credit and solid employment. Or take a credit line against your home equity that you use only if necessary. Homeowners 62 and older with substantial home equity are probably eligible for Home Equity Conversion Mortgages (FHA reverse mortgages called HECMs), which could put cash in their hands even if they have little income and shaky credit.
However, if you need to buy a home and have no other option to secure funds for a down payment, borrowing against your 401(k) can provide the necessary cash. What is a 401(k) account if not a financial resource to be used to the fullest? If you need access to that money to buy a home, that alone may be reason enough to use your savings now rather than at retirement.
If borrowing from yourself sounds attractive, you may be able to use your home equity instead of a 401(k) to access the cash you need. A home equity line of credit (HELOC) or home equity loan can offer a competitive interest rate and more flexible loan terms.
As you consider purchasing a car, you can work out the costs in a variety of ways. Most people rarely stop to think, should I finance a car or pay cash? Even if you have enough savings to pay in cash, you should compare your interest rate and savings return rate to understand if you're making the right decision.
Your attitude toward taking out a car loan may be more than just a logic-driven evaluation of pros and cons. Some families may have unconscious money mindsets ranging from "we never buy anything that we can't pay for in cash" to "substantial but strategic debt allows us to live the life we want." If you value the freedom of owning something outright, you are probably more interested in paying cash for a car. If you prefer to invest your savings and pay reasonable interest over time, then a car loan might be a better deal.
Most people agree that high interest rates create wastefully high costs. No one wants to pay high monthly payments that don't fit into your monthly cash flow. However, car loans are often offered in reasonable payment sizes for a reasonable term with a lower interest rate than other consumer debt. That is because they are secured by the vehicle, meaning that the lender has the ability to repossess the car if the borrower stops making payments. If you qualify for a good interest rate, financing your car could free your savings to be invested or spent elsewhere.
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