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Americans aren’t bashful when it comes to borrowing money to buy a car. About 85% of buyers take out financing to cover their new ride, according to Experian Automotive. But suppose you’ve?enough in the bank to pay in cash – would be that the smartest move? Or does financing the acquisition with today’s low interest rates and investing your hard earned money within the stock market make more sense?
To answer those questions, NerdWallet crunched the numbers for any hypothetical consumer: A buyer with sufficient savings to invest $25,000 on the F-150 XL pickup, which is area of the Ford F-Series, the best-selling type of vehicles within the U.S. In our scenario, the buyer?would spend $5,000 of the profit the checking account around the truck and take out a $20,000 five-year loan at a 2% APR to pay for the rest. When looking for a loan, make sure to shop around to find the best?APR – lending institutions will frequently provide the lowest rates.
The buyer’s remaining $20,000 would be invested in a catalog fund that tracks Standard & Poor’s 500 index, with a 10-year annualized rate of return of seven.7% by July. The buyer would then take money from the index fund every month to make payments around the car loan.?
So where does that leave the customer? After make payment on final loan installment and factoring in capital gains taxes, the customer could be left with about $2,723 in the fund, or an 11% savings around the price of the brand new pickup.
A few words of warning
Not everybody is able to afford to purchase a brand new car in cash. As well as for those who can, the peace of mind that accompany being debt-free might be more valuable than the potential payoff of taking out a loan and investing in the stock exchange. Others might not mind the danger and extra legwork of getting financing and buying a fund, so long as the potential return is substantial. ?
There exist several caveats that needs to be mentioned: First, past performance from the stock exchange isn’t a reliable indicator of future performance. Should the stock exchange nosedive, you can lose much of your investment, and you will be on the hook for the $20,000 loan.
Also, consider the annual percentage rate in your loan carefully. The lower the annual percentage rate, the greater you will save over the lifetime of a five-year loan. However, there aren’t any guarantees on how the stock exchange will work. Despite a low APR, the risk of investing might not be worth it.
Check the chart below to determine how the APR could affect the potential savings, assuming the S&P 500 were built with a 10-year annualized rate of return of seven.7%.
|Auto loan APR||Five-year potential savings|
You may also choose to leave your $2,723 in the index fund for another five years. Of course, the value of your investment could fall, but assuming the 10-year annualized rate of return of 7.7%, that would bring it to $3,997. Stretch it to twenty many it might grow to $12,639. That’s enough to cover a lavish family vacation – or another car.
Victoria Simons is really a senior analyst covering loans and insurance for NerdWallet.
Infographic by?Jazeena Pineda.
Image via iStock.