Pay Cash or Finance a Car?

Next time you buy a new or used car will you be paying cash or financing it?

It’s these big financial decisions that can really make an impact on your budget and ability to reach your financial goals for years to come. This is a tough decision, and with the way interest rates are looking it’s only gotten tougher over the past few years.

Like many personal finance decisions, there are mathematical and emotional aspects to consider. On one hand, you could compare your cost of financing (i.e. interest payments, higher insurance, affects to credit score and ability to borrow) with your cost of outlaying that much cash (i.e. your money could earn more elsewhere).

On the other hand, you’ve got some emotional considerations, mostly revolving around your wants and the act of incurring debt. For me, it’s not an open-and-shut case.

An Example of Cash vs Financing

Pay Cash or Finance a Car
Heck of a deal…

Let’s examine this potential purchase. I went to the Honda website and was greeted with an offer to purchase a new Civic for 0.9%. Let’s assume I’m a well-qualified buyer as the ad says is required. That means I could finance the new Civic for 0.9% over 5 years.

Let’s say I want the nicer model Civic and pick the one that costs $20,000. My payment would be $341, and my total interest paid over the 5 years would be…$460.87! If you are like me, you are saying, “that’s all!”. I ran the amortization schedule twice just to be sure.

But, yes, you would be paying a little over one extra car payment to have the ability to spread the purchase over 5 years. Using math as our guide, it’s fairly easy to suggest that financing is the best option. What could you do with $20,000 right now? Well, you could put it into a 5 year FDIC insured CD and earn 2.5% annually.

At the end of year one, your $20,000 investment into the CD would have netted you $500. In just one year your CD has already beat the cost of financing the car at the 0.9% rate.

But we all know that the math doesn’t present the complete picture. By taking on the $20,000 debt, you would be obligated to the financing company for at least 24 months. In our case, 60 months. You would have to get full coverage auto insurance based on the needs of the financing company. You would potentially decrease your ability to borrow money for a home (however, in some high-income cases, the debt may actually help).

If you’re not worried about debt or the short-term credit score effects, then the financing is the winner in this case. If you have an objection to debt, then no math formula is going to convince you. Just pay cash for the car. According to this NY Times article, that’s the number one reason people avoid car financing; they simply don’t want to have debt in their life.

Is Saving to Pay Cash for a Car Possible?

Backing up a bit, I think it’s fair to ask the question whether it’s possible to save up the $20,000 and pay for a car with cash. In our example, I had $20,000 lying around to make a purchase with.

This isn’t money that is in my emergency fund. It’s not money in my retirement savings. It’s money that was saved up, either over time or from a windfall, with the intention of buying a car. Who has that kind of money? Who is disciplined enough to save up that much money for a car?

Not everyone can or will be able to do this. But that doesn’t mean it’s impossible. According to the same article cited above, about one third of the people who pay with cash, pulled the money from savings. Another third are selling stock to make the purchase. We’re left to assume whether this was stock in an account designated for retirement.

So while it’s clear that some people are able to make this purchase, it’s not clear whether they are going about it in the smartest way.

To begin saving for your car, why not designate a separate savings account and start putting a “car payment” into the account each month? At a minimum you will have a very nice down payment when you decide it’s time for a new car, and then you could just pay off the car loan as quick as possible.

One last thing to consider here is that you don’t have to buy a $20,000 new car. You could opt for a used car; something in the $10,000 range. Or you could possibly opt for a car under $1,000 and possibly go pay for a car today without needing financing. Then, start working your way up to a nicer, newer car as you continue to save.

The Best Way to Finance

There are some things you should know about financing if you decide to go that route.

First, you should never walk into a dealership waiving the 0.9% ad that got you in the door. In fact, you should not tell the dealership how you are going to pay for the car. They will ask, but don’t tell them. Tell them you have options.

How you are going to pay has nothing to do with your number one goal: getting the best price possible for the car. That should be your sole focus; not payment, not interest rate, not down-payment. Focus on the price of the car you are buying. Get that number down as low as you can get it. Bring information from with you. Know what the invoice price is and what rebates there are available to the dealer.

Before you even step into the dealership though, you should have visited a local credit union or bank to secure your own financing. Credit unions have great rates (currently 2.75% in my area), and they will allow you to apply for the loan before you have the specific car in mind. You may not end up needing the credit union’s loan, but you just might. And it’s good to have that option when it comes time to pay. Or you can check out Fiona for other personal loan options.

Another thing to do before you go to the dealer is to check your credit score. If you have a top-notch score, you can demand top-notch financing. Having all of the information is key before you walk into this place. If you find out your credit score isn’t as high as you’d like, check out Experian Boost to see how they can help.

Back to the dealership. Once you’ve negotiated the best possible price for the car, now it’s time to talk financing. Tell them you saw the ad for the 0.9% financing and you want that rate. Tell them that you have a solid credit score and that you have very good deal on financing from someone else (don’t tell them how much). If they offer financing below what you can get with the credit union, then take it. If not, be willing to walk away or tell them you’ll just pay with the credit union financing.

At this point a dealership is in a tough spot. You’ve already got a solid price on the vehicle. So they aren’t making money there. Now you don’t even need them for financing, an area where they hoped to make some money on the deal. Given the choice of not financing the loan (and making no profit from the deal) vs financing for very little, the dealership is likely to give you the great financing rate you want.

Have you ever paid cash for a nice, new car? If so, why? Given the choice, what would you do, pay cash or finance a new car?

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  1. Quite frankly, regardless of time & place, it is usually better to pay cash for a car. Yes, it does diminish, somewhat, your ability to invest but to be free of car payments and all of the addes insurances needed to protect the car’s value…including “Gap.”

    Once you pay cash, you own it…as long as you understand that to make the cash payment worthwhile, you must keep the car 5 – 7 years to validate cash and not financing.

    That is the caveat!

  2. Avatar Bygracemichelle says:

    Fascinating article….I actually was asking myself the same question.  Do I pay cash or do I finance, pay off early, but have that rather large (to a woman, that equal’s security) emergency fund and buy a house with at least 10 percent down.  I’ve changed my mind so many times I’ve lost count.  The unfortunate bit is I love cars and I actually don’t mind the negotiations that come along with playing the car dealers off one another as all it takes these days is a few emails.  Case and point, I was curious as to a new 2012 Acura TSX might cost.  MSRP says $32k+; however, the dealers are very willing to give me below invoice at $27k.  Not saying I would pay that much for a car, but that demonstrates to me how bad things are out there and what kind of pull we consumers have.
    For me…I’d make do with a lesser car, pay around $15k….buy a house and aggressively pay down the student loans.
    Btw: please take no offense….but have you read what Consumer Reports has said about the 2012 Honda Civic?  I’ve talked three friends out of buying one.  I have a 2008 Honda Civic paid for with 115k miles and not a single repair EVER.  Good luck to everyone…. 

  3. Saved 10k for a car and could NOT bring myself to spend that much on a car. Ended up with a car for 7k and spent some of the difference on jewelry, shoes, clothes, etc. 🙂

    1. Avatar Philip Taylor says:

      Isn’t that how it always works? You aim for something you *think* you want and you end up making a smarter move in the end. Good for you!

  4. Avatar Francois Booyens says:

    Guys, you are so lucky! We here in South Africa pay an average of 8.5% interest on a finance deal! Not only that, our cars are taxed 103% import duty!! The cheapest Chevrolet here (called the Spark) costs 82,300 South African Rand, which is $12,205.00. The average income here is around R60,000 per year…

    So, come save your money here in SA at 7.5% interest in a normal saving account, and buy the car you want! 🙂

    Great article, thank u!


    1. Avatar Philip Taylor says:

      Thanks for the international perspective, Francois. If it weren’t for currency risk, I’m sure we’d all be taking you up on that offer.

  5. Avatar Eric J. Nisall says:

    I would have to say that I tend to lean toward taking the financing off (as long as it’s a great rate) and having the cash unencumbered and liquid. Other than that, I completely agree about having a plan before going into the dealership. Know what your credit score is, shop around to see what other dealers are offering in terms of packages for the model you are looking at as well as financing options. It’s ok to lie to them about having alternative means of purchasing the vehicle, and always be willing to walk away, even if it is just a power play. All excellent points of how to gain control over the situation.

    1. Avatar Philip Taylor says:

      So where would you put your cash, Eric? Do you have somewhere you’d keep it to get a decent return?

      1. Avatar Eric J. Nisall says:

        It would all depend upon the timing of the decision. A couple of years ago, I would have said online savings banks. Like you mentioned, even if you put the cash into a CD you would come out ahead of the interest. Plus, there are still some banks where you can earn more than the .90% interest used in the example above which would keep you totally liquid. My preference if to invest in high-yield dividend paying stocks at the current time. Sometimes, it’s not about the return but the comfort level in a situation.

        Personally, I’m not opposed to taking on debt if the advantages outweigh the drawbacks. For example, I am not one to put $20,000 into a car in one lump sum, nor am I handy when it comes to fixing them. I would rather have manageable monthly payments on a lease and not have to worry about maintenance, or worry about repairs down the road. That’s just my preference.

  6. Avatar cashflowmantra says:

    Not quite in a position to pay cash for a car as I have other debts that are taking priority in terms of payoff. You are right that you should negotiate the best price. First on the car, then trade-in if applicable, and lastly for financing.

    1. Avatar Philip Taylor says:

      We will need another car soon and I’m with you. There is another priority that may prevent us from throwing cash at the car purchase. The funny thing about my negotiation advice is that I hate using it. The car dealership is a drain to me, even though I know how to deal with them. Ignorance is bliss, when it comes to them I think.

    2. Avatar Matt Iwan says:

      unless you need a credit boost… Then the risk could be worth the effort, save more in the long run. And you buy something just out of your reach you’d normally not buy, even with cash.

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