Should I Finance a Car or Pay Cash in 2018

Should I Finance a Car or Pay Cash in 2018

Posted on September 25, 2018

There are reasons for and
against financing a car or paying cash. It can seem like a smart idea to buy a
car you can afford to pay cash for. It might also seem like a good idea to
bolster your credit by purchasing with financing and paying it off quickly with
cash in hand. The good news is: both are smart. The other news? Those aren't
the only reasons to choose financing or paying cash. 

The Difference
Between Cash and Financing

The major difference
between buying with cash and financing a car is in the interest to be paid.
Cash payments have no interest added on, obviously, but are limited to the
amount of cash on hand. With financing, a monthly payment is made and that
includes some interest, which is the profit the financing company makes for
loaning the money. 

The downside to paying cash
is that the limit is where the cash ends. A buyer with $10,000 to spend may
only be able to afford an $8,000 or $8,500 car because taxes, registration, and
other costs will come over and above the purchase price. That same $10,000
applied to a finance deal as a down payment could mean the purchase of a
$20,000 car that is far better than the $8,500 car and with a very low amount
of interest because of the large cash payment. Financially, that second
scenario can be a win-win.  

Flipping that, if the
vehicle is the right one and the price is right, then cash is usually preferable.
No dealership or seller will balk at the idea of a buyer handing over cash
money or writing a verifiable check for a vehicle purchase.  

Understanding
Interest Rates

The other question about
whether you should be financing a car or pay cash this year is with the
interest to be paid. On a loan such as the one outlined above, the interest
rate is likely to be very low. A person with a great credit score and plenty of
cash to spend is in a far better position than is a person with little money to
spend and the same great credit. But there is more at play. 

Financially, having money
in the bank (savings, invested, etc) is preferable to having money spent. If
inflation is at two percent and savings accounts pay out three percent, you'll
profit by one percent on your basic savings investment. Other types of
investments can boost that much higher. A simple investment that makes about
five percent may be equal to or better than the interest being paid on a good
vehicle loan. 

As an example, a buyer with
good credit has $20,000 in the bank as cash on hand. That buyer sees a vehicle
they'd like to purchase and makes a deal to purchase for $18,000. Financing the
vehicle yields a 2% interest rate loan with a $5,000 down payment and a total interest
cost of about $300 plus $100 in fees. Obviously we're using nice round numbers
to keep the math simple. Investing the other $15,000 in a long-term savings
lock like a certificate of deposit or similar would yield 3% interest,
compounding annually. That savings interest totals nearly $1,400 in profit.
Clearly paying cash for the car is not the better deal. 

Building
Credit