Should I Finance or Pay Cash for a Car?

Should I Finance or Pay Cash for a Car? article image.

Ready to slap down a fistful of dollars to buy a car? Pump the brakes and check the map first. The cash-only approach can be the right way to go, but there are circumstances when a loan or another alternative might be the better option.

To decide, you'll need to evaluate your personal finance situation, credit history and long-term goals. There are pros and cons to covering the entire cost of a car with cash, so know what they are, as well as the full array of options.

Benefits of Paying for a Car With Cash

Buying a car with your own money comes with some distinct benefits. Some great reasons to use cash include:

  • Your expenses and other obligations won't be affected by a monthly car payment.
  • Since you're not dealing with a loan, interest won't be added.
  • You don't have to concern yourself with qualifying for a loan.
  • You won't get into—or add to existing—debt.
  • It reduces the chance of overspending on a car that's priced outside your means.
  • A car loan won't appear on your credit report, so it won't impact your debt-to-income ratio and your ability to qualify for other loans, like a mortgage.
  • It prevents the possibility of being upside down on a loan, which can happen when you owe more than what the car is worth.
  • If you run into financial trouble later, you won't have to worry about making your payments on time or defaulting on the loan.

Owning your car outright generally makes you more financially flexible as well. If needed, you can cut back on the level of insurance you carry since a lender won't be requiring a minimum level of coverage, and you could sell the car if you need some quick cash.

When Paying for a Car With Cash Might Not Make Sense

On the other hand, there are some arguments against using your own funds to buy a car. For example:

  • You might deplete savings that are necessary for current expenses or future emergencies.
  • You may not have enough to buy a safe and reliable car.
  • If you need to start or reestablish a credit history, paying with cash won't help, but a loan that you properly manage will.

If you're thinking of waiting and saving up cash because you think less-than-perfect credit won't qualify you for a loan, financing still may be an option. Special financing deals are sometimes available to people with lower credit scores, and you may be able to finance a car at a decent rate so you can go to work or school, or use it for your family after all.

When Is It a Good Idea to Finance a Car?

When you finance a car, you're taking out a loan. You might borrow the money directly from a bank, financing company or credit union, or use dealership financing, where the dealer arranges the loan via the financial institution it works with.

In any case, you would usually make a down payment, then repay the debt in equal monthly installments over an agreed-upon term (anywhere from 24 to 84 months). The lender may change fees to process the loan, which is added to the balance, and interest is built into the payments. The interest rate you're offered depends on your credit scores and other factors. Higher credit scores could land you lower rates, and vice versa.

Financing a car may be a good idea when:

  • You want to drive a newer car you'd be unable to save up enough cash for in a reasonable amount of time.
  • The interest rate is low, so the extra costs won't add much to the overall cost of the vehicle.
  • The regular payments won't add stress to your current or upcoming budget.
  • Low monthly payments will free up funds for your other necessary expenses.
  • You're certain you can and will make the payments on time.
  • You want to enhance your credit history with an installment loan.

Alternative Forms of Car Financing

If you don't have the cash to buy a car, but normal financing isn't feasible, there are other ways to get the car you want.

Lease a Car

First up is the option to lease a car, which is essentially a long-term rental. Leases tend to require an upfront payment, and then regular monthly payments for a fixed number of years, similar to a loan. When the lease expires, you'll either return the car, buy it or start a new lease on a different vehicle. Among the advantages: You can drive a new car every few years with affordable payments. Disadvantages include a host of fees and potential penalties, and a higher ultimate cost if you keep it after the lease is up than if you were to buy the car in the first place. Leases also tend to carry an annual mileage restriction, with fees enforced if the lessee goes over the limit.

Buy With a Credit Card

You may also consider charging a car to your credit card. Some dealers allow buyers to charge the down payment or even the entire cost. While there are some upsides to this method (if you use a rewards card, the accumulated cash back or points can be significant, and the minimum monthly payments will be small), the downsides are plentiful. Credit card interest rates tend to be very high compared to car financing rates, which will greatly increase the total cost of the vehicle.

For example, if you charge a car worth $25,000 to a card with a 20% APR and pay it off in equal installments of $662 over five years, the total interest would be $14,740. The monthly payment on a car loan with the same term and a 5% interest rate would be $472, and the total interest paid would be $3,307.

More, if you use up all or most of your credit line, it will drive up your credit utilization, which would almost certainly impact your credit scores negatively. For this reason, buying a car with a credit card usually makes sense only when you have the means to pay off the balance very quickly.

Explore Peer-to-peer Lending

Yet another possibility is peer-to-peer lending (P2P), which is a web-based alternative to traditional credit sources. P2P lending platforms connect willing investors with potential borrowers. Common platforms are Prosper and LendingClub. The upsides to P2P for car purchasing include competitive interest rates and swift loan processing. Downsides include loan limits that are often in the $10,000 to $25,000 range, and stricter credit score and income requirements than other lenders.

Weigh Your Options

Buying a car, either with cash or a loan, is always a major decision. Do so with full knowledge about your income capability, the final costs, and what really makes sense for you. If you're a first-time carbuyer, slow down and take all the facts under consideration. If you choose to finance, be aware that lenders will assess your creditworthiness to determine qualification and terms, so check your credit report long before car shopping. You can get a free copy of your Experian credit report and your FICO® Score .