If you can pay cash, why did you finance?

[kev_rm]

Up front apology: This is a first world problem.

I generally subscribe to the theory if you are ever upside down on a discretionary asset, you can't afford it - in other words, pay cash if you can, but in any case always stay ahead of depreciation curve no matter what - pay 20-50% down on cars, boats, etc with short-ish term loans. My last cruiser I paid cash for. My last new car/truck I did a zero interest 24 month loan. That felt good. No pressure.

I've got a new (to me) boat under contract. I could pay cash. I am toying around with maybe being a little more leveraged - not upside down, but maybe a longer term (say 10 yrs) with 30% down. My thinking is why not let the bank take a risk too?

What are your reasons for leveraging up a boat purchase if you are in the position to pay cash?

[boat is in the 100-200K price range if it matters.]

[peghall]

Whether or not to use my own money for a large purchase depends on the interest rate and the length of the loan....if it's less than I'm making on it, I use the bank's money for at least half of it and finance for only a few years instead of the longest period available. That guarantees I'll never be upside down and still have the cash to pay off the balance if I have to.


--Peggie

[Chuck34]

Everyone has a different financial picture. What works for Joe may not be good for Sam. People in the high income brackets with substantial assets can have very complicated finances...money tied up in such a way, there could be substantial penalties for early withdrawal.

[Stu Jackson]

Many folks also make the decision based on simple cash flow, in addition to the ideas already expressed.


Sometimes "the cost of $$" has to be balanced against availability at any given time.


An example: living on a fixed income but expecting an inheritance in the near future.


I'm sure there are others, like considering bonuses or windfalls.

[kenbo]

The defining term in your question is discretionary asset. Using debt to acquire a depreciating, non-income producing discretionary asset is, in my opinion, improper use of debt or leverage.

Of course, many do use debt to purchase discretionary assets and I believe that the more that do just leads us to another "Minsky moment" as happened in 2009.

[Belezar]

It depends, like most things financial. The primary consideration should be your risk tolerance. The basic what keeps you up at night question. Some people debt bothers the heck out of, some not at all. Then there is the financial return. What is your money earning you? With a boat loan 4.5 - 5 %, assuming no tax deduction, you’ll need to earn 6-8% pretax to break even. That’s pretty strong if guaranteed. In other words, if you pay cash that is essentially what your money is earning. If your money does better than that, and you are worried about a liquidity crunch, then there’s nothing wrong with financing a toy. I do think it smart to stay well ahead of the depreciation curve and have it insured.

[Belezar]

Originally Posted by kenbo

Of course, many do use debt to purchase discretionary assets and I believe that the more that do just leads us to another "Minsky moment" as happened in 2009.

The funny thing about that was it wasn’t a discretionary assets being purchased, it was homes. Yes, many people took cash out as well and spent it foolishly, but the crash came from loans on bad collateral, not the use of the funds.

[kenbo]

Originally Posted by Belezar

The funny thing about that was it wasn’t a discretionary assets being purchased, it was homes. Yes, many people took cash out as well and spent it foolishly, but the crash came from loans on bad collateral, not the use of the funds.

In many cases the real estate loans were not taken for primary residences. If they were I wouldn't consider them discretionary assets. There was speculation by developers and individuals having outsized optimism on the real estate market and the bulk of those bad loans were hidden in plain sight through financial engineering through CMO's (collateralized debt obligations).

So when the OP asked about leveraging a discretionary asset my thought was buying this boat is based on optimism that the used boat market will project into the future as predicted by past valuations. What if a Black Swan event occurs and I can see three very real possibilities in the next 3-5 years. I believe in such a scenario, discretionary assets will get pounded and you could very easily find your assets worth a lot less than the note value.

Remember, Minsky postulated that the worst thing for debt holders is outsized optimism on the future.

[FlyingScot]

Here are some reasons not to:
1. Investments that pay above loan rates have risk.
2. Bank loans can be a hassle. Gathering paperwork, proving income, following any rules and steps required, etc. Bank delays could cause you to miss out on a deal or the boat you really wanted.
3. Financed items insurance requirements might not line up with your wants/needs.

Only you can answer if the amount you can make by investing the money elsewhere is worth it.

[Shenandoah52]

Originally Posted by kenbo

Remember, Minsky postulated that the worst thing for debt holders is outsized optimism on the future.

Kenbo is right on target with the 'Minsky Moment' emphasis. A Minsky Moment is basically where one is forced to sell good assets to cover bad liabilities. That could mean fire-sale prices.

Obligating future cash flow to discretionary items is fine in a stable environment but we all know how things can change, and suddenly that obligated cash flow becomes an alligator. And if that discretionary item is as illiquid as boats are known to be it is a recipe for disaster. This wipes out any preplanning where one balances the interest earned by holding the cash versus paying full cash for the item.

On the flip side, paying all cash for a boat in a changing environment has it's unexpected hazards. I'm watching a guy I know try to sell his $200K boat in a market that is moving rapidly away from that style of boat. So even though the brokers are listing those boats at the standard $200K valuation the public is not supporting those numbers.

The current sold comps for that boat are $119K, $124K, $43K, and on top of that there is the same boat he has in a nearby marina to him that is now for sale for $115K. From where I sit it looks to me like he's not going to get his desired $200K back.

[belizesailor]

Originally Posted by kenbo

The defining term in your question is discretionary asset. Using debt to acquire a depreciating, non-income producing discretionary asset is, in my opinion, improper use of debt or leverage.



Of course, many do use debt to purchase discretionary assets and I believe that the more that do just leads us to another "Minsky moment" as happened in 2009.

Thats my perspective too. Its very easy to make a strong financial case for appropriate debt service on an income producing asset. Adding interest expense to a depreciating unecessary non-income producing asset is just adding insult to injury.

If I cant afford to pay cash for a toy then I dont get that toy.

Ive never financed a boat and could not ever see myself doing so.

[belizesailor]

Originally Posted by Shenandoah52

Kenbo is right on target with the 'Minsky Moment' emphasis. A Minsky Moment is basically where one is forced to sell good assets to cover bad liabilities. That could mean fire-sale prices.



Obligating future cash flow to discretionary items is fine in a stable environment but we all know how things can change, and suddenly that obligated cash flow becomes an alligator. And if that discretionary item is as illiquid as boats are known to be it is a recipe for disaster. This wipes out any preplanning where one balances the interest earned by holding the cash versus paying full cash for the item.



On the flip side, paying all cash for a boat in a changing environment has it's unexpected hazards. I'm watching a guy I know try to sell his $200K boat in a market that is moving rapidly away from that style of boat. So even though the brokers are listing those boats at the standard $200K valuation the public is not supporting those numbers.



The current sold comps for that boat are $119K, $124K, $43K, and on top of that there is the same boat he has in a nearby marina to him that is now for sale for $115K. From where I sit it looks to me like he's not going to get his desired $200K back.

Exactly, the oft used argument that money properly invested can earn x% thus covering the discrectionary interest expense is naive...especially when the chips are down and you are forced to start selling otherwise good assets at pennies on the dollar.

It certainly doesnt fit my risk profile.

[S/V Illusion]

Originally Posted by kev_rm

What are your reasons for leveraging up a boat purchase if you are in the position to pay cash?
]

I can think of only one reason to pay interest on a loan - when the money is better leveraged at a higher rate of return in a business or other revenue source.

Everything else is a rationalization.

Boats are always depreciating assets. Exacerbating that cost by paying interest on lost money is why ‘god invented financial managers’. Ask one.

[kenbo]

Originally Posted by S/V Illusion

I can think of only one reason to pay interest on a loan - when the money is better leveraged at a higher rate of return in a business or other revenue source.

Everything else is a rationalization.

Boats are always depreciating assets. Exacerbating that cost by paying interest on lost money is why ‘god invented financial managers’. Ask one.

Well said! Another rationalization often heard is "I have the cash flow to service the loan". If you ask the next question, "how do you provide for recapitalization" you often hear crickets. Even if your boat is your only asset you still need to recapitalize, so what is the real cash flow?

[barnakiel]

Banks are taking no risks. You are fooling yourself when you think they would.


If you can back from a financing option and your present investments pay over the financing cost, then you should leverage AS MUCH AS ONE CAN. No brainer.


b.