This fact broke through my thick skull slowly, and late. Mainly because of my own low aptitude for, and devil-may-care attitude toward, arithmetic.Not long after I got out of college, I bought a new car. So, at the same time, did my then-girlfriend. She had a modest trust fund; I didn't. Because she got an extra $25k or so every year out of her trust fund, and was more frugal than me anyway, she had a lot of cash in the bank. I didn't. Unlike her, however, I liked cars, and knew a little bit about them. I was going to "help" her buy her car.
So off we went to buy our cars. The car I wanted cost $15,000 (this was back in the 1980s) and the car she thought she'd get cost $13,000. You know...I was older, I was the one who liked cars, etc., so it made sense that I'd be the one buying a somewhat nicer one.
First we went off to her dealer. The car my girlfriend wanted cost more like $14,000 once it was loaded up with some of the features she needed. It turned out that the next model up came with all the features she wanted (and more) as standard equipment. That model, normally more, was marked down to only $16,000 as a result of some sort of promotion the manufacturer was running at the time. (I'm rounding all these numbers off, of course). The salesman (no doubt after sizing her up as someone who was going to make a hard-boiled financial decision based on dollars and cents, rather than sentiment, emotion, and self-indulgence), pointed out that the better car would actually cost less than the cheaper one if she were going to keep it for four years or more, because better cars retain more of their value for longer—that is, they're worth more after you're done with them. It's called "residual value." So she eventually decided to buy the more expensive car, the one with the sticker price of $16,000.
Then the salesman asked how she was going to pay for it.
"With a check," she said. The salesman looked startled (she was quite young). "Assuming you can move a little on the price."
Well, move he could, and move he did. She ended up buying a "demo" that had all of 163 miles on it, for $15,000, give or take. Plus they didn't make her pay for the alloy wheels and the extra speakers it had, because she hadn’t wanted them and said she wouldn’t pay for them.
Okay. So, next, me.
We went to my car dealer and I looked at the $15,000 car I wanted. I could only put $1,000 down on the car, so I would have had to finance the remaining $14,000. I had already looked at my budget and decided what I could spend on a monthly payment. The salesman thought he could squeeze me in under my highest feasible monthly payment number if he could get me approved by the best finance company at the best rate.
I was a photographer at the time. Like most photographers, I tended to juggle money: clients had long billing cycles, and work went through dry times and flush times. Sometimes I paid my bills on time; other times I paid them early; and other times I paid them late. I thought "early" and "late" more or less balanced out.
Have I mentioned I knew very little about money and finance at the time? (Well, still, but let's stick to the point.) For the record, people who lend you money generally don't care about early. They do care about late. They care about that quite a lot, it turns out.
The salesman came back looking crestfallen. My credit, he said, was poor. Not only could I not get the best rate, but the best company wouldn't even loan me any money at all! I had to go with another company. The second company had standards that were more lax, but they also charged more.
That put the $15,000 car out of reach. I had to settle for the next car down—the economy model in the lineup—which cost $12,000. And the $12,000 car loan I needed (subtracting the down payment) would end up costing me another $3,000. Over time, of course; but still, that was the cost of the loan.
So are you getting what happened here? I bought a $12,000 car and a loan that cost $3,000. Both my girlfriend and I paid the same exact amount for our cars—$15,000. But because she could pay cash, she had leverage with her dealer. He cut her an especially good deal, and she basically got a bigger, nicer (and, to my annoyance, faster) car that normally sold for $17,000. A nice discount.
I, on the other hand, because I didn't have cash, and had poor credit, and needed a loan, didn’t have much leverage. For my 15 large, I had to settle for a smaller, cheaper, slower car worth only $13,000. And no discount.
Not only that, but then you have to factor in our respective residual values. By the time I'd paid my car off—five years—it was only worth about $5,000. At the end of the same amount of time, my girlfriend's car was worth nearly twice that much—almost $10,000.
So for the same actual cost, my girlfriend got to drive around in a much nicer car for five years, and ended up five grand ahead of me in the value of her owned asset. At the end of five years, she had enough residual value left in her car that it was painless for her to trade hers in on a new model. I didn't. I kept driving the old one. At least I could put one of those bumper stickers on the back that said something like "At least it's paid for."
Kept that car for nine years, it turned out, until one summer when it whacked me with large repair bills in each of two successive months and nearly bankrupted me. I sold it to a wholesaler for $500 in hundred dollar bills. Which went into the down payment for my next economy car / expensive car loan package.
I'm still in touch (occasionally) with that former girlfriend...but I don't have the heart to ask her what she's driving these days. (She's now a doctor in San Francisco.)
Like I always say, it costs more to be poor.
"Open Mike" is a series of off-topic musings that appear often, but not always, on Sundays on TOP.
CORRECTION: I had to go research, and modify, some of the numbers originally used in this post, because I wasn't remembering them correctly and several readers took me to task for it. I do remember the relationships between the numbers correctly, however, I'm reasonably certain of that. Because therein lies the story, and stories are what I remember.... —Mike
Original contents copyright 2013 by Michael C. Johnston and/or the bylined author. All Rights Reserved. Links in this post may be to our affiliates; sales through affiliate links may benefit this site.
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Featured Comments from:
John F. Opie: "The Brits have a saying: I'm too poor to buy cheap. Had to do with shoes (i.e., buying one pair of good shoes was less expensive in the long run than a series of significantly less expensive shoes) but it's the same principle.
"The real question is why you didn't get any financial education: I know I didn't. My folks taught me, though, that if you can't pay for it cash, then you can't afford it. Depression-era generation. Sure, the banks are more than happy to earn lots and lots of money off you: the question is why you want to let them do it."
Nikojorj: "As we say in French: on ne prête qu'aux riches (only riches get a loan). Indeed."
Steve D: "I play math games with my ten-year-old daughter (who actually enjoys math puzzles and games) about concepts like 'present value' of money. What costs more when figuring in different types of interest and 'opportunity cost' of spending. Stuff like, if Jane and John both have ten dollars and they both want blah blah.... It's too late for me to do much with the idiotic mistakes I've made over the decades but by god I'll be darned if she'll go into young adulthood ignorant about such things. Gluttony, lust and desire may get her the same as it did me but she won't have the excuse of ignorance."
Craig: "Actually, I think the point here is not that 'it costs more to be poor,' but that it costs more to live beyond your means—not quite the same thing."
Mike replies: The story above came from a never-published book manuscript, which included five or six different concepts and stories to illustrate each. The principle, which holds true across a broad spectrum of cases, is that if you have bad credit you will pay more for necessary loans, and if you need loans for large purchases you will end up paying more than if you don't—and generally get lower-quality goods into the bargain. All this story really illustrates is that if you can pay for something straight up you'll pay less for it than if you need to take out a loan to buy it, which I believe is pretty close to indisputable—? But I'm open to being corrected if I'm wrong.
JG: "If it's any consolation, it's my experience that paying cash for a car does not get one much of a price break these days. This is because the dealer (and its salespersons) factor the spiffs they will receive for arranging loans for their customers into deal. Deny them their spiff by paying with a check and their bottom-line price may well go up, not down! I've even had a salesman refuse to sell me a car for cash and insist I let him arrange a loan for me, which he assured me I could pay off without penalty after the first month. Needless to say, I passed on his 'deal,' which puzzled him greatly...."
Slobodan: "There is a conceptual error in your calculation. You take into account interest on your car, but you do not take into account so-called opportunity cost of your girlfriend's cash payment. You know, she would be earning interest on that cash, had she kept it invested in that fund she had. It is generally foolish to pay cash if your good credit rating allows you to get a rate well under a commonly expected rate of return on investment (i.e., 8–10% per year, long term). Perhaps by getting a good cash discount and other promotions she ended up better off anyway, but it is important to take the opportunity cost into account for apples to apples comparison. But, other than that, I agree with the gist of your post."