Help - Use Savings or Take Out Loan?

amethystcash

I'm looking for a bit of help to get my head round something. We will be thinking about buying a new car in the not too distant future. We have a couple of options open to us and any advice you can offer would be much appreciated.

We could take out a loan and use monthly interest that we get on our savings to pay back the loan (currently all our savings are annual interest so we would need to set things up differently).

Or we could withdraw money from savings and pay for the car with cash.

What I can't work out is which would be the best option.

I understand that with option 1 we would lose interest on the interest amount that is being withdrawn monthly (as that would have been left in the account and continued to accumulate interest) and with option 2 we lose interest on the amount that we withdraw from the savings account, but what I can't figure out is which one loses least and what other factors (savings interest rates/loan interest rates, duration of loan, etc, etc) we need to take into account to work this out.

Help!

Thanks

debbie42

The most obvious way is to compare the (APR) rate you would be paying on a loan with the (net) AER rate on your savings. So, for example, if you are earning, say, 6% on savings (4.8 net, if a basic tax payer), then any loan rate above that would be better paid first, leaving aside any loan t&c.

I'd consider keeping some savings aside as "emergency" money, too.

amethystcash

Debbie, not sure I explained myself well in my original post given your reply.

Thought if I used some figures:

We have £100k in savings and don't buy a car - we would continue to receive interest on the full £100k.

or

We could remove £25k from the savings to buy a new car paying for it cash. That way we would only receive interest on £75k. To compare with the option below we would need to know how long the loan payments in that option lasted for so that we could calculate comparable interest on £75k net savings. Once I know the loan period below I can work out how long to calculate interest on savings of £75k to compare it to the option below.

or

We could fund the car by taking monthly interest from our £100k savings and using that towards buying a car - ie take out a loan. That means that at 5% on our £100k savings we could pay back about £415 per month. If we wanted a £25k car how long would it take for us to pay back the £25k, assuming 6.9% interest on the loan. Once I know that I can work out what this option is going to cost me over the loan period.

Once I know this I can then work out over the correct comparison period how much money I would have if:

1. I had done nothing
2. I had bought a car using cash from our current savings and earned interest on a lower savings amount
3. I had bought a car by taking a loan and used monthly interest from our existing savings to fund the loan payments.

Then decide do I really want a new car, and if I do which of the options 2 or 3 would cost me less money over the appropriate comparison period.

I hope this makes sense.

CLAPTON

The correct way to do the calculation is to compare the interest rate you are getting (net of tax ) from your savings with the APR of the borrrowing.

If you get more from your savings then borrow the money, if you are getting less on your savings than wthe loan will cost then pay with your savings.

Almost certainly, it will be cheaper to use your savings.

You don't need to do any other calculation...it is as simple as that.

debbie42

amethystcash wrote: »

Then decide do I really want a new car, and if I do which of the options 2 or 3 would cost me less money over the appropriate comparison period.

2 or 3 are as I suggested, and as the other poster has. It's a straight comparison. The period of loan would make no difference unless, perhaps, you were taking the cash from an account that has penalties for withdrawing early, say.

As for 1 and deciding whether you really want a new car, then that's a completely different question.

bryanb

Don't forget that a cash buyer can often negotiate a better discount.

QTC

The previous posters have said it all, just about..To make the loan option worthwhile, you'd need to find a loan deal charging a lower interest rate than your savings are earning..which is unlikely.

amethystcash wrote: »

...

That means that at 5% on our £100k savings we could pay back about £415 per month. If we wanted a £25k car how long would it take for us to pay back the £25k, assuming 6.9% interest on the loan. Once I know that I can work out what this option is going to cost me over the loan period.

.

I've got a spreadsheet that works out loan repayments. You'd have to double check this, to make sure it's right, but it tells me that, for a loan of £25k, at 6.9%, monthly payments of around £411 would pay back the loan and interest in 6 years 3 months. On your £25k, you'd pay £5847 interest.

A lot of bank sites have savings interest calculators which help to make comparisons. http://www.smile.co.uk is an example..look under savings and then savings calculators.

amethystcash

Thank you to everyone who has responded. Obviously I was making things a lot more complicated for myself than they needed to be!