Should I Pay Cash for a Car?
It’s a classic question – “Should I pay cash for a car?”
For those with the resources, the appeal of owning a car outright is strong. No car payment. You get the title. No annoying bank to deal with now or in the future.
However, for some people, paying cash for a car isn’t a prudent decision. Plus, dealers often offer financing that can be extremely attractive and sometimes cheaper than paying cash!
Let’s look at the advantages and disadvantages of paying cash for a car.
Should I Pay Cash for a Car? Advantages of Paying Cash for a Car
There are many benefits to paying cash for a car. The biggest is the peace of mind knowing you own the car outright.
You Own The Car Outright
I know it’s obvious, but it needs to be said because there is peace of mind with it. When you own the car outright, you get the title.
You get the comfort of knowing every time you sit in your car, it’s yours – 100% yours.
You don’t have to deal with getting the title when you pay off a loan. You don’t have to jump through extra hoops to sell your car while buying a new one.
It’s simple because it’s yours.
No Car Payment
Debt can feel like a heavy burden.
Even for people who understand their financial situation thoroughly and are financially well off, the weight of a monthly payment can be substantial.
It’s a wonderful feeling knowing there is no monthly payment that needs to be made. No recurring transaction you need to set up or watch.
If your financial situation changes, you have one less monthly payment to worry about.
Reduce Odds of Over Spending
When you pay cash, you have a certain amount earmarked for the car purchase. In a way, it’s like an anchor.
You are far less likely to be swayed to spend more if you have already anchored to a certain price.
This can help you reduce the odds of overspending. If you planned on spending $20,000 and have that number in your head, you may be less tempted to spend extra on warranties, a nicer vehicle, or upgrades.
No Interest Payments
Since you are not making a car payment, you also aren’t paying any interest!
For example, if you borrow $25,000 at 2.5% for 60 months (5 years), you will pay $1,621.04 of interest over the life of the loan.
Another way to look at it is that you are paying about $52.08 in interest with the first payment. With each subsequent payment, you pay a little less interest each month. In year 2, you are paying between $32.88 and $42.18 in interest each month. Below is a chart to help visually see how the monthly payment work.
|Beginning Balance||Interest||Principal||Ending Balance|
No Chance of Being Upside Down on a Loan
Another benefit of paying cash for a car is that there is no chance you go upside down on the loan.
“Upside down on the loan” is what happens when your car is worth less than what you owe.
For example, if you bought a car for $25,000, put $2,500 down, and your car depreciated 30% the first year, your car would be worth about $17,500, but your loan balance at the end of the first year would be $18,221.91. This assumes a 60-month loan at 2.5%.
If you were to sell your car for $17,500, you would need to come up with extra money to pay off the loan.
When you pay cash, there is no loan, which means you can sell it at any time without worrying about being upside down on a loan.
Disadvantages of Paying Cash for a Car
Paying cash for a car is great, but there are a few downsides.
Miss Great Financing Deals
Although credit unions can be a smart place to line up financing, particularly for used cars, dealerships often have really attractive financing deals if you qualify.
I once got a car loan with a zero percent interest rate. Even today, many car loans are under 2%, which is a very low interest rate.
In addition to low interest rates, sometimes dealerships will offer better prices on cars if you finance through them. The banks that offer the financing usually provide commissions to the dealership, which is why they can offer lower prices.
If the bank gives the dealership $2,000 for each loan, the dealership may be willing to give you $1,000 off the car price, as an example.
If you pay cash, the dealership doesn’t have the opportunity to get commissions from the financing arm and less of an opportunity to add on other extra costs.
Not Building Credit
If you pay cash for a car, you also are not building your credit.
Since your credit score is partially based on the type of loans you have, a car loan could help boost your score over time. For example, many people have credit cards, which are revolving accounts, but lenders also want to see that you can use installment accounts responsibly. Installment accounts are mortgages, auto loans, and student loans.
I wouldn’t not pay cash for a car just to build my credit, but it’s a consideration.
Depletes Cash Savings
Another big disadvantage of paying cash for a car is you may deplete your savings.
If it is from a bank account, you’ll have less money readily available in the future. If it is from an investment account, you’ll have less money compounding and working for you.
Should I Finance a Car? Advantages of Financing a Car
Although paying cash for a car is a great feeling emotionally, financing a car is also a good option.
Less Cash Needed
If you only need to put 10%-20% down, you’ll have more money available for other things – bills, investing, or charitable donations.
For example, if you put 20% down on a $25,000 car, that equals $5,000 as opposed to needing to come up with the full $25,000 at once.
Financing gives you more room in your monthly budget.
Build Credit History
Auto loans count as an installment account, which many people with relatively short credit histories lack because they often don’t have a mortgage or have a short student loan history. New auto loans can contribute to the credit mix, which is used to determine your credit score.
Although it’s one of the smaller factors that impact your credit score, it still has a 10% weighting in the calculation.
However, a new auto loan can also impact the amount you owe and the average length of your credit history. This can ding your score temporarily, but over time, an auto loan should help raise your score, assuming payments are made on time.
Take Advantage of Low-Interest Rate Financing Offers
Car dealerships sometimes have the best low-interest rate financing offers, particularly for new cars.
You’ll want to shop around and have your financing lined up prior to wanting to buy a car, but I would look into what the dealership is offering.
The lower the interest rate, the less you pay in interest.
Plus, dealerships and the financing company often have arrangements where the dealership gets paid for new loans. This provides incentives for dealerships to offer better prices if you finance through them.
Sometimes, financing is the cheaper route to go compared to paying cash. Often, you can finance the car and pay down the loan immediately after taking it. Or, if your loan is required to be open for a certain number of months, you might be able to pay down the loan to $100 or another small amount to reduce the amount of interest you pay and then pay it off after the required time.
There are ways to finance a car and game the system to your benefit.
Disadvantages of Financing a Car
Although there are many advantages of financing a car, there are notable disadvantages.
Pay More Interest
Since you have a loan that presumably isn’t at a 0% interest rate, you’ll pay more in interest by financing a car.
However, the interest may be worth it if it gives you more room in your budget or allows you to invest the cash that earns a higher rate of return.
Hurt Credit if Not Managed Properly
Another disadvantage is that although an auto loan could help you build your credit, if you miss a payment or borrow too much, you may hurt your credit score. Like anything else financial, you need to use credit responsibly.
Temptation to Buy a More Expensive Car
Another disadvantage of financing a car not many people think of is that you may be tempted to buy a more expensive car.
If you go from buying a $25,000 car to a $30,000 car and you pay cash, that $5,000 is felt immediately.
If you go from a $25,000 loan to a $30,000 loan over 60 months at 2.5%, your payment will go from $444 a month to $532 a month.
Most people can justify less than an extra $100 a month because it’s less painful than the $5,000 upfront.
Be careful if you are financing a vehicle that you stick with what you budgeted originally.
It’s Not Yours
This one is obvious, but it’s worth mentioning because it is a psychological disadvantage.
Every time you look at the car, you’ll know it’s not really yours. The title is with the lender – not you.
Many people are used to the bank owning their car, but it’s a really nice feeling when you have the title in your possession and can do with it what you want.
Should I Finance or Pay Cash for a Car? – The Verdict
Whether you decide to pay cash car for a car or finance, don’t tell the dealer until you agree to a price. Ignore their monthly payment gimmicks by asking you how much you can afford.
I remember one car I bought where they tried to use a four-square method. Don’t let a dealership do this to you. It’s meant to confuse you with four different numbers to haggle over. Many people pay the most attention to the monthly payment because we think in monthly payments, but it’s really easy to manipulate the monthly payment.
You want to negotiate the price first, and then you can haggle over the rest and how you are paying for it.
Better yet, see if your dealerships have an internet car salesperson. Often, dealerships will allow you to input your name and phone number in return for a special online price. This is an easy way to comparison shop across many dealerships to find the one with the lowest price.
On top of that, the dealerships know people asking for quotes online are already price-sensitive, which means they often offer a lower price up front than you would get the first few rounds of negotiating at the dealership.
Summary – Final Thoughts
If you have the option to pay cash for a car, having the title and peace of mind that it is 100% yours is nice.
When approaching the dealership, don’t tell them whether you are paying cash or financing upfront. Negotiate the price first and then explore what financing options are available.
You may be surprised that you can get a better deal on the car and potentially a very low rate of interest.
There are advantages to paying cash for a car, but financing is a great option for those who have less cash or prefer not to deplete as much of their cash savings.
How do you think you will pay for your next car?