My wife and I recently financed the purchase of our Ford Escape and I couldn’t be happier, both with the vehicle and with our decision to finance.
Many people disagree with taking out a loan to get a vehicle. In fact, if I had a dollar for everyone that says you should pay for your next car in cash, I’d have enough money to retire and I’d currently be sipping a Mai Tai on some beach in Hawaii.
I don’t disagree with paying cash for your car. Heck, my last car I paid in cash and I loved every minute of the 6-plus years I went without a single car payment.
But today I don’t want to talk about paying cash for a vehicle. Today I want to discuss 3 reasons you should finance a car instead of pay cash.
1) Low Interest Rate
When you get an auto loan you can typically get the lowest interest rates on the market. If you buy new sometimes you can get zero percent interest for x number of months. Let’s assume you are buying used, though. If you can get anything below 3.5% I think that’s a huge win. Some of these low-interest loans are actually lower than inflation (depending who you ask).
While taking on debt to pay for a car may seem like a bad idea, it can help free up money to pay down higher-interest debt. Last time I checked mortgages interest rates were higher than 4%. Throw in student loans and credit card debt and you have a wide variety of areas that would be more advantageous for you to pay down compared to a rock-bottom interest rate car loan.
My wife and I got an interest rate of 2.19% on our five-year loan. We did it a little differently, though, where we actually got the loan (and money in our bank account) before we ever set foot on a car lot.
We got our loan through LightStream and the application was very short and painless. I applied in the morning and the money was in my bank account that afternoon. If you’re looking for a simple loan application I would highly recommend checking them out.
2) Build Your Emergency Find
Let’s say you have two options: pay for a car in cash or keep the cash and take out a loan. What should you do?
It depends who you ask. You’ve probably heard of Dave Ramsey or even went through his course. He recommends a $1,000 emergency fund while you aggressively pay down debt. I think $1,000 is far too low and you are better off having at minimum 1-3 months of expenses, preferably more.
I personally think it’s to your advantage to keep your cash liquid. While it might be nice not having that car payment, if you are disciplined with your savings you should be able to easily afford the monthly payments. After all, having the choice of paying cash or financing implies that you have enough cash in your bank account to pay for the car. If you set most of that money aside in an emergency fund (I say most because I’m assuming you will use some for a down payment) and don’t touch it, you are guaranteed to be able to make payments.
With so many potential unexpected expenses in life, as well as unexpected income in an ever-changing economy, I think you should keep as much cash liquid as you can. Plus, this is more of an ‘additional’ argument on top of the low interest rate you’ll get on your car loan.
3) Reliable Vehicle
In a previous post I talked about three things to consider when shopping for your next car. One of the things I touched on was reliability. As far as I’m concerned the older the car, the bigger the risk. Older used cars are more likely to break down and need repairs. Some of these repairs are potentially expensive and you could easily spend more on repairs than you did on purchasing the car in the first place.
Prior to purchasing our newer-used car my wife and I both drove two older cars, both purchased with ~100k miles on them. Mine has done well over the years and I got lucky and only needed some of the expected maintenance such as new brake pads. My wife, on the other hand, has had countless issues with her car and it seems like we’ve replaced most of the parts over the past few years.
I realize that newer cars can also require repairs, and those repairs might be costly as well. But they also are going to drive longer so putting $3k into a car with 40k miles on it makes a lot more sense than putting $3k into a car with 150k miles on it.
An additional aspect is safety. Newer cars *typically* have more safety features than older cars. You might have younger kids and want to provide a safer car for them. To get a newer car, you are going to have to pay more. Financing a car makes this possible. Additionally if you live in a frozen tundra like Minnesota it’s really, really nice to have anti-lock brakes and with some cars, 4 wheel drive.
What are your thoughts on financing versus not financing a car purchase? I won’t take it personally if you disagree! I know many in the “cash only” camp who have very legitimate reasons for being in that camp.
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All three of the items listed above are valid reasons to finance a car. 1.) If you have the cash and decide to invest it instead of paying cash for the vehicle, you’ll likely come out ahead 2.) owning a car outright doesn’t do you any good if you don’t have an emergency fund and your fridge stops working 3.) peace of mine is priceless. However, many people don’t finance a car due to any of these reasons – other than usually #3 because they haven’t saved up the cash to buy a new car. The #1 reason people finance a car (myself included) is simply convenience. It’s HARD to save up enough money to buy something as expensive as a vehicle – it’s like paying a bill that you don’t have to. Paying interest, for 99% of the population, is simply a convenience fee.
We have TWO financed cars right now. It’s never fun making monthly payments but like you’ve mentioned, the rates are so cheap it makes sense. We’ll probably pay them off early as we won’t want to hang onto the monthly payments for 5 years, but the student loan takes priority. So we’ll see when that gets paid off.
I think these are definitely valid reasons to finance – especially if you have higher rate debt you can throw your money at or have another opportunity where you can earn more. That said, I think in the future we’re going to do all we can not to have a payment. It’s largely as I really don’t want to take on a payment. It’ll depend on the circumstances at the time, but as of now I’d likely just look to finance it ourselves.
I have been thinking a lot about this lately as my 12 yr old car has just started showing signs of its age. I REALLY do not want a car payment but it is a huge inconvenience to constantly need repairs. I am lucky that I have an uncle who is great with autos but at some point I might need to throw in the towel. I just checked out Dave Ramsey & thought the same thing about having such a low emergency fund. Glad to hear I am not alone.
Sincerely,
Heavily Considering Financing :-)
I completely agree, DC. There’s no sense in paying cash when you can get rates this low. Congrats on the new purchase!
I am definitely in the camp of financing a car, especially when you have a low interest rate, and at 2.19%, you could easily invest the cash you would have paid for the car and make more than that in your investment account.
We got a really low interest rate on our car in 2012. It’s ridiculously low compared to what my siblings are paying for theirs! We also were able to pay for half of it in cash, so it cut it down even further.
There are plenty of sub-1% loans out there too. Even with that, if you are getting less than 1% at the bank, it may make sense to pay cash – assuming you have an emergency fund.
Evaluating the opportunity costs of a loan is huge. Evaluating the opportunity costs of keeping your old car just a bit longer is even more financially savvy.
We are already out of debt (don’t want to go back) and have an established emergency fund so paying in cash makes sense for us. We’ve been saving and plan to purchase one towards the later part of this year. I’d much prefer life without car payments.
I can see why you didn’t pay cash since you got such a low interest rate. It sounds like you bought a reasonable car that you can afford…and that is all that matters.
That’s a pretty low interest rate…there’s often a lot of places you can invest your money where you’ll get a better return. If you decide to, you can always pay it off…as long as there’s no prepayment penalty.
My husband and I are financing a 2011 Toyota Corolla that we got last year after my 1995 Mercury Sable bit the dust in the summer. I paid $1500 for that hunk of rust and probably paid well over $3000 in repairs the 6 years I had it. We only had $1000 saved up for a new car at the time (we had hoped mine would last another year). We needed a new car so we went to a dealership. My husband has little to no credit and some bad marks on his report so alone he would have faced a very high interest rate. My credit is great but I have a high DTI ratio, which I guess is something they don’t look at when you’re a co-signer? Together, we got an awesome rate of just 1.9%!
My wife just financed her car purchase. She got a rate of 1.75%. I don’t know how you can beat that and it frees up a lot of money to do other things. You know I don’t have issues with financing as long as you have a plan with your other money.
Of course you know I was exactly in the same boat so my response is really my article. lol! But I also totally agree with you that DR’s advice of 1k in an emergency fund is way too low as well. There are way too many emergencies that cost a LOT more than that!
I 100% agree, especially with the part about having a safe vehicle. We bought an SUV after the baby was born, and while I hate the car payment, it is worth every penny to have space when we travel as well as peace of mind. We’re trying to pay it off as quickly as possible though…
I can totally see the logic. If we needed a car and got a low rate, it would make sense to finance in many cases. I’m glad you have four wheel drive. I don’t think I could do a winter without it.
I can see both ways! I bought my last two cars using cash up front and I’m so used to the no payment car lifestyle that I ideally want to keep doing it that way. I think it also grounds you into getting a car you can truly afford because you have X amount of dollars literally to work with.
Spot-on analysis!
I’ve got an article coming out on Wednesday taking a similar spin on why you shouldn’t pay off your house early.
The problem is that debt has a negative stigma, so when someone says “I want to buy a car in cash,” nobody ever argues with them. The problem is that the analysis of this situation is usually done in a vacuum: “If I finance it, I have to pay 3% interest on this money for five years, and I have $30,000 available so why wouldn’t I use that to avoid this?”
The problem is that $30,000 invested in the stock market for five years (*IF* it is earning the average 7% returns) grows to $42,000. So, a $12,000 gain and you’ll pay about $2,300 total in interest on the car. This represents a net gain of $9,700.
Now instead, let’s say you paid for the car in cash, and invested the $540/month in the markets. What does that look like? Well, we know you’ve paid no interest in this scenario but your money did grow to $38,700. Otherwise $8,700 gained after 5 years.
The catch is that you have to be an avid investor for things to work out this way. If you’re going to pull your $30,000 out of the stock market to buy a car, but then you’re not going to invest the $540/month you’re saving, then you definitely should just finance the car. On the flip side, if you’re just going to end up cashing out that $30,000 on a European vacation or something, then financially speaking, you’d might as well just use that money to buy the car in cash. The decision ends up being very person.
Thanks for the great article!
David
In a low rate environment I agree you should finance a car. You do need to put enough down so that you won’t ever owe more in the loan than the value of the car.
DebtChronicles Thanks for sharing your perspective, Travis. I agree that it really does boil down to it being a convenience fee. Thankfully that fee isn’t very high, but it definitely is difficult to save up for a car purchase. It’s such a big lump sum that the only way to realistically pay for it in cash is through a few years worth of planning and saving.
BudgetforMore We’re in the same boat as far as having the student loan take priority. I would want to pay those off completely before even considering paying the auto loan down quicker. I really don’t mind the payment and would rather have the cash in my account and make monthly payments than pay it off earlier.
FrugalRules It’s hard to imagine not beating that interest rate in the stock market, but like I’ve said in the past I understand the psychological reasons for not wanting a car payment. It sure was nice not having one the past six years!
Catina That’s great that your uncle is good with autos, always a benefit when your car needs repairs or maintenance. I think financing makes sense if you are in the process of trying to build an emergency fund, as I would hate to wipe out my savings to pay for a car when I can keep the cash in my account “just in case.”
Laurie TheFrugalFarmer Thanks Laurie! I really don’t LIKE the psychological side of having a payment, but it definitely makes senses when you remove emotion and just look at the numbers.
blonde_finance Agree 100%, Shannon! I’m glad we are on the same page with this.
fitnpoor Sounds like a great deal for you! Sounds like you are in good shape, especially by paying half in cash.
No Nonsense Landlord I hear you about the sub 1% rate on savings and how it might make sense to pay cash. If I had money in addition to my emergency fund I would invest it, which (I would hope) pays more than 1 or 2%.
Brian @ Luke1428 I hear you, and I hope to be in your spot one day. I’d love to not have a mortgage or auto loan. At this point, though, it makes sense for me to take the low interest loan and focus on higher-interest student loans.
Holly at ClubThrifty Thanks for the comment, Holly. I know you aren’t a fan of payment so it’s nice to see you are open to other perspectives/opinions on the topic.
Andrew LivingRichCheaply Yep no prepayment penalty on my loan, which is one reason I am really happy with it.
debtperception That’s an AWESOME rate! Congrats on that! We also have put in about $3k in repairs in my wife’s car, maybe more. It really motivated us to get a newer car this time around.
DebtRoundUp 1.75% is amazing! It’s hard to say no to a rate like that.
Beachbudget Yeah I don’t know what emergencies that guy is facing, but $1k? Unbelievable.
RetiredBy40 We don’t have kids but I’m sure I will feel the same way when I do have one. It’s easy to drive older cars when it’s just you who has to put up with the consequences of a break-down or worse.
Eyesonthedollar I’m thinking we will get winter tires because I’ve heard really good things about them from those who went that route. With that being said, having them swapped out seems like a hassle.
DC @ Young Adult Money and that is why we didn’t. That is the great part about a credit union!
I’m with you on this, DC. My husband and I financed the car we purchased a few years ago for 0% interest and are on track to pay it off this year (one year ahead of schedule). Paying cash for a car is certainly preferable, but if you’re buying new or have something specific in mind (high fuel efficiency, for example), financing is sometimes inevitable.
Beachbudget
trshmnstr BeachbudgetI don’t care how much debt you’re in, $1,000 isn’t enough of an emergency fund and you risk going into deeper debt (likely at a high interest rate) if you do hit an emergency that costs well beyond $1k.
I also disagree with this idea of an “average” emergency being under $1k. An emergency is something like a collapsed sewer drain-out that will cost $4k+ to repair. That’s an emergency! Or a transmission going out and needing a replacement.
I think the ‘starry eyed’ comment is a bit demeaning and makes assumptions that aren’t qualified.
You could make a good argument for getting a car that has a near-zero interest rate and has 3+ years of warranty on it. It’s insurance against any major issues and actually will give you a buffer of time where you know you won’t have a $1-$3k repair bill or need to purchase a new car.
I have a feeling we’ll end up agreeing to disagree on this. The $1k emergency fund is a joke imo. Better than zero, but still shouldn’t be the max you are shooting for.
Great post! After buying two used cars in the past 7 years that both gave me tons of trouble, I recently financed my first brand new car and I couldn’t be happier. It’s so common to hear people fearing the dreaded monthly payment and questioning the logic of paying interest if it’s not totally necessary, but the simple truth is that, like you said, auto loan interest rates are incredibly low and unless you’re extremely well off financially, a monthly payment is going to keep your financial situation in much better shape than getting rid of a big chunk of cash all at once. I think it’s worth paying a little bit extra in the end to keep your financial situation comfortable. Like you said, if you buy used, high-mileage and end up with costly repairs, you’ll probably wish you had been making monthly payments instead of paying in cash…since you could now be using that cash to more easily cover the repair bills. Plus financing makes it easier to afford a new (or newer) car that may come with a warranty and will many years without problems. We’re talking tiny interest rates here, not those of credit cards, so why not take advantage of the flexibility?
We bought our vehicles with cash but I still don’t disagree with you, DC. :) As a whole, I don’t have a problem with people financing their cars as long as they are not doing it because they have to “keep up” by replacing their new car every two years or something similar. In that situation, which I know was not your situation, then no matter how great the interest rate is – you are not really getting ahead. But if it strategically makes sense to take a loan, then go for it.
PinkSunshine94 I definitely can see why people pay cash – I did so myself with my last car and I loved not having a payment! I agree with you that it really confines you to only purchase what you can afford. With a car loan it’s very easy for you to creep up to the higher-cost cars.
Charles@gettingarichlife Good tip about putting more money down so that you won’t ever owe more than the value of the car. This is something that I didn’t follow but probably should from now on.
HassleFreeSaver The 0% interest deals are definitely tempting, especially if you know for a fact you can pay it off in time. Definitely a good time value of money hack!
MarkThom Thanks for the kind words and thanks for sharing your perspective. We have a 5 year 100k warranty and it definitely gives me more peace of mind knowing that for at lest the next 3 years (minimum) I won’t have to pay more than the $100 warranty deductible on each visit, regardless of how major the problem is.
ShannonRyan Hey, I bought my last car with cash and I definitely enjoyed having no payments the past six years, especially since in that time I was finishing college and getting my post-grad life started.
It’s a tough answer in the aggregate, because it really depends on your situation, interest rates, and what other things you’d be likely to do with the money instead of paying cash.
But at 2% interest (and, say, .75% earned in a savings account) we’re kind of splitting hairs. When we’re talking a 1% delta between your choices, I figure you should just do what you think is best. You’re not going to go broke, or get rich, off any of the choices.
I bought my last car with cash but not everyone is in position to do so. Just this weekend a close friend had some terrible car issues and was pretty much told that she will need to replace her car after 12 years. She is not prepared to pay cash and she needs a car to get to work. So she’ll have to finance. I was checking some deals for her online and she can get finance for as little as 0.9%. That’s an excellent rate. This made her feel much better about her situation.
I think if you can get such a low interest rate, it makes sense. For his next car, my boyfriend is planning on putting down as much as he possibly can and will finance the rest. Mostly because he probably won’t have enough saved up to pay for it all in cash. I’ll be surprised if it lasts the rest of the year without needing repairs.
JourneytoSaving No I hear you, it’s really hard to save up for a car that is newer. I think it’s worth it to finance a good chunk of it, though, because you can avoid some of those expensive repairs that come out of nowhere.
I think if the interest is low and you’re sure can be disciplined paying back your loan, I see non problem in financing it. I personally feel ‘safer’ if I can pay the car in cash (who knows what’s going to happen in my life financially), but if it’s an emergency situation or if it’s a basic need, definitely go for it.
We financed our last car too, though I’m jealous of the rate that you got! Ours was still less than the mortgage and there were no discounts for paying in cash, so obviously we took the low rate and put our money to work somewhere else, where it was more productive!
I agree that taking out a loan to finance the purchase of an auto is not all that bad if you do it right. Yes, in a perfect world you’d be able to plunk to down your cash and walk off the lot with the car. If you can do that, great, but that’s not usually the way it works for most people. If you shop around for the lowest rate, buy a reasonably priced and economic vehicle, etc. then it’s perfectly acceptable to purchase via a loan. This is especially so if you can put your money to better use such as paying down other higher interest rate debt (as mentioned above in the article).
And, there’s nothing prohibiting you from paying down the loan faster than your minimum payments (most loans don’t have a prepayment penalty and, if it does, you shouldn’t take it). If you take that approach, the overall interest you pay will be fairly minimal.
SuburbanFinanceYes, to each their own. I almost like the payment for the same reason you like paying in cash: I don’t know what my finances will be like in a year, two years, etc. I’d rather have the cash on hand in case of an emergency or some other situation where it would be beneficial to not have my capital tied up in a vehicle.
I think paying cash is the best option if you have the cash to pay (when our car flooded during hurricane Sandy we fortunately had the money in our emergency fund to buy a new to us car). But a lot of people wouldn’t have the money to do so, and still need a car. So if you can get a loan at a low rate and pay it back quickly, I see nothing wrong with doing so.
StudentDebtSurvivor That makes a lot of sense. I can’t imagine having a car flood during a hurricane, it sounds terrible. I’m glad you had money to pay for a new one, though.
I’m so glad I don’t have a car — but if I did, I’d want to pay cash, but at this time in my life, I’d need a low-interest loan. Heck, it’s lower than my student loans that’s for sure!
deardebt That’s what I’m saying! It’s hard for me to imagine life without a car as I’ve had one for the past 9 years now and it would be really different to have to figure out other modes of transportation.