Car buying and financial ratios - what do Bogleheads do?

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Car buying and financial ratios - what do Bogleheads do?

Postby C319 » Fri Jan 07, 2011 7:04 pm

Greetings everyone. Long time reader, first time poster here. This site is the best source of unbiased investment information anywhere as far as I'm concerned. Keep up the great work, folks. I searched the archives and couldn't find what I was looking for, so here goes:

My daily driver is a very reliable Toyota sedan with 120K miles worth $6K , and I've got the itch to "upgrade" to a used Lexus for about $35K.

I'm 43, household income $300K+/yr. Debt: -$300K mortgage. Besides my daily driver we have two cars (wife's used Lexus and a classic sports car I rarely drive) so would have $85K tied up in vehicles if I buy the LS460.

While I realize that on paper our income/car (22.3%) and net worth/car (5.7%) ratios probably look okay, I've never spent this much on a car that I was going to drive every day (and depreciate in the process), so it just seems like a lot of money to be spending on some wheels. I've always followed Dave Ramsey's rule on cars (less than 50% of income) and/or tried to keep vehicles to less than 4% of net worth. I'm a saver and my wife says I need to relax a bit. I don't know.

I'd like to hear what folks on this board think are some good rules of thumb on car purchases, and also some limits. It seems like regardless of one's income or net worth there's a limit to what's reasonable to spend on something that goes DOWN in value faster than a rock. I look forward to your responses. Thanks!
Last edited by C319 on Sat Jan 08, 2011 2:57 am, edited 2 times in total.
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Postby norookie » Fri Jan 07, 2011 7:11 pm

:D When I was young , stupid, and burning money I purchased a italian sports car. You have a "sunday driver" per your OP. Buy transportation. Then when your retiring you can buy a nice "ride". :wink: JMO
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Postby bottlecap » Fri Jan 07, 2011 7:24 pm

Man, I think you're nuts. :wink: Dave Ramsey's rule is not for people with high incomes. That said, it's your money and you can afford it. $35k is not outrageous, either. I just enjoy trying to drive my car forever...

Good luck,

JT

P.S. My rule of thumb is never buy a car that ever, at any point, sold for more than $35k. Indexed for inflation going forward, of course.
Last edited by bottlecap on Fri Jan 07, 2011 7:27 pm, edited 1 time in total.
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Postby Chuck » Fri Jan 07, 2011 7:26 pm

It's been said before that this is not the Suze Orman forum, and you don't have to get approval from the frugal police. :)

$38K will buy you a LS460 now, or $180/mo of income at retirement*. Just choose which one gives you more utility.

* Assumptions: retirement income in 2011 dollars at age 65 after investing at 2% real.
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Postby ElJay » Fri Jan 07, 2011 7:40 pm

This forum may be unbiased when it comes to investing, but it has an extreme bias against nice cars. :lol:
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Postby edge » Fri Jan 07, 2011 7:54 pm

Wow, Lexus resale values seem to have fallen through the floor unless that 35k LS460 has a billion miles on it. Remind me to never buy one new.

Anyway, 35k is not very much at all given your income.
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Postby Leesbro63 » Fri Jan 07, 2011 8:25 pm

C319, I've been a Lexus "LS" driver for many years. One thing to be careful about is if you live int he snow belt. Unless you get a 2009 or later AWD (they didn't make them with AWD till '09), you may be in for a shock. The cars are AWFUL in snow.

That being said, the LS is the finest mass produced car in history, IMHO.
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Postby jsl11 » Fri Jan 07, 2011 8:28 pm

Before you buy the used Lexus, check out a new Camry XLE. You can get a fairly high level of luxury, a new car (rather than a 2008), and save 10K besides. IMO, the performance of the 4 cyl is so good, you don't need the 6 cyl. You have to test drive one to appreciate it.

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Postby Leesbro63 » Fri Jan 07, 2011 8:37 pm

No comparison bet eventhe top Camry and ANY Lexus LS
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Postby Flashes1 » Fri Jan 07, 2011 8:53 pm

My everyday car is a Chrysler 300 with 105,000 miles, and while it's a very lovely car..........My dream at 42 yrs old is to buy a Porsche 911 Carrera. The 2007 model goes for roughly $55,000......I'm thinking in the next five years I'll get one..not a big fan of the sterile/lifeless Japanese cars....only American (german too!)...use as a weekend car. Delayed gratification is the best.
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Postby tludwig23 » Fri Jan 07, 2011 9:21 pm

Unless there is something you're not stating, e.g., you have 6 children about to enter college, you can easily afford a $35K car on your income/assets--as I'm sure you already know. You really just need to decide if this is what you want to spend your money on. I drive a 1999 Mazda Protege with 173K miles on it, which my wife sarcastically refers to as my "fancy doctor car," but spent $8,000 on a carbon fiber bicycle. To each his or her own.
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Postby C319 » Fri Jan 07, 2011 9:22 pm

Appreciate all the thoughtful replies so far.

Chuck, you hit the nail on the head...I don't just think of the cash outlay today, but the net present value of a future retirement income stream. That's why I've never owned a new car, and somewhat bothered by the concept of spending $35K on a used one to drive to work, although technically I guess I can afford to.

Edge: Clean 2008's seem to be selling for more than $35 right now. To clarify, I'd planned to save up cash from monthly income until the 2012's are out - so am basing my target price of $35K on what a clean 2007 is worth on auction today. The 2008/09's haven't depreciated quite that much yet as far as I can tell but should move down the scale when the next model year rolls out at year's end.

jsl11: I agree the Camry XLE is a wonderful car. Right now I have an old Avalon and would like my next car to be at least that size, so I probably wouldn't consider it. Not trying to start a "water propulsion contest", I simply like the LS better than the Camry.

Leesbro63: Snow is not much of a problem here in south Tejas, but good info to know for when I travel- thank you.

Flashes1: My "other" car is a classic 911 Turbo - bought it used seven years ago and still worth about what I paid for it. Best driving car I've ever owned and one of the most reliable to boot. I've had several P-cars and two Prancing Horses over the years, and I think Porsche is the best sports car. I hope you do get yourself that Carrera - you will love it.
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Postby Cherokee8215 » Fri Jan 07, 2011 9:35 pm

Buy the Lexus and keep it for 5+ years. You can afford it, and the per-year cost of this used vehicle will be fairly reasonable over time.

You obviously want it, otherwise your guilty conscience wouldn't have made this large post to get the cheapskates on this board to talk you out of it. :wink:
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Postby edge » Fri Jan 07, 2011 9:49 pm

jsl11 wrote:Before you buy the used Lexus, check out a new Camry XLE. You can get a fairly high level of luxury, a new car (rather than a 2008), and save 10K besides. IMO, the performance of the 4 cyl is so good, you don't need the 6 cyl. You have to test drive one to appreciate it.

Jeff



Um, the Lexus LS has a 4.6 liter V8.
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Postby C319 » Fri Jan 07, 2011 9:51 pm

tludwig23 wrote:Unless there is something you're not stating, e.g., you have 6 children about to enter college, you can easily afford a $35K car on your income/assets--as I'm sure you already know....


Just one small child, no other hidden liabilities that I know of... LOL!...

Point well taken, and yes, I know I can buy it, just not sure that I should, or will. My question was asked out of curiosity - to get data points from a group of people who I collectively admire, and who seem to think differently than our consumerist society.

Our family and friends all believe that we have a LOT less than we do, because we are pretty frugal and generally don't show it. Most are deep in debt (but with high lifestyles) and any talk of savings or investing is met with a doglike-head-tilt blank stare. Based on reading old posts on this board, I know many of you can relate to this.

Truth is, I have very few opportunities to talk about this stuff in real life without some weirdness resulting from the conversation, so I figured I'd ask here. I'm not so much looking for confirmation (or permission), just data and alternate points of view, which I'm getting. Thanks again.
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Postby epilnk » Fri Jan 07, 2011 11:04 pm

So buy it already - you want it and there's no reason not to. It doesn't really matter how fast cars go down in value because they're consumption items, not investments. You won't have $85K tied up in vehicles, you'll have spent that much. That's a lot, so if you can find a cheaper car that makes you happy buy that instead. But $35K is just not that much to spend on a car that is going to be your main transportation for 10 years; it's a luxurious expense, but not ridiculously so. Your classic sports car is the bigger indulgence.
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Postby edge » Sat Jan 08, 2011 8:54 am

C319 wrote:Truth is, I have very few opportunities to talk about this stuff in real life without some weirdness resulting from the conversation, so I figured I'd ask here. I'm not so much looking for confirmation (or permission), just data and alternate points of view, which I'm getting. Thanks again.


The reason it is weird is because most people have no idea what they are doing and are most likely being irresponsible.
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Postby Nate270 » Sat Jan 08, 2011 9:52 am

Get the LS. It's a great looking car and you earn enough income to have it for sure. It's reliable, and pretty practical for a true luxury class of car. My own opinion is to drive cars for 15-20 years because the real cost is the transaction costs of taxes/dealer costs/your time.
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Postby EmergDoc » Sat Jan 08, 2011 11:40 am

It's more than I'd spend, but as long as you can pay cash for it.....I can't argue with you about it.

It seems to me your net worth is a little low to be blowing that kind of cash on an unneeded item though. You're got a nice commuter AND a nice "Sunday ride" already. This clearly isn't a need. Blowing it versus investing it might delay your retirement a year.
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Re: Car buying and financial ratios - what do Bogleheads do?

Postby Wagnerjb » Sat Jan 08, 2011 11:43 am

C319 wrote:I'd like to hear what folks on this board think are some good rules of thumb on car purchases, and also some limits. It seems like regardless of one's income or net worth there's a limit to what's reasonable to spend on something that goes DOWN in value faster than a rock. I look forward to your responses. Thanks!


I don't have a rule of thumb. If you have a healthy income and are saving an appropriate amount for retirement (or other goals), then don't deny yourself the benefits of material possessions such as a fine car. You undoubtedly made major sacrifices to achieve your success and you should enjoy it without guilt.

I am not in the faction of Bogleheads that believes in extreme frugality, but I do believe in being sensible and finding value. In my case, I have purchased several luxury cars over the years. Each time, I buy them after they have been driven 1-2 years. Those cars can be purchased with a considerable amount of warranty left, and they come with a nice discount off the original purchase price.

Don't deny yourself the luxury, just be smart about how you buy it.

Best wishes.
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Postby touchdowntodd » Sat Jan 08, 2011 2:48 pm

i dont have any opinion on what most people drive because i spend decent money on my classic car (although I could argue its an appreciating assett :lol: )...

that being said, and my background with cars, etc.. i dont think any car is worth more than say $30k to me personaly.. there is SO much out there for your money... i just dont see it..

if i was a billionare, bentleys etc would still do nothing for me.. i dont want to impress anyone, and i sure dont want to take a 100k+ hit on selling something (obviously ferraris etc that can be investments are not included in this statement).. i would simply have a toyota venza base model and a scion for my wife who doesnt want anything longer than 11ft ever LOL..

i just dont see it.. but i understand those that do... and your income is 3.5 times my household income so who the hell am i to give an opinion anyways LOL .. LS are nice cars..
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Postby tadamsmar » Sat Jan 08, 2011 8:57 pm

What year and model is your wife's Lexus?

Depending on what your wife has, it might make more sense to upgrade both your cars to ones with modern safety features. That's easy to do with about 35K.

If I found that my wife's car did not make the grade, that's what I would do.
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Postby edge » Sat Jan 08, 2011 9:17 pm

EmergDoc wrote:It's more than I'd spend, but as long as you can pay cash for it.....I can't argue with you about it.

It seems to me your net worth is a little low to be blowing that kind of cash on an unneeded item though. You're got a nice commuter AND a nice "Sunday ride" already. This clearly isn't a need. Blowing it versus investing it might delay your retirement a year.


I am reading his net worth as 1.7 million (85k/.05) which is probably more than OK given he has 20 more years @ 300+k/yr income.

I seriously doubt 35k is going to make a dent in the retirement, especially given the cost is _actually_ 10k (assume a good new-ish reliable car with reasonable features is around 25k).

I pretty much agree with Andy, at certain income/wealth levels it just makes no sense to clip coupons and worry about a Honda accord vs an S class. These cease to be material decision points. The key is to just be smart about it and make sure your overall lifestyle costs are not out of bounds.
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Postby beareconomy » Sat Jan 08, 2011 9:36 pm

Wasn't there some issue with the LS460s and bad engines, like a recall or something? I think it had to do with bad castings on the engine. I would look into this before buying that car. It may not be worth the aggrevation.
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Postby greg24 » Sat Jan 08, 2011 9:38 pm

Buy it.
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Postby EmergDoc » Sun Jan 09, 2011 1:38 am

edge wrote:
EmergDoc wrote:It's more than I'd spend, but as long as you can pay cash for it.....I can't argue with you about it.

It seems to me your net worth is a little low to be blowing that kind of cash on an unneeded item though. You're got a nice commuter AND a nice "Sunday ride" already. This clearly isn't a need. Blowing it versus investing it might delay your retirement a year.


I am reading his net worth as 1.7 million (85k/.05) which is probably more than OK given he has 20 more years @ 300+k/yr income.

I seriously doubt 35k is going to make a dent in the retirement, especially given the cost is _actually_ 10k (assume a good new-ish reliable car with reasonable features is around 25k).

I pretty much agree with Andy, at certain income/wealth levels it just makes no sense to clip coupons and worry about a Honda accord vs an S class. These cease to be material decision points. The key is to just be smart about it and make sure your overall lifestyle costs are not out of bounds.


For some reason I got the impression his net worth was less than $300K.
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Postby C319 » Sun Jan 09, 2011 2:00 am

EmergDoc wrote:For some reason I got the impression his net worth was less than $300K.


edge was closer...actually $1.5M net. $300K left on the mortgage, no other debt. Sorry if my original post was confusing.
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Postby Leesbro63 » Sun Jan 09, 2011 3:19 am

There was, indeed, a major recall repair on most/all 2007 & 8 LS460 cars. Lexus has been handling this well, but you should go to CLUBLEXUS.COM to learn more about this and everything else Lexus.
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Postby Frugal Al » Sun Jan 09, 2011 8:27 am

What do we work for? You obviously like cars. Are your savings goals on track? Have all reasonable financial contingencies been planned for or insured against? Will you hit your "number" by retirement even considering poor investment return scenarios? Have you met your charitable goals? If so, buy what you like, as frugally as you reasonably can. I certainly don't consider a used Lexus to be extravagant given your net worth and income levels. I don't agree with those that try to establish rules on how much car one should or shouldn't buy because of some relatively arbitrary guidelines.

Some people like watches, some like boats, some cars, some are audiophiles, some...whatever. As long as the musts are taken care of, there's nothing wrong with indulging in some likes. How do we look at the death of a pauper who turned out to be a millionaire? Wow, what a genius. Or, wow, how sad they couldn't have enjoyed themselves a bit more.
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Postby EmergDoc » Sun Jan 09, 2011 6:51 pm

C319 wrote:
EmergDoc wrote:For some reason I got the impression his net worth was less than $300K.


edge was closer...actually $1.5M net. $300K left on the mortgage, no other debt. Sorry if my original post was confusing.


In that case I retract my previous comment. Buy whatever you like. Seriously. You save money to spend it on things you like.
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Re: Car buying and financial ratios - what do Bogleheads do?

Postby Valuethinker » Mon Jan 10, 2011 6:40 am

C319 wrote:Greetings everyone. Long time reader, first time poster here. This site is the best source of unbiased investment information anywhere as far as I'm concerned. Keep up the great work, folks. I searched the archives and couldn't find what I was looking for, so here goes:

My daily driver is a very reliable Toyota sedan with 120K miles worth $6K , and I've got the itch to "upgrade" to a used Lexus for about $35K.

I'm 43, household income $300K+/yr. Debt: -$300K mortgage. Besides my daily driver we have two cars (wife's used Lexus and a classic sports car I rarely drive) so would have $85K tied up in vehicles if I buy the LS460.

While I realize that on paper our income/car (22.3%) and net worth/car (5.7%) ratios probably look okay, I've never spent this much on a car that I was going to drive every day (and depreciate in the process), so it just seems like a lot of money to be spending on some wheels. I've always followed Dave Ramsey's rule on cars (less than 50% of income) and/or tried to keep vehicles to less than 4% of net worth. I'm a saver and my wife says I need to relax a bit. I don't know.

I'd like to hear what folks on this board think are some good rules of thumb on car purchases, and also some limits. It seems like regardless of one's income or net worth there's a limit to what's reasonable to spend on something that goes DOWN in value faster than a rock. I look forward to your responses. Thanks!


I can't fathom doing this even at your income, unless you've paid off that $300k.

You might get sick or have a bad accident. Your business might suffer fraud or market change or default of major customer.

Why not be debt free if that goal is within reach? Most of us have debts because it is not feasible to eliminate them.

Say my mortgage is 5%. I need to earn (UK taxes are higher) 8% before tax to beat paying down the mortgage. And that mortgage repayment is risk free.

On your income, I would imagine you could liquidate that debt in 2-3 years at most?

Then you can look at fancy cars.

In the meantime, I would guess you could get a decent car for USD 30k?
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Postby edge » Mon Jan 10, 2011 8:22 am

Heh, sinking 300k into illiquid and 'iffy' assets like housing where the debt is very cheap? 8% is pretty inaccurate given the mortgage tax credit and at 300k income the guy is definitely itemizing. What if the guy wants to (or has to) move in 3-5 years and all his money is trapped in a house that he cannot offload?

Seems a lot more risky to me than blowing an extra 10k on a car. Bad advice IMO.

All the other 'what if's in your post are either solved by insurance or not solved at all (aside from his already solid 1.5 mln net worth) - but the point is - an extra 10k saved on a car purchase ain't going to solve them either. And you yourself suggested a car that costs approximately 5k less than the one he intends to purchase. Bizarre. I mean, the guy, after tax makes like 18k a month. This 5k you are scaring him over looks ridiculous.
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Postby Valuethinker » Mon Jan 10, 2011 9:08 am

edge wrote:Heh, sinking 300k into illiquid and 'iffy' assets like housing where the debt is very cheap? 8% is pretty inaccurate given the mortgage tax credit and at 300k income the guy is definitely itemizing. What if the guy wants to (or has to) move in 3-5 years and all his money is trapped in a house that he cannot offload?


Good point - 8% may be too high a pre tax rate (note I specifically point out that I am UK-- my marginal tax rate is 40%, that's pretty normal and our mortgage interest is not tax deductible). My mortgage is 5%, my marginal tax rate is 40%, cost of interest on my mortgage is 5/0.6 which is c. 8%.

(at his income, my marginal tax rate would be 50%, now).

Bad point - confusing 'investing' in housing by owning a house, with 'investing' in housing by paying off the mortgage.

He already has the full exposure to housing prices-- via buying the house.

If he bought an $800k house with $1k of equity, he has $800k of housing exposure. The gearing just multiplies his return.

If he sells for $400k then he's still got to repay $799k of debt.



Seems a lot more risky to me than blowing an extra 10k on a car. Bad advice IMO.


Your logic is incorrect as above.

Once you've bought the asset you have the full exposure to the gross asset value. If his house is worth $800k he has $800k exposure to the housing market.

Gearing magnifies your gains or losses to equity, but it does not change your exposure to the housing market.

All the other 'what if's in your post are either solved by insurance or not solved at all (aside from his already solid 1.5 mln net worth) - but the point is - an extra 10k saved on a car purchase ain't going to solve them either. And you yourself suggested a car that costs approximately 5k less than the one he intends to purchase. Bizarre. I mean, the guy, after tax makes like 18k a month. This 5k you are scaring him over looks ridiculous.


I wasn't really focusing ($30k was a direct translation of what a similar car might cost in the UK) on a cost-benefit of his alternatives.

It's a fair point that $5-10k is neither nor.

Maybe the macro question though: on that income, why not pay off existing debts?

Even on your numbers, your pre tax return on that would be around 6%? Which is bloody good compared to any safe investment return you can get.
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Postby edge » Mon Jan 10, 2011 9:25 am

Having 'asset' exposure to the house is sideways/irrelevant and a strawman.

What is relevant is his ability to be mobile/flexible. My point is that he does not have to sell if he has to move because he would have 300k liquid that he could utilize. If he dumps all that cash into the house then he has less flexibility and may have to sell ala everyone living in Michigan. You are painting him into a corner to save on already cheap money when he easily has the resources to maintain flexibility.

Frantically paying off (most likely) non-recourse debt because

1) Avoid low interest payments
2) Be 'safer' during a life crisis

makes no sense. Avoiding low interest payments does not make sense given the liquidity crunch and I don't understand how he is in a worse position in a crisis when holding non-recourse debt.
Last edited by edge on Mon Jan 10, 2011 9:49 am, edited 1 time in total.
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Postby sscritic » Mon Jan 10, 2011 9:44 am

edge wrote:Having 'asset' exposure to the house is sideways/irrelevant and a strawman.

What is relevant is his ability to be mobile/flexible. My point is that he does not have to sell if he has to move because he would have 300k liquid that he could utilize. If he dumps all that cash into the house then he has no flexibility and has to sell ala everyone living in Michigan.

He is not stuck. He borrows $300k against his equity in the house. He then buys the new house where he is moving and keeps the old house. Isn't that your plan? Use the $300k cash to buy the new house and keep the old house? The result is the same whether he keeps the current $300k mortgage he has now or takes a new one later.

[I am assuming the $800k house. I don't think he actually told us.]
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Postby edge » Mon Jan 10, 2011 9:53 am

Yes, in a perfect or 'normal' world he could borrow against the equity in his house. Unless he cannot get a HELOC (very common these days) - which is why I specifically mentioned the liquidity issue. Especially a very large HELOC and it also depends on the asset performance of his house. If he puts 300k in and home values continue to fall - there is less/no equity on which to base a LOC.

But this is not just to buy another house - that is a choice that he would have to make at the time given where he would be moving/etc there are tons of other major expenditures etc.

Another question is interest rates, if he takes a HELOC, its rate could become a problem depending on how things end up.

Now, you may ask 'well, what should he do with this mythological 300k then'. I have no idea it really depends on the OP's situation, all I am saying is that dumping it into a house is probably a bad idea - and an odd 'alternative' to spending an extra 5k on a car.

sscritic wrote:
edge wrote:Having 'asset' exposure to the house is sideways/irrelevant and a strawman.

What is relevant is his ability to be mobile/flexible. My point is that he does not have to sell if he has to move because he would have 300k liquid that he could utilize. If he dumps all that cash into the house then he has no flexibility and has to sell ala everyone living in Michigan.

He is not stuck. He borrows $300k against his equity in the house. He then buys the new house where he is moving and keeps the old house. Isn't that your plan? Use the $300k cash to buy the new house and keep the old house? The result is the same whether he keeps the current $300k mortgage he has now or takes a new one later.

[I am assuming the $800k house. I don't think he actually told us.]
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Postby fishnskiguy » Mon Jan 10, 2011 9:59 am

He's owned two Ferraris in the past and wants to know of he can drop $35K on a used Lexus? :shock:

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Postby sscritic » Mon Jan 10, 2011 10:09 am

edge wrote:Yes, in a perfect or 'normal' world he could borrow against the equity in his house. Unless he cannot get a HELOC (very common these days) - which is why I specifically mentioned the liquidity issue. Especially a very large HELOC and it also depends on the asset performance of his house. If he puts 300k in and home values continue to fall - there is less/no equity on which to base a LOC.

This assumes he has no other assets. He can also afford to move using the $1 million in his taxable account. The OP said he would end up with 85k in cars which would put him over the Dave Ramsey 4% of net worth. If the 85k is 5% of net worth, his net worth is $1.7 million. Maybe he doesn't need that particular $300k to move; he can use another $300k. He has over five of them!

The real issue is what are the alternatives for his $1.7 million. How much does he want in cars, how much in house, how much in municipal bonds, etc. You have to look at more than just the house, the mortgage, and the cars.

I definitely agree with that dumping cash into the house is "an odd alternative to spending an extra 5k on a car." We tell people to look at the overall portfolio when making investment choices; we should say the same about overall asset portfolio when making asset choices. [The too much house problem that people discovered a few years ago - many should have bought a bigger car rather than a bigger house]
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Postby edge » Mon Jan 10, 2011 10:30 am

Possibly, I do not know how much of his net worth is liquid so that is up in the air. I saw you mentioned a million in taxable - I didn't see that in his post so I must be missing something.

One thing that I don't really understand is ValueThinker's interest rate math. This guy can only only put maybe 5% of his money in tax advantaged accounts right now so I am not sure why we are grossing up the taxes as if he had a tax advantaged alternative. Pretty much all his income at this point is after tax so we should just compare after tax returns. The mortgage is maybe costing him 3.75-4% including the tax deductibility. This does not seem to be a big cause for concern unless I am missing something.

Finally, although Dave Ramsey has some good rules of thumb for the middle they just do not work as well for people at the tails. For the ultra-rich they cannot even find a car that costs near 5% of their net worth so its not a decision point and likewise for the working poor - they likely have to buy a car that is more than 5% of their net worth.
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Postby Valuethinker » Mon Jan 10, 2011 10:34 am

edge wrote:Having 'asset' exposure to the house is sideways/irrelevant and a strawman.

What is relevant is his ability to be mobile/flexible. My point is that he does not have to sell if he has to move because he would have 300k liquid that he could utilize. If he dumps all that cash into the house then he has less flexibility and may have to sell ala everyone living in Michigan. You are painting him into a corner to save on already cheap money when he easily has the resources to maintain flexibility.

Frantically paying off (most likely) non-recourse debt because

1) Avoid low interest payments
2) Be 'safer' during a life crisis

makes no sense. Avoiding low interest payments does not make sense given the liquidity crunch and I don't understand how he is in a worse position in a crisis when holding non-recourse debt.


OK I see where you are coming from, I think.

I think if you can be in a position to eliminate a debt, then you should.

Debt is not low interest in the sense that the cost of owning home equity is the opportunity cost of other uses of the money.

If your mortgage is at 5%, then say 7% pre tax? That's better than any other certain return you can make. Even if only 5% pre tax, it's still attractive.

Liquidity crunch. On his income and the presumed value of his house, I wouldn't see that he his likely to be affected by a liquidity crunch. He could presumably just sell some assets.

I've honestly never seen anyone with a mortgage = gross annual income (well, not who has discussed it with me). it just seems so easy to just pay that off.
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Postby Valuethinker » Mon Jan 10, 2011 10:38 am

edge wrote:Possibly, I do not know how much of his net worth is liquid so that is up in the air. I saw you mentioned a million in taxable - I didn't see that in his post so I must be missing something.

One thing that I don't really understand is ValueThinker's interest rate math. This guy can only only put maybe 5% of his money in tax advantaged accounts right now so I am not sure why we are grossing up the taxes as if he had a tax advantaged alternative. Pretty much all his income at this point is after tax so we should just compare after tax returns. The mortgage is maybe costing him 3.75-4% including the tax deductibility. This does not seem to be a big cause for concern unless I am missing something.

Finally, although Dave Ramsey has some good rules of thumb for the middle they just do not work as well for people at the tails. For the ultra-rich they cannot even find a car that costs near 5% of their net worth so its not a decision point and likewise for the working poor - they likely have to buy a car that is more than 5% of their net worth.


The difference may simply be my location vs. yours.

UK mortgage rates (fixed rate, up to 5 years): around 5% (could be as high as 6%).

UK marginal tax rate: 40% up to £150k pa (from £42k or so), £50% above that (it's not quite as straightforward as that, some odd 'wobbles' where your marginal rate goes to nearly 100% due to benefits withdrawal).

So 5%/0.6 = 8% pre tax. That's your indifference point against paying down debt.

So I was thinking US maybe 7% pre tax ie slightly lower tax rates (although my friends in New York don't seem to pay any less tax).

It's impossible to get more than about 3% on investing right now (fixed rate investments).

A tax deferred account is just that, tax deferred: you'll pay tax someday, and possibly not at a lower rate. There are tax free accounts, but the amount you can invest is limited to £10k pa (+ that for your spouse).
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Re: Car buying and financial ratios - what do Bogleheads do?

Postby porcupine » Mon Jan 10, 2011 10:39 am

C319 wrote:[...]My daily driver is a very reliable Toyota sedan with 120K miles worth $6K , and I've got the itch to "upgrade" to a used Lexus for about $35K.

I'm 43, household income $300K+/yr. Debt: -$300K mortgage. Besides my daily driver we have two cars (wife's used Lexus and a classic sports car I rarely drive) so would have $85K tied up in vehicles if I buy the LS460.
[...]
I'd like to hear what folks on this board think are some good rules of thumb on car purchases, and also some limits. It seems like regardless of one's income or net worth there's a limit to what's reasonable to spend on something that goes DOWN in value faster than a rock. I look forward to your responses. Thanks!

C139:

A lot of people in a lot of places around the country have spent even 10 times that for something (their primary home) that has dropped in value faster than a car would - though they did not do so consciously.

That said, at less than half your household income - and most likely, less than half your disposable income - we bought a (new) car at half the price of what you are considering for yours. So, my vote is "go buy that thing!"

One thing though - when I wrote the above, I assumed it was a new car. Now looks like you said it is a used car. So, I now wonder how many miles, how old etc. I have not had good luck with 'old' used cars. Obviously, (not literally speaking) your mileage will vary!

- Porcupine
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Postby Valuethinker » Mon Jan 10, 2011 10:40 am

sscritic wrote:
I definitely agree with that dumping cash into the house is "an odd alternative to spending an extra 5k on a car." We tell people to look at the overall portfolio when making investment choices; we should say the same about overall asset portfolio when making asset choices. [The too much house problem that people discovered a few years ago - many should have bought a bigger car rather than a bigger house]


If you said 'dumping the extra money into the mortgage' would that make more sense.

Agreed if you are buying a new house, then you want to think about it.

But if you've already got the house, and the debt, why not reduce the debt? Given you'd need to get 6-7% pre tax on any other investment to match it.
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Re: Car buying and financial ratios - what do Bogleheads do?

Postby Valuethinker » Mon Jan 10, 2011 10:47 am

porcupine wrote:
C319 wrote:[...]My daily driver is a very reliable Toyota sedan with 120K miles worth $6K , and I've got the itch to "upgrade" to a used Lexus for about $35K.

I'm 43, household income $300K+/yr. Debt: -$300K mortgage. Besides my daily driver we have two cars (wife's used Lexus and a classic sports car I rarely drive) so would have $85K tied up in vehicles if I buy the LS460.
[...]
I'd like to hear what folks on this board think are some good rules of thumb on car purchases, and also some limits. It seems like regardless of one's income or net worth there's a limit to what's reasonable to spend on something that goes DOWN in value faster than a rock. I look forward to your responses. Thanks!

C139:

A lot of people in a lot of places around the country have spent even 10 times that for something (their primary home) that has dropped in value faster than a car would - though they did not do so consciously.


But a home also provides shelter services. You live rent free when you own a home. Unless market rents fall, that's not a reduction in value (even if the capital value falls).
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Postby edge » Mon Jan 10, 2011 10:56 am

I really don't understand why we would worry about 'pre-tax' interest rates on his gross pre tax when 95% of the guy's money is taxed. Just worry about after tax, its simpler.

The mortgage costs him 3.75-4% (reasonable assumption) after tax. Can he find an alternative that guarantees more after tax - possibly not.

But again, my reasoning is not based on mortgage/investment interest rate gaps/arbitrage - it is about risk reduction which ironically is precisely the reasoning/goal that you started with but your advice does not actually support it.

Lets just compare what happens in risky situations here:

- Assume home value declines
- Assume the guy gets very sick and can no longer work
- Assume that the LtV ratio of the current house is high (if it is low then he is paying it off quickly anyway so the point is moot)
- Assume a relatively insufficient amount of liquid assets

(You may say that there are too many assumptions here but I would imagine that quite a few people are in this situation currently - I know of at least a half dozen in similar (not all are sick obviously) situations)

In your world he would be pretty screwed here with a house that he may not be able to pull money out of and also one which most likely is too big and he cannot reasonably offload. In mine he can walk away from that house and still have most of his assets to survive on. And at that point it is basically about survival so all that stuff about 'moral obligation' to pay back the mortgage is out the window IMO. The bank gets the asset and if the bank has been issuing non-recourse loans with absolutely no facility/capability for marketing/selling homes then its their own damn incompetence.


Valuethinker wrote:
edge wrote:Possibly, I do not know how much of his net worth is liquid so that is up in the air. I saw you mentioned a million in taxable - I didn't see that in his post so I must be missing something.

One thing that I don't really understand is ValueThinker's interest rate math. This guy can only only put maybe 5% of his money in tax advantaged accounts right now so I am not sure why we are grossing up the taxes as if he had a tax advantaged alternative. Pretty much all his income at this point is after tax so we should just compare after tax returns. The mortgage is maybe costing him 3.75-4% including the tax deductibility. This does not seem to be a big cause for concern unless I am missing something.

Finally, although Dave Ramsey has some good rules of thumb for the middle they just do not work as well for people at the tails. For the ultra-rich they cannot even find a car that costs near 5% of their net worth so its not a decision point and likewise for the working poor - they likely have to buy a car that is more than 5% of their net worth.


The difference may simply be my location vs. yours.

UK mortgage rates (fixed rate, up to 5 years): around 5% (could be as high as 6%).

UK marginal tax rate: 40% up to £150k pa (from £42k or so), £50% above that (it's not quite as straightforward as that, some odd 'wobbles' where your marginal rate goes to nearly 100% due to benefits withdrawal).

So 5%/0.6 = 8% pre tax. That's your indifference point against paying down debt.

So I was thinking US maybe 7% pre tax ie slightly lower tax rates (although my friends in New York don't seem to pay any less tax).

It's impossible to get more than about 3% on investing right now (fixed rate investments).

A tax deferred account is just that, tax deferred: you'll pay tax someday, and possibly not at a lower rate. There are tax free accounts, but the amount you can invest is limited to £10k pa (+ that for your spouse).
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Postby Valuethinker » Mon Jan 10, 2011 11:16 am

edge wrote:I really don't understand why we would worry about 'pre-tax' interest rates on his gross pre tax when 95% of the guy's money is taxed. Just worry about after tax, its simpler.


That's fine. I tend to think about expected pre tax returns (because tax rates vary):

- government fixed income (risk free) - c. 4% pre tax

So sub 3% after tax?

If your mortgage interest rate exceeds that number, you are better off paying down debt.




The mortgage costs him 3.75-4% (reasonable assumption) after tax.


A UK mortgage costs, aftet tax, what it costs before ie 5-6% (you can get lower rates for shorter periods, but I am assuming 3-5 year fixed rate).

Can he find an alternative that guarantees more after tax - possibly not.


Risk free? Probably not.

But again, my reasoning is not based on mortgage/investment interest rate gaps/arbitrage - it is about risk reduction which ironically is precisely the reasoning/goal that you started with but your advice does not actually support it.


It would as and when he was paid off.

Lets just compare what happens in risky situations here:

- Assume home value declines


Unless in negative equity then it doesn't matter. He's got that investment in the home already.

- Assume the guy gets very sick and can no longer work


Yes but then he would not want to buy the more expensive car either? The money's gone, whichever way you put it.

- Assume that the LtV ratio of the current house is high (if it is low then he is paying it off quickly anyway so the point is moot)


Not sure it makes a lot of odds (unless negative equity).

- Assume a relatively insufficient amount of liquid assets


Agreed then you want to be more liquid eg by not buying as expensive a car.


(You may say that there are too many assumptions here but I would imagine that quite a few people are in this situation currently - I know of at least a half dozen)

In your world he would be pretty screwed here with a house that he may not be able to pull money out of and also one which most likely is too big and he cannot reasonably offload.


Assuming he did not buy a more expensive car but banked the cash in liquid assets?

In mine he can walk away from that house and still have most of his assets to survive on. And at that point it is basically about survival so all that stuff about 'moral obligation' to pay back the mortgage is out the window IMO. The bank gets the asset and if the bank has been issuing non-recourse loans with absolutely no facility/capability for marketing/selling homes then its their own damn incompetence.


UK mortgages are not non recourse. I am aware they are in some states.

nonetheless given what an undischarged debt can do to your credit rating (and in the UK blocks you from some things, eg being a company director, and certain professions) I am not sure if a 'walk away' is really a good idea, if you are the kind of person who has been making $300k pa.

Valuethinker wrote:
edge wrote:Possibly, I do not know how much of his net worth is liquid so that is up in the air. I saw you mentioned a million in taxable - I didn't see that in his post so I must be missing something.

One thing that I don't really understand is ValueThinker's interest rate math. This guy can only only put maybe 5% of his money in tax advantaged accounts right now so I am not sure why we are grossing up the taxes as if he had a tax advantaged alternative. Pretty much all his income at this point is after tax so we should just compare after tax returns. The mortgage is maybe costing him 3.75-4% including the tax deductibility. This does not seem to be a big cause for concern unless I am missing something.


As below. You can do it after tax if you prefer.

Finally, although Dave Ramsey has some good rules of thumb for the middle they just do not work as well for people at the tails. For the ultra-rich they cannot even find a car that costs near 5% of their net worth so its not a decision point and likewise for the working poor - they likely have to buy a car that is more than 5% of their net worth.


The difference may simply be my location vs. yours.

UK mortgage rates (fixed rate, up to 5 years): around 5% (could be as high as 6%).

UK marginal tax rate: 40% up to £150k pa (from £42k or so), £50% above that (it's not quite as straightforward as that, some odd 'wobbles' where your marginal rate goes to nearly 100% due to benefits withdrawal).

So 5%/0.6 = 8% pre tax. That's your indifference point against paying down debt.

So I was thinking US maybe 7% pre tax ie slightly lower tax rates (although my friends in New York don't seem to pay any less tax).

It's impossible to get more than about 3% on investing right now (fixed rate investments).

A tax deferred account is just that, tax deferred: you'll pay tax someday, and possibly not at a lower rate. There are tax free accounts, but the amount you can invest is limited to £10k pa (+ that for your spouse).

I think your argument boils down to:

- spend the money it's not consequential (agreed it might not be)

- repaying mortgage is a bad use of cash because it reduces credit available from housing wealth, and that's risky. That's only true if you don't then spend the money on some other consumption item (like a car)

If your gross income is that close to your mortgage debt, it would seem to me a near no brainer to focus on paying off your mortgages.

Exception would be if you can find tax exempt investment opportunities that are time limited (for example we have yearly limits on pension contributions). However that might not pay off in the case of pensions (because they are only tax deferred savings, not tax exempt): since we cannot forecast future tax rates at retirement, we don't know ex ante.
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Postby edge » Mon Jan 10, 2011 11:21 am

I do not know why you keep bringing up the car, the car is 100% irrelevant when talking about paying off a 300k debt.

The one major point I see here and we probably agree on is that you need to be extremely careful when signing a recourse loan. I doubt I would buy anything more expensive than my income if it was recourse and frankly is one reason why I find home ownership in the EU/UK extremely unattractive besides the loan rates and tax rates and...well, there are dozens of reasons but that is one of the more important ones.
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Postby Valuethinker » Mon Jan 10, 2011 11:28 am

edge wrote:I do not know why you keep bringing up the car, the car is 100% irrelevant when talking about paying off a 300k debt.

The one major point I see here and we probably agree on is that you need to be extremely careful when signing a recourse loan. I doubt I would buy anything more expensive than my income if it was recourse.


Well UK debt is 100% recourse. I believe that is also true in some US states? (vis a vis mortgages). If there is a shortfall on your home when it is sold, the bank comes after you to make it up.

Your argument is by not investing the money in repaying debt, you increase liquidity.

But then, if you spend that money on consumption, you don't have that money anyways. It is gone.

That's why I don't see the car as irrelevant. I am saying 'don't buy as expensive a car, pay down debt'.

Paying down a debt is, in effect, an investment in fixed income (at quite a nice after tax return, risk free).

I am really arguing for deferred consumption. On the grounds that the good times may not roll forever, and $300k mortgage, $300k income, the date when you owe the bank nothing is not far away.

In my case, 19 years ;-).
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Postby edge » Mon Jan 10, 2011 11:35 am

Ya, but he isn't buying an expensive car. He is buying a pretty cheap one given his income and his current car is expiring. So he could buy a new Camry with nice options for 25-30 or pay 35k for a used car that he might actually like. In the end, a completely immaterial decision point given the 300k we are talking about (1.5%?). He probably saves more than 5k a month.
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Postby CAP » Mon Jan 10, 2011 11:40 am

For what it is worth, in my opinion, as far as cars go, I would pay cash or buy less car so cash could be paid.

I only had car payments once for a short time till I paid the car off. I really hated car payments & have never financed again though I kept that car till it died. I enjoy using the saved finance interest & charges for other more important things.
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