To finance or not to finance ...

[Gary Fowler]

In today's society, there seems to be a strong, almost default, tendency to finance purchases. Tractor purchases do not seem to be an exception. In my case in particular, a tractor purchase is (will be) largely a toy. Sure, it will save me time, and allow me to do things around my property I otherwise would not be able to do, but I have survived just fine without it for years, and could continue doing so.

The question, then, is if it is worth financing it to get said projects done earlier and enjoy the luxury of it, or should I wait until I can pay cash?

A simple analysis.

Lets assume a new tractor price of $30k.

Option 1:

I finance the entire purchase price at an interest rate of 5% over a 5 year period, I can buy my tractor now, but at the end of 5 years, I will have PAID: $33,968.22

So, it will have COST me $3,968.22 in interest.

Option 2:

I save $500/mo for 5 years, so that at the end of 5 years I have $30,000. But, as I save, I invest the money in a S&P500 Index Fund. Historically, the S&P500 has earned 10% interest, with 3% inflation. So, assuming a 7% return on my money, at the end of 5 years, I will have $35,799.00 (minus a negligible amount for management fees), yielding a PROFIT of $5,799.

It seems the true cost, therefore, of buying a tractor now instead of waiting 5 years, and then buying it, is $3,968.22 + $5,799.00 = $9,767.22!

That is money that I will never see again, and will never recoup in reselling the tractor, as it is lost in interest.

In other words, it's roughly 1/3 of the price of the tractor, which seems an incredibly steep amount for an item that is not necessary for my livelihood. I realize that down payments, interest rates, etc. will all affect the numbers, but in the end, I think it comes back to a statement I heard years ago. "Those that understand interest earn it, those that don't pay it."

Am I missing something? Why does it seem so many individuals finance tractors, then?

First off, I don't think your interest on stocks will make 7% average, mine sure don't especially after paying the investment fees. It seems that inflation is averaging about 5% per year on equipment cost and could significantly increase due to proposed import tariffs.
You not only don't get 5 years of use out of your tractor, but the purchase price increase is going to eat up any interest on saving that you may have.
If you have use for a tractor even part time, buy it now and enjoy it. If not, just save your money, hire everything done, pay the piper and go on your merry way. Personally, I enjoy the feeling of accomplishing a task done with my hands rather than with my wallet.

 

[TheFarmerInAdell]

One thing my dealer told me when buying my tractor (used, paid cash) is that new tractor prices will to go up 3% per year on average. I don't have the time or ambition to figure that into your equation, but keep that in mind if saving your money and waiting the 5 years. That 3% per year is on the full price of the tractor, where as the 5% is on the remaining balance of what you owe, not the full amount.

I cannot justify buying a new tractor as it is a tool for me and for the little use I do use it, I can very well get away with buying used. It may not be new and pretty, but it is a tool that will not always look new and pretty after use so why spend more? If someone can justify spending more for new, more power to them and congratulations! it just makes it better for people like me with more used equipment for the future.

When I was younger I financed everything. Now, I try to not finance. If I were to loose my job or something more serious happened I need to know that I (or my wife and children) can afford to live without worry.

 

[TheFarmerInAdell]

Also, typically the 0% offers have a higher price tag on the tractor than cash or other financing. I looked at the numbers for fun on MF tractors and I would only be ahead on the 0% if I were to take it out to 6 or 7 years. Before that the price difference of the tractor would outweigh the 0% financing offer. Check with the dealer on price difference of 0% vs regular financing. They're going to get their money either way.

 

[ViperDriver]

My cash is king right now in a new house build process. Finance now, keep cash available for other things. Pay off after closing.

 

[atsah]

I don't like to finance any items but if offered 0%, I do that instead of paying cash unless there are incentives for paying cash. If I didn't actually need a tractor I sure as heck wouldn't buy one though.. I don't consider a tractor a toy. If it's not a necessity I don't buy it..

 

[CMV]

Where is that $500/month going today? Where did it go last month? Where did it go Jan this year?

Your scenarios both start at $0. So where is this $500/mo for saving or tractor payment coming from and why is it not currently building up as savings?

And also no reason you can't do both - pay cash for some portion, finance remainder. That is what I did and had advantages - borrowed smaller amount at low interest not thru manufacturer finance arm so paid cash discount price, have smaller payments, if I needed to get out of it for some reason, not "upside down".

A slightly used machine, still under factory warranty, and a brand that has good local support network is great option too. Low cost, no sales tax (if applicable and buying from private seller), but still the peace of mind of warranty. I bought my first that way and got all my $ back out of it when I decided I wanted something larger.

 

[arrow]

You should be able to get a deal close to 0% if not 0% from the manufacturer. (Unless they have stopped those programs)
In addition as was pointed out your gain on the 5 year investment will have taxes on the dividends and or/cap gain so take off 20% for the government unless you fall into that bad category and then 23.8%. (Add another 7-9% more if your state gets involved)
The opportunity cost loss of not having it is big, unless you don't really need it and it is just a play toy, then I would not waste 30k on a play toy. But if you have projects that you are going to use it for then 5 years of back breaking labor on your body as it ages has a very finite cost to your long term health. Just because you are not a professional does not mean you don't have a real good reason to own and use one.

0% is simply a tactic to appear as borrowed money cost you nothing. An absolute fairytale. Proof? The price of the tractor will be more financing at "0" or if it stays the same, they are insuring that they are paying the financial companies with the residual with a high enough mark up. In other words you are not getting 15-18% off a tractor plus 0% unless the list for the tractor has been elevated as they do at some car dealerships.

 

[metalbender]

When my house in the city sold, looked at the new Massey 1742. When the cheque was in the bank, I ran to the dealer and stroked a cheque for the tractor. Money in the bank does't do chit, the tractor does real work. The 1/2 mile drive was a tad much for my little Case 446 blowing snow. There's no free money, zero % financing is paid for in the purchase. They smooth it over like a politician, and you don't even get a kiss. LOL

 

[arrow]

In today's society, there seems to be a strong, almost default, tendency to finance purchases. Tractor purchases do not seem to be an exception. In my case in particular, a tractor purchase is (will be) largely a toy. Sure, it will save me time, and allow me to do things around my property I otherwise would not be able to do, but I have survived just fine without it for years, and could continue doing so.

The question, then, is if it is worth financing it to get said projects done earlier and enjoy the luxury of it, or should I wait until I can pay cash?

A simple analysis.

Lets assume a new tractor price of $30k.

Option 1:

I finance the entire purchase price at an interest rate of 5% over a 5 year period, I can buy my tractor now, but at the end of 5 years, I will have PAID: $33,968.22

So, it will have COST me $3,968.22 in interest.

Option 2:

I save $500/mo for 5 years, so that at the end of 5 years I have $30,000. But, as I save, I invest the money in a S&P500 Index Fund. Historically, the S&P500 has earned 10% interest, with 3% inflation. So, assuming a 7% return on my money, at the end of 5 years, I will have $35,799.00 (minus a negligible amount for management fees), yielding a PROFIT of $5,799.

It seems the true cost, therefore, of buying a tractor now instead of waiting 5 years, and then buying it, is $3,968.22 + $5,799.00 = $9,767.22!

That is money that I will never see again, and will never recoup in reselling the tractor, as it is lost in interest.

In other words, it's roughly 1/3 of the price of the tractor, which seems an incredibly steep amount for an item that is not necessary for my livelihood. I realize that down payments, interest rates, etc. will all affect the numbers, but in the end, I think it comes back to a statement I heard years ago. "Those that understand interest earn it, those that don't pay it."

Am I missing something? Why does it seem so many individuals finance tractors, then?

You are coming from a direction that does not necessarily help you. You are looking at this as an "economics" lesson. Seems you're struggling attempting to justify a purchase. Answer this very basic question and everything else will be more clear cut: What do you need more of at this point in your life?

 

[RSR]

A couple of follow-up comments:

1) As a few (and surprisingly only a few) have mentioned. There is no such thing as 0%. The cash price should be (and my understanding is that it is - maybe I'm wrong?) always lower than the 0% financed price. If a dealer tried to tell me otherwise, I would walk.

2) If I already have the $30k, then I agree, if you can get the finance rate at lower than what you can make off of investing, it makes economic sense. However, for the sake of argument here, I'm looking at assuming starting from zero savings. So, each month, I'm saving $500 towards the purchase price, and investing that money.

3) There is no guarantee of stock market returns. 10% is the historical average of the S&P500. Average inflation is 3%. This is factored into the consideration by calculating returns based on a net 7% gain. Over the last 5 years, however, my retirement savings have averaged 15-20%/year (index funds). At that rate the difference would be huge. As to Jeff's point - yes, I'm wondering too when this Bull run is going to end. Probably sooner rather than later.

I ignored management fees, because on a Vanguard S&P500 index funds, the management fees are 0.14% (negligible). The comments about taxes were (kind of) correct. Capital gain tax rates are 15% (not 20%) unless you make over about $500k/yr. If I did, I wouldn't be having this discussion. So, subtract 15% off the investment savings.

4) The question of the tractor appreciating in price sounds like salesman speak to me. A used tractor may appreciate at about 3%/year (inflation) and the cost of the tractor will go up about 3%/year (inflation). But again, that is factored into my calculations by subtracting that out of the returns on my investment. (i.e. I assume I lose 3% each year to inflation, so my net return is 7%, not 10%). If someone can point me to concrete examples of a tractor selling for 3%/year more than the purchase price, please do. That seems like a worthwhile brand to consider. My admittedly limited perusing seems to be that you can often (on average) sell a JD or Kubota for what you paid for it, but to sell it for more at a rate of 3% seems questionable?

5) As Jeff pointed out, I can see some special cases where paying cash may incur a large tax burden that would outweigh the finance costs.

I guess the point is, you can play around with the numbers and it will shift them in favor one way or the other. But when it comes down to it, special cases such as Jeff's aside, if it's financed, you are going to lose money over paying cash. It's just a question of how much. For my case, I am amazed by how much that money really turns out to be.

Arrow - I think you get at the crux of the question. "What do you need more at this point in your life?"