20/04/2020 0 Comments
Cash versus Financing – What option should you choose?
The assumption that paying cash for a large purchase like a car or home is automatically the best way to go is a bit flawed. If you're thinking about whether to finance a purchase or pay cash, this article is for you. When you are in the enviable position of having cash on
hand to invest or purchase something as expensive as a car, a boat, real estate or property in 2020, why would you willingly borrow money instead of buying the asset outright?
It may come as a surprise, but wealthy people do it all the time, especially when interest rates are favorable. The logic is simple: When you can borrow money at a lower interest rate than you can earn on money you invest, it’s cheaper to take a loan than to pay cash. Still, millions of people share the simple conviction that debt is to be avoided at all costs. If you’re one of them, it may be because you have experienced being over your head in debt. Otherwise, you might have seen this happen to someone close to you, and you know the toll too much debt can take. However, in Robert Kiyosaki's book "Rich Dad, Poor Dad". He suggestion was that even if you have enough money to buy an asset with cash, you would better get a loan, invest your money and pay your rates with the interests you get from your
investment. When your car is payed off, you will still have the invested money that keeps generating passive income.
Sometimes people feel better about spending large amounts of money if they can pay it off over time, rather than spending it all at once.
They tell themselves that they will come out ahead with their investments, or they will be earning more later, or some other story to make themselves feel better about overspending. If getting the loan is allowing you to spend more money on an asset than you would spend if you were paying cash, then you will not come out ahead by investing; you would be better off to spend a smaller amount of money now.
Important to consider when deciding between cash or financing is to consider the opportunity cost. This is the benefit, profit, or value of something that must be given up to acquire or achieve something else. Since every resource (land, money, time, etc.) can be put to alternative uses, every action, choice, or decision has an associated opportunity cost. Whether or not you pay cash for a large purchase or finance it, there are costs in addition to the price of the asset. When you finance, the cost is obvious: it’s the interest you’ll pay on the loan. When you pay cash, however, there is an opportunity cost in the future interest or investment returns you could earn from keeping that cash.
When buying a home, the benefits of paying cash for a home include; eliminating the need to pay interest on the loan and any closing costs, not having a mortgage could also negate a homestead exemption if you find yourself seriously in debt in the future. On the other hand, obtaining financing also has significant benefits; stretched a lot financially to buy it with your cash reserves, stretched a lot financially to buy it.
To sum up, there’s no hard-and-fast rule about how low an interest rate needs to be relative to your expected average annual return, normally a two percent differential starts to become attractive and a three percent differential or more makes borrowing extremely attractive. The best advice when considering whether cash or mortgage makes the most sense is to opt for the choice that gives you the bigger bang for your buck.