It’s time for you to get a new ride, and you are weighing your financing options. You have ruled out leasing, so you are down to two options: buying a car outright, or getting an auto loan.
Among car buyers in the U.S., 43% opt to finance them while 36% buy them outright, according to data from Statistic Brain (the remaining 21% lease).
Here’s a look at the pros and cons of cash versus financing and what you should consider.
Cash or Loan: Pay cash for a car vs. getting an auto loan
Paying cash is simple. You find the car you want, pay for it and own it. The only cost is what you pay the seller for the car. You can reduce what you pay out-of-pocket by trading in an old vehicle. No financing is required, which means no interest or fees. You don’t have to worry about monthly payments or carrying any debt as you will own your vehicle free and clear.
While this sounds good because it will cost less than getting a loan and is more convenient, there are some potential disadvantages. First, consider that by paying cash you are missing an opportunity to build up your credit. Second, when you spend your cash on a car, it will not earn you any more money. In fact, cars depreciate as you drive them. So the question you need to ask is, could that money be more beneficial to you if it was used to make investments instead? If the returns on your investments cover the financing costs of an auto loan and then some, getting a loan will be more beneficial than having had paid for your car in cash.
Compare the pros and cons to make a better decision.
- Save money because you don’t pay financing costs
- Peace of mind in knowing you own your vehicle
- The convenience of no monthly payments
- You may be able to earn returns on your money if you were to invest it while getting a loan for the car
- You are missing an opportunity to build a positive credit line
Getting a loan
If you get a loan for your car, it is in your best interest to shop around to find the lender who can offer you the best value in terms of interest rate, loan terms and service. This takes time. You will also have to pay for financing, which will add to the cost of the car. And obviously, you will have monthly payments and won’t own the car until it’s paid off. However, you will be building your credit, assuming you make timely payments and will have the cash you would have put up on hand to use as you see fit.
Compare the pros and cons to make a better decision.
- Build a positive credit line
- Have cash available to invest elsewhere and increase income
- Pay more for the car because of financing costs
- Need to invest time in vetting lenders to find the best deal
- There’s an inconvenience in making monthly payments
- Investments have inherent risk and you could lose money
Which is better?
Whether paying cash for your car or getting an auto loan is better for you is going to depend on a few factors. You’ll need to ask yourself the following questions:
- How much will your auto loan financing cost?
- What is the estimated return on investments you will make using the cash that would otherwise be invested in your car? Are you experienced and confident with making investments?
- Do you have a personal preference in terms of convenience and peace of mind?
- Do you want or need to build your credit?
You will want to weigh the financing costs of an auto loan against the potential returns of making an investment. If you can likely make more by investing, getting a loan will be a reasonable route to take. However, there is inherent risk involved with investing and so the possibility of losing money and still having to pay off your loan should also be considered.
The more experience and confidence you have with making investments, the higher the likelihood this option will be beneficial to you. For those who have little experience with investing and want to minimize risk, you probably will be better suited to save on the financing costs and pay cash. Another option is to hire a trusted professional with a good track record to manage investments for you. In this case, the costs of hiring a professional and the potential returns would have to be weighed.
Your personal plans and preferences will also play a role in this decision. If you highly value the peace of mind gained from owning your vehicle in full and not having any payments, paying cash upfront probably will be better for you. Similarly, if you don’t like the risk involved with investing, paying outright eliminates it. However, if you don’t mind carrying debt, are OK with taking calculated risks and are interested in building your credit while trying to make as much money as possible, an auto loan should be considered.
Here’s an example of one scenario to help you determine whether getting an auto loan and investing your cash is a good financial move.
In this example, you would break even if you could make at least $1,595 over four years by investing your $18,288; a minimum return of 8.7% over 4 years, which is an annualized return on investment (ROI) of 2.11%. If you estimate you could make more than that, getting a loan and investing would net you more money.
By figuring out what minimum return you would need to break even on your car financing costs and what returns you estimate you can earn on investments, you can decide whether getting a loan and investing is a risk you are willing to take.
Find a good lender
If you do decide to get an auto loan, it’s important to shop around to get the best rate and terms. Keep in mind the better the deal you get, the easier it will be to make up the loan cost and to start earning profit from your investments.
Many lenders are now online so you can easily get quotes and compare them. For example, Lightstream is a leading provider of unsecured personal loans that can be used to finance cars. They offer very competitive rates, especially for applicants with good to excellent credit. You can apply online and get approved as soon as the same day. LendingClub is another good option. It’s the world’s largest lending marketplace for loans and offers competitive rates. You can also easily apply online.
If you’d like to review an extensive list of auto loan companies in one place, check out our auto loan prequalification tool that makes it easy. Answer a few quick questions and we will provide you with a list of recommended lenders you can review, get quotes from and compare against each other. Then you can choose the lender that provides you with the best deal.
The answer to whether you should buy a car with cash or a loan depends on a number of factors. Now you know what those factors are and how to evaluate if investing is likely to provide profitable returns or not. Weigh the risks and benefits as well as your personal preferences to make the right call for you.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.