When a car gets too old and repairs become too costly, it’s time to get a new one. The question of how you plan to pay for a new or used car is an important one. You are going to fall into one of two categories:
- You have the cash to pay for the car – if you so choose
- You do not have enough cash to pay for a car in full and must finance the purchase
If you don’t have enough cash to pay for a car, you obviously have to finance. But what if you do have enough cash to pay for the car? It’s not always obvious whether you should finance the purchase or not.
My First Car – Paid for with Cash
When I bought my first car, I was lucky enough to pay for it in cash. I bought it after my first year of college. One of the big reasons I could pay for it in cash is because my Dad bought a car for my sister and I to share in high school (nothing amazing, but we weren’t complaining). Thankfully my parents hadn’t cut me off until after high school! Anyway, paying for my first car in full was a great feeling because I had no monthly car payment to worry about. Especially considering the fact I was a broke college student, it was nice to know I had reliable transportation and no monthly cash outflow because of it.
Fast forward a few years and I’m still driving that same car. I’m approaching 215,000 miles so I’m not sure how long it will last before it needs a big repair, but it’s been pretty amazing not having that monthly car loan payment. As I’ve started to research my next car purchase, there is one thing that I find really interesting: dealerships will try to entice you to purchase from them because of the favorable interest rates and other financing packages they have to offer.
The Financing Dilemma
Even if you had the cash to pay for a new car, it might not make sense to pay in cash for a car when you can get ~2% interest rate on the loan. Inflation is higher than some – perhaps even most – auto loans, and likely will only increase in the future (that’s for another blog). Besides that, if you can get financing at a low rate and can invest the money elsewhere for higher return, you would be missing out if you paid cash for a car.
Instead of paying cash for a car, you could take that money and invest it in stocks or a small business. With so many financing options available through your car dealership, local credit unions, banks, or through companies that specialize in auto finance, there will usually be someone willing to provide a low interest loan for your auto purchase.
While I understand the psychological reasons to pay cash for large purchases if it’s an option, I think it’s important to consider the opportunity cost of going that route.
What do you think? Is it better to pay in cash and not have the monthly auto loan payment or does it make more sense to take the financing and invest your cash elsewhere?
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Normally I would be all for paying cash, but with dealer finance rates ridiculously low (1% is offered by multiple companies where I live) it makes more sense to save up the money, invest it in a TD or other secure manner and take the cheap credit. Investing in TDs probably won’t return as well as stocks, but it’s guaranteed profit opposed to taking a chance on stocks.
financialindep I agree. It’s hard to justify paying cash for a car when you can take advantage of essentially guaranteed profits.
I always pay for my cars with cash but then they are usually only 1500-2000 dollars. With the wifey we tend to get a more expensive car and unless its under 5k im not going to pay cash unless we have everything else in order. Depends on the person and the situation. Some people are not going to invest the money anyways so they are better off just paying cash. I would say never pay cash unless you have a significant retirement fund and emergency savings. Why pay 15k for a car and lose your job and have no cash on hand.
YourDailyFin That’s a great point. If you don’t have a large emergency fund, why not put the money there in case you hit hard times? Makes sense to me.
I guess in a situation like that I would take out a loan and invest the money. I don’t feel that same way about paying off mortgages, primarily because a mortgage loan is so large, but with a car, if the investment did tank, or even if it didn’t, it would likely be easier and quicker to sell the car than it would the house.
Laurie TheFrugalFarmer Great point, Laurie! Mortgage debt is a different ballgame, though I still find it hard to get motivated to pay it off faster when the interest rate is so low.
I hate car payments and have vowed to never have one again. I just think that it takes too big of a bite out of my budget, even if it’s a small car payment.
Plus, I think paying in cash keeps the real cost of the car in perspective. It’s easier to get a nicer can than you planned if it only costs you $50 more per month.
Holly at ClubThrifty That’s a fair point, Holly. Cash flow and how it impacts your budget is an important thing to consider, and I totally agree that it’s way easier to get a more expensive car when you don’t have to pay for it all up-front.
I wouldn’t invest the money for a car in stocks or a small business. Why? Time. Most car loans are four years or less. If you’re investing money in the stock market or a business with only a four year time frame, you’re absolutely nuts. Historically that’s way too much betting for me. You’re far more likely to win if the investment is 10 years or longer.
AverageJoeMoneySome of us like to gamble, though :P Just kidding, you’ve got a point. I did not think of the investment horizon.
If we are getting a car loan with relatively low interest rate then I would go for a loan. It all depends on your financial situation also if you can pay out cash upfront for your car.
Rita PI definitely agree! That’s why I made a point at the beginning of the post to distinguish who would fall under this category. If you don’t have the cash and need to get a loan you don’t have much choice in the matter.
We actually have this option right now and we’re going to pay with cash. The reason is that our alternative is not investing in the stock market but keeping it in savings for another car in a couple of years or a down payment. That returns is small and not worth the loan interest in my opinion. Regardless, you also need to factor in the possibility that you may lose your job, become disabled, or something of that kind and would no longer be able to afford the monthly payments from income. In that case you would need reserves around to foot the loan bill, so investing in the stock market may not be the best choice for the funds anyways because of the risk.
Matt @ Mom and Dad MoneyGreat points, Matt! If you don’t have a large enough emergency fund, you probably shouldn’t be paying cash anyway since you might need that liquid capital to help you through the hard times. Actually I think I just argued a counterpoint to your counterpoint? haha
There are some cases when you can finance for 0% and I would jump at that. Why not keep your cash flow and not have to pay a penny in interest? I would even go with an auto loan at 2% because I can invest that money long term and it grow for me. Joe makes a good point, but if I was going to invest it, I would put it in for the long term, not just the time for the auto loan. I wouldn’t have that option if I paid for the car in full.
I have a similar post going up soon DC, so you beat me to it.
DebtRoundUpNo worries, I look forward to your post as well. Joe’s comment makes me stop and think about whether I left out an important variable (investment time horizon). If it’s a zero percent interest loan for 5 years I would almost 100% go for it, though. You could at least get some small return in a conservative investment.
I think it’s definitely better to pay in cash. My first two cars I paid cash. Actually I onlypaid $20 bucks for my car because iI bought it from a social service company that wanted to get rid of it. Lol Anyway now I pay $325 a month for my car. Although I love my car I wish I would have just paid cash. That $300 could have went toward paying down my student loans or towards my house fund.
MonaSezI think not having that cash outflow each month is the top reason to pay in cash. I have definitely enjoyed not having a car payment the past 5 years.
It’s so very hard for me to recommend financing a car, just on principle.
But low interest rates have distorted things so much, that sometimes it DOES make sense.
But it’s not something I’ve done before, and it’s unlikely that I will
No Accouting For WasteFair enough and I really am on the fence whether it’s worth it or not to try to take advantage of the distorted interest rates. I most likely will (assuming I have the cash on hand for my next car).
I WISH I could’ve paid for my car in cash but I didn’t have many options. I only worked part time and most of my money went to paying for college and medical bills so I had NO savings at all. I did get approved for a higher loan but decided to go for a cheaper and more reliable car. But my friend paid for hers in cash but she also is able to get on her mother’s insurance. I have to pay for my own.
Paulette Mensah Yeah if you are in the position to pay with cash it’s a nice place to be.
I will always pay cash for my cars now that I am out of debt. Being free from debt provides more benefit than raw numbers would suggest. Not to get all philosophical on you, but having no debt does wonderful things to your psyche. I truly believe that when you have no debt, you are more confident, and that confidence leads you to increase your income in ways you never imagined.
ayoungproI agree with your psychological argument, but let me turn it around on you – Donald Trump has tons of debt, but on paper he is worth $1B+. Even if you have debt you have to look at your paper net worth and not think of the debt as if it’s in a vacuum ;)
DC @ Young Adult Money Haha, good point DC! I think the Donald, and indeed probably other people, has the ability to be supremely confident even while taking on lots of debt. Sadly, I don’t.
ayoungpro Haha fair enough
I’m getting really sick of seeing that finance payment go out of my bank every month, cash all the way for me next time.
MoneyBulldog I can’t blame you, it’s really nice not having a car payment!
Hi DC! You make a good argument for putting the money elsewhere. Like you say, if you get the right financing terms and you don’t mind the monthly payment, putting that principle elsewhere might be the better deal.
I just bought a laptop on credit because it’s 0% interest for the first six months. Strategically, it makes more sense to take advantage of the 0% interest and buy it on credit and then use that $800 towards our 30% store credit card. Saving Win/Win!
Lindsey at SenseI actually financed the new fridge and range for our rental apartment on a similar 0% interest plan. It was great because I could spread out the purchase over the course of 4 or 5 months and use the income from the rental to pay for them.
DC @ Young Adult Money Lindsey at Sense
It’s a good idea. You use the extra monthly income to pay for the purchases and there’s nothing come out of pocket. What could possibly be better?
We paid cash for our vehicles. I understand your point and agree it’s worth considering as long as you have a long-term investment perspective as Joe mentioned. Otherwise it would be too risky since the four years might be bear market years. :) And are disciplined to actually invest the money rather than use it towards something else.
TheHeavyPurseI really need to think about Joe’s point more. It seems to make sense but I also feel like I’m missing something or there’s some counter-argument that I’m not thinking of.
This is an interesting question because there really is no right or wrong. First off, I would make sure I had enough money to purchase the car in cash before I actually bought it. I would then decide if that money should be spent on the car, or invested while paying monthly payments. I think if I could get 0% on a “loan” for like 36 or 60 months, I would just keep the cash and invest it. If I was paying anything more than 0%, then I’d probably just fork out the cash upfront.
CommonCentsWealth Yep, there really is no right or wrong answer.
I would definitely finance if I could get a great deal on a used car financing, but that’s highly unlikely as my next dream car is a 2006 Mazda5 (yep I want a minivan!) Personally, I can’t buy a new car ever but everyone’s needs are different (I’m a light driver) so if going new with 0% interest is your plan, I say go for it!
I think I would rather pay for my next car in cash. There are good deals out there to take advantage of, but I’m not sure if I would want to deal with a monthly payment. I think there is also a slight psychological aspect where I’d also feel really proud of myself for being able to do something like that.
If you truly do invest the money in something that will further your wealth or career, I’d say low interest financing is smart. If you are like my former self, you might be tempted to spend the extra money on things that do not build wealth or further your career, but I think you’re too smart for that.
I’m probably be more inclined to pay in cash for the vehicle. I can’t imagine your insurance being cheaper for a financed vehicle versus one that you own. Plus for me, the psychological benefit of not having the monthly payment.
I just paid off my loan but it wasn’t that big of a deal. I think that the personal finance community makes loans to be bigger deals than they really are. Car loans don’t have that high of interest rates and in my opinion, if you know even the slightest about investing and even with a relatively safe investment, you can make more in interest than you will incur with a loan.
I have a 3% savings account so anything under 3% I would finance, although the mental drain of having monthly payments is not really worth it, it would free up some cash for other investments that may bring over 3% in return and make it a good move.
If I can be able to save up enough money, I would rather buy the car cash. However, if I have enough cash flow to help me make monthly payments plus insurance comfortably and a secure job, financing could be an option if I can get a good deal.
I paid cash for my first vehicle, and we’re planning to pay cash for our next one as well. It does seem tempting, if you’re making a 6% average return a year, that means you’re only pulling in 4%…is it worth the risk? I’m not sure. And although I can get a 0-2% for a new car here, last time I checked, auto loans for used cars were slightly more expensive – about 3-4%. I’ve had my car for over 10 years now, and I like not having to worry about a car payment.
This is exactly what I plan to do with my next car! My current car is 9 years old so its time for a new (used) car soon but I want to wait and buy it only in cash. That would be awesome!
It would be difficult for me to justify financing a car I could pay for in cash. Perhaps with a house, yes but I don’t think I would with a car. It’s mostly just personal preference, but I’d still consider the option. I just like buying cars outright and not having to make payments.
When I bought my scooter I paid for it using a credit card that had a 1.9% rate for 12 months. I worked out it was better to pay the minimal interest on the CC and keep the money in the bank for 12 months, than paying cash straight up. I also negotiated a great deal on my scooter so I was pretty happy with that purchase :)
I used to only pay cash for cars. The first four. I bought ones I could “afford,” though so they were usually beaters. They all died within six months. Then I financed. I spent a good bit of money, but it was totally worth it. Seven years later I still have the same car and it’s paid off. I’m not spending a ton of money on repairs, either, which was about the same cost as my payments every month when I had them.
Brian and I don’t have a car right now, but we bought our first car in cash. It was great not having a monthly payment, but boy, gas and insurance still added up!
I think it really depends on the interest rate. If I was getting a ridiculously low rate, it would make more sense for me to use that money to pay off my higher interest debt (though if I had the money to buy a new car, why didn’t I pay off my student loans first? Ha). I’d also consider where I am in life: If I have an emergency fund separately, then I would prefer to pay cash for the car.
I did not need to finance my car but needed to establish credit. I no longer own a home so I financed my car since the rate was so low. It turned out that 6 months later I lost my job after 13 years and was out of work for 9 months. I was grateful to have the extra liquid cash. My car payment is low because I put a large deposit down and I bought a 3 year old car. Whew!
I am not sure if I would pay it off once I get a permanent job. I am a contractor at the moment.
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Not to get all philosophical on you, but having no debt does wonderful things to your psyche. I do agree with http://www.livefyre.com/profile/19917816/ “You make a good argument for putting the money elsewhere.” that principle elsewhere might be the better deal
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