Before We Begin

Welcome back! Once again, before we begin, I need to make very clear that this is Part Three of a series of posts. If you have not read Parts 1 and 2, you will probably not understand what is going on.1

Click on this to get back to the first post, and lay the foundation for what’s to come.
If you’ve read that already, head on over to Part 2 and prepare for some interesting math.
And once you’re done, come right back here by clicking on “Next Post” at the bottom.

Very well! Onward!

What Are We Doing Again?

Okay, let’s get back on track here.

Remember that the original goal is to figure out if financing can be worth it compared to paying for something upfront. And the way we figure that out is by seeing how much money our not-currently-spent cash can make us.

Let me frame the issue, using the fees and rates we’ve been using until now – $100k loan, 5% interest, for 5 years, with monthly payments and compounding.

If I had a savings account, that had a 5% interest rate, with $100,000 in it, and I pulled my monthly payments of $1,887.12 from it, would the remaining balance generate enough interest to counteract the interest paid on the loan itself?

Let’s find out.

Coffee Break

But first, I need to figure out if there’s an equation that can help us.

Otherwise, I will just be doing 100,000 x 0.05 – 1887.12 x 0.05 – 1887.12…. until we’re out of money.

So, I’ll be right back.

Meanwhile, imagine that you’re relaxing on the ocean, rocking on the waves, as the sun comes up over the horizon.

Ahh So Relaxing

Ok, I’m done. You can come back now.2

And I’m just going to spoil it right away. Yes, it will be exactly equal.

Wait Really?

Let me re-frame it so you understand why.

If we’re paying off our loan every month, we are lowering the total of money that is generating interest, every month.

If we’re pulling money from our account every month, we are also lowering the total money that is generating interest, every month.

It’s the same thing! It doesn’t matter if the money is in our account because we put it there or we borrowed it from a loan. The math is even the same:

$100,000 x 0.00416667 – $1887.12

That is the math for the first month. The starting balance, multiplied by the monthly interest rate, and then minus the payment. Whether it’s the first month of your bank account or your loan, it’s the same.3

So What Was The Point

All of this was to prove that, in fact, that if you financed a car for $100,000, at a 5% APR4, and then you set aside $100,000 in a bank account that generates 5% interest per year, you will have bought that car for $100,000 total after five years.5

If you’re following, you probably realized something, which fully answers our original question.6

If the “savings account” you put that $100k into, had, say, a 10% APR instead of 5%. Does all this mean that you would have more money when all this is done?

Yes. $14,255.06, to be exact.7

Tying Loose Ends

If we go back to our Pros and Cons list from the first article, we can now add another Pro to the Financing side:

• If you invest your money in a high-interest account or asset, not only can you make back the money lost in interest, you can make even more money.

Especially if you’re financing something like a car that depreciates in value, you can come out ahead if you invest the money, because instead of locking all that money into an asset, you can make your money make more money.8

Now, you might be yelling that there’s no way you’ll find a savings account that gives you 10% APR. While that may be true, your money doesn’t have to be in a savings account. You can put it into a stock that climbs steadily, or even buy a property when real estate is going up. As long as you have income that can cover the cost of your monthly payments, or you can pull payments out of the investment tax-free, you’re golden.9 The idea is to make your money grow faster than your interest rate.

Conclusion10

I don’t know about you, but this journey made me entirely re-think the concept of financing and interest.

I used to tease my poor financing friends that they were wasting money for no reason. And while that still holds true for the person that doesn’t invest their saved money, it’s not as bad of an idea as I thought it was.

Thank you for coming along this ride with me, and I’m glad you made it to the end.

Here’s a cat for you.

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I know what you really want to do right now. You want to read this whole series over again. So here’s a link back to Part One!

You know what else I know? You loved this so much, you now need to know when my next scintillating post is coming out. Fortunately for you, if you sign up here, you’ll get an email when that happens!

After all this, are you still wondering how my brain works? Here’s a blogcomic that might explain it.11

Did I do some of the math wrong? Please let me know12 in the comments below.

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