Three ways to own a car

I ended the last post promising to talk about the thing that quietly eats your months of "no". The app, the instant approval, the easy monthly payments.

I'm going to keep that promise, and I'll start with the perfect example.

I knew someone who changed cars constantly: before they'd finished paying for the one they had, they were already looking for the next one to finance. And every single month that car cost them more than it lost in value, because on top of the depreciation you had to add the interest.

They were burning through their months of "no" and they didn't even get to keep the car. And that's what bad debt is: the difference isn't the interest rate, it's whether you're left with something when you finish paying, or just the memory of it.

So far, the post I promised you

For years I thought debt was bad, full stop. So when I bought my car I paid cash, without ever stopping to wonder whether there might be a better option. I felt like a financially clever person for about three weeks, which is roughly how long it took for the penny to drop.

The money I paid for that car wasn't sitting idle in an account. It was on a peer to peer lending platform paying me 7.5% a year. In case it doesn't ring a bell, that means lending your money straight to whoever needs it in exchange for interest, with no bank in the middle. In my case, to people doing property deals. It was a temporary thing: I'd rather keep my money in index funds.

To pay for the car in one go I had to pull that money out of somewhere it was working and put it into an object that starts losing value the day it leaves the forecourt. So it didn't cost me £19,000: it cost me £19,000 plus everything that money was going to earn while I slept.

And that's the crux of it. If I'd paid monthly, that return would have covered part of the payment. What I was calling "not getting into debt" was taking my money out of somewhere it grows and putting it somewhere it shrinks.

So I did the maths to settle the question: three different options, and what would have happened with each of them after four years.

• Option 1, paying cash, which is what I did. I paid £19,000 for a second-hand Toyota Yaris that was a year old. I had it valued at the dealership a year later and they'd give me £17,000 for it, less if I took my time thinking about it. So that's £2,000 of depreciation in a year, £166.67 a month. Add the £118.75 a month of return I stopped earning, and owning it cost me £285.42 a month that first year. At the end of the four years I'll still have the car and nothing on the platform. For a five-year-old Yaris, a dealer currently pays between £7,500 and £11,500, depending on the state of it.

• Option 2, leasing. The same car costs £285 a month on a four-year contract with one month as a deposit. The payments would have come out of the £19,000: after four years I'd have been left with £9,558 and I'd hand back the keys. No car.

• Option 3, financed through the dealership. Nothing down: £351 a month for four years and then £7,500 more and the car is mine. The payments would also come out of the £19,000 invested, which would keep earning. After four years I'd have £5,895 left but I'd have to pay £7,500. I'd end up £1,605 in the red. With the car, mind you.

Against leasing there's no clear answer: if the car is worth £11,500 after four years, paying cash wins by around £1,900; if it's worth £7,500, leasing wins by around £2,000. And you never know that in advance.

Against the finance deal, the better option is obvious: I keep the car either way, but paying cash wins by £1,605, about £33 a month, whatever my Yaris turns out to be worth at the end. And it wins for a very specific reason: that finance deal worked out at 10.2% a year while my money was earning 7.5%, so I'd have been borrowing at a higher rate than I was being paid. Which is where the rule I'd never thought of comes from:

Compare what the finance costs you with what your money earns. If the loan costs less than your money generates, financing is worth it. If it costs more, pay cash.

But there's a catch in all my reasoning: the interest on a loan is something you know from day one. The return on your investments is only an expectation.

The question I never asked

The rule above is just the small version of a bigger question: what is my money doing while I pay for this?

And I only half answered it. I checked whether my money earned more than the loan cost, which is already more than I used to do. But there's a better answer I never even considered: that the thing you buy does the working. That the car pays for itself. I tried it with mine and couldn't, for reasons specific to the city I live in, but it changes the question entirely: from "how do I pay for this car?" to "can this car pay for itself?". That's what the next post is about.

Because months of "no" aren't bought by saving. They're bought with assets: things that put money in your pocket.

Worth saying that not every decision is made on money. With a small child, having a car is enormously convenient.

Freedom isn't given. It's built.