Find out the upsides and downsides of financing or paying cash for your next vehicle.

14 minute read

Hey, everyone. It’s good to have you back this week on the money girl podcast, I’m Laura Adams and I’ve been hosting the show since 2008. I’m the author of a bunch of books. Nine now. And I’m super excited to let you know that the most recent one is available as an audio book that I narrated.

So if you or someone, you know, is self-employed or maybe you want to be, you want to create a part-time side gig or even be a full-time solopreneur.

I hope you’ll check it out. The title is money smart, solopreneur, a personal finance system for freelancers entrepreneurs and side hustlers. It came out at the end of September, and I’m super excited that it’s been an Amazon number one new release. You can order the paperback, the e-book, or now the audio book for yourself or as a holiday gift. And if you’ve already purchased the book or the audio book. Thank you. Thank you. Thank you. I really appreciate your support. And if you liked it or found it helpful on your entrepreneurial journey, do me a quick favor and review it on Amazon audible.com or wherever you purchased it.

I would be so grateful for that. And speaking of reviews, likewise, if you’ve been enjoying the podcast, you can give me and the entire quick and dirty tips network, a thumbs up by rating and reviewing the podcast wherever you listen. All right, let’s get onto the show. Today’s topic was inspired by an email from Ryan S who says I’m looking into buying a car and have enough cash to pay for it. But someone mentioned that I should get a loan to get a lower price and just pay off the loan right away. They also said this could increase my credit score. Is it true? Thank you for your question. Ryan buying a vehicle is a really big purchase, so I’m glad you’re giving it careful consideration. This podcast will answer your question by reviewing the upsides of financing and the upsides of paying cash for a car.

We’ll look at the two and help you figure out what is best for your situation. Before you spend your cash. It’s really critical to understand how doing that will affect your finances going forward. You’ll find the notes for this and every show in the money girl section@quickanddirtytips.com. This is episode number 664 called should you buy a car with cash or get an auto loan? So it’s so terrific that Ryan has enough savings to pay for a car, but I want to caution you just because you have money in the bank. Doesn’t mean that spending it is the right move. First, let’s review some advantages of paying cash for a car. Then we’ll talk about the flip side of doing alone. So the biggest advantage certainly is that you avoid interest and financing charges. Paying cash means that you can save money by avoiding of interest payments on an auto loan.

And depending on your loan amount, the interest rate, the term, your savings could be thousands of dollars. So this is really going to depend on the loan that you qualify for. In some cases you may qualify for a 0% APR loan. And in that case, you really need to consider this a little bit more carefully because you’re not going to be saving anything in interest. You may save some money on some processing and underwear fees, but, uh, basically if you have an APR on a loan, you know, you’re going to avoid that. All right. The second advantage of paying cash is that you might buy a less expensive vehicle. So let’s say you’ve got a budget, maybe you’re saying, okay, I’ve saved up $15,000 and you know, that’s it, that’s all I’m going to pay for a car. If that’s all you’ve got, you may be more likely to stick to your budget that can help you avoid overspending, or maybe getting talked into financing, a higher price vehicle than you planned.

You all know what it’s like when you go to buy a car and you get swept away by a really good salesperson, or you fall in love with some special features of a vehicle that, you know, you hadn’t planned on paying for you, hadn’t planned on getting so, you know, it definitely can be an emotional decision. And if you’ve only got so much to spend that, can I think help take some of the emotion out of it and let you just, you know, stick to the numbers. The third benefit of paying cash for a car is you avoid getting upside down the average two new car depreciates about 20% the first year you own it. I mean, it’s just kind of the sad reality of buying a car. In most cases, they are not investments. You know, they are expenses. I need an order to get to work by the things we need to buy get around.

So that loss of value can really be a big problem. If you take out a loan and then you end up owing more than a car is worth, that’s known as being upside down. And when you pay cash for a vehicle you’re going to avoid that. You’ll always be able to pocket at least the full market value of a vehicle when you sell it, or you do a trade in. Also remember that paying cash for certain cars. Maybe you’re only option if that car, or you can not qualify for financing. This can apply to an older car. Maybe you’re looking at an antique or a collectible car. Some lenders will not finance vehicles that are purchased from private sellers. And those that do may charge you higher interest rates. So be aware that, you know, the type of vehicle, the age of the vehicle that you’re purchasing will also come into play.

All right? So let’s switch gears and talk about getting alone while paying cash mash certainly comes with advantages. There are some upsides of getting an auto loan. Number one is you maintain your cash reserve. If paying for a car would leave you with no or too little emergency savings in the bank, it’s a bad idea draining your bank account to buy a vehicle, or really anything could leave. You unprepared for an emergency, such as a loss of income or a high unexpected medical bill, unless you would still have a healthy reserve left over. I want you to think twice about spending your cash on anything except a real emergency. The right amount of emergency money is a little different for everyone depending on your work and your family situation, but a good rule of thumb that I often talk about is to accumulate at least 10% of your annual gross income as a cash reserve.

For instance, let’s say you earn $60,000 a year, make a goal to maintain at least 6,000. That’s 10% of your annual salary in your emergency fund. There’s another formula that you’ve probably heard me talk about. And that is to look at your average monthly living expenses. So these are your essential costs, the food, housing, insurance, transportation, all those things. You have to have take that amount and then multiply it by a reasonable period, such as three to six months. For example, if your living expenses are $3,000 a month and you want to have a three month reserve, you would need a cash cushion of $9,000. And the length of time that you need to consider really does depend on a lot of things. You know, it depends on what’s going on with your work. It depends on what’s going on with your family, or, you know, do you have two earners in your family or are you the sole breadwinner?

A lot of things can come into play here. So it’s really something that you need to decide for yourself, but these are rules of thumb that I think can get you started. And if you are listening to me right now, and you’re thinking Laura, I have nothing, I have zero in savings. You just have to get started. You want to start with a small goal, maybe saving 1%, maybe 2% of your income each year. You can also start with a target number. Maybe just say, you know, by the end of next year, I want to have $500 and then increase that amount each year until you have worked your way up to a healthy cash cushion, don’t worry. Yeah. You know, it might take a few years to accumulate what you really need and that’s okay. As long as you’re working on it, you’ve got that as a goal.

You just got to get started now and before you know it, you’ll lift your head up and go, wow. You know, I’ve got this nice emergency fund and I feel like I’ve got security. All right. The second advantage of getting an auto loan is that you might pay a lower purchase price for the vehicle. The advice that Ryan received about using an auto loan to get a lower purchase price on a new car may be correct. It really does depend where you get the vehicle. Many dealers offer rebates when you finance a vehicle through their company or through their financing company, because they make money on your loan, even when it’s a 0% APR loan. So if you’re considering paying cash for a new car, I would encourage you to ask the dealer for a side-by-side comparison of its financed cost versus the cash cost.

You know, it’s pretty counterintuitive to think that paying cash may cause you to pay more for a vehicle, but that’s just the reality. A lot of dealers are making money on those loans. So, you know, the, the fact that you can kind of whip out a bunch of cash, uh, you know, from your bank and say, Hey, look, I’ve got this cash offer for you. It really isn’t going to make much of a difference to many, uh, you know, many dealers out there. So have that discussion with them. As Ryan mentioned, you can take out a car loan with a dealer to qualify for purchase incentives, and then always pay it off early, pay it off the first month or the first year or whenever, you know, whenever it makes sense for you. Again, I don’t recommend using your cash to pay off a loan, unless you would still have plenty of emergency money in the bank.

The third reason that you might want to get an auto loan instead of paying cash is you can build credit. Ryan mentioned the possibility of an auto loan helping his credit, which is definitely true to build and maintain good credit. You have to have credit accounts in your name, and you’ve got to manage them wisely. Having a mix of credit accounts, such as revolving accounts and installment accounts is one factor in your credit scores, revolving accounts or credit cards and lines of credit things that just always stay open. As long as you make those monthly payments, the, you know, the account will stay open indefinitely. Uh, installment loans on the other hand are very different. They have a set maturity, a set time that you make the payments. And then once that period is over, the loan goes away. And so you want to mix of those different types of credit accounts that shows that you know how to handle them responsibly.

So taking out an auto loan can boost your credit if you make the payments on time. However, if you pay off an auto loan after having it for only a month or two, you probably are not going to see much benefit to your credit. So, you know, if it’s something that you’re going to hold for the longterm, I’d say, you know, at least six months, you know, years probably better. It can definitely help you build some credit, but if you just get it and then, you know, shut it down right away by paying it off, that’s still okay. If you don’t need to build your credit, you’re just looking to get that purchase incentive, getting that lower price on the car. No problem. You know, you can get the loan. There’s, there’s no law that says you can’t pay it off right away. Just remember that if getting good credit or building credit as your goal, paying it off quickly, you know, is not going to help you achieve that.

So before you spend your cash on a vehicle, ask yourself the following questions, would I still have enough emergency savings since the future is unpredictable? And you know, if 2020 has taught us anything, it’s that we never know what’s around the corner in terms of our financial situation, our job, our savings, you never want to raid your cash account without a very valid reason. And the reality is we should probably all be saving more right now, instead of draining our emergency money, unless you have a true, true emergency. If you don’t have any emergency money to fall back on using credit cards and racking up debt would probably be the only way to manage a hardship. And many of you listening may be in a situation where you’re doing that right now. And you know, you just are going to have to kind of stay the course.

Um, there may be relief down the road, doing your best to manage is, you know, all you can do right now. So another question to ask yourself is, am I saving for retirement before spending cash on a car or anything, you know, paying off any kind of debt, make sure that you are saving regularly for retirement. The sooner you start the better, not only to starting sooner, give you more time to contribute to an account, but it puts the power of compounding interest on your side. Let me give you an example. Let’s say you contribute $500 a month for 35 years, and you’ve got an average 8% return on your retirement account. You would end up with more than $1.2 million to spend in your retirement. But if you wait until 10 years before retirement to begin, you would have to invest over $5,000 a month to accumulate a million dollars by the time you’re ready to retire.

Um, there may be relief down the road, doing your best to manage is, you know, all you can do right now. So another question to ask yourself is, am I saving for retirement before spending cash on a car or anything, you know, paying off any kind of debt, make sure that you are saving regularly for retirement. The sooner you start the better, not only to starting sooner, give you more time to contribute to an account, but it puts the power of compounding interest on your side. Let me give you an example. Let’s say you contribute $500 a month for 35 years, and you’ve got an average 8% return on your retirement account. You would end up with more than $1.2 million to spend in your retirement. But if you wait until 10 years before retirement to begin, you would have to invest over $5,000 a month to accumulate a million dollars by the time you’re ready to retire.

If you have expensive debt, maybe credit cards or payday loans, paying them down could be a better use of any excess cash you have than spending it on a vehicle. For instance, you would come out ahead by paying a credit card. That’s charging you 27% APR and getting a lower rate auto loan. So maybe you get an auto loan that’s, you know, six or 7%. If you can use your excess cash and pay down that expensive credit card debt first, uh, that would leave you in a better position. Again, you still don’t want to raid your emergency fund to do that. You want to make sure you would still have plenty of cash leftover. Ryan did not mention if he has a healthy emergency fund, if he saving regularly for retirement or has any high interest debt. But if his finances are in good shape, there’s nothing wrong with paying cash for a car, nor is there a reason not to finance one to get a better price and then pay it off early.

However, as I mentioned, that won’t help your credit as much as making payments over time, as you initially agree with alone. So if you’re considering using all or most of your cash cushion to buy a car, the takeaway from this podcast is that doing that can make you more vulnerable to a potential financial hardship plus plunking down a significant cash payment may cause you to actually pay more for a car than you would by financing it. So I hope this show has helped you think a little bit more clearly about when it makes sense to spend your cash and when you need to hold onto it, if you have a money question or a comment I would love to hear from you. One option is to leave me a voice message by calling (302) 364-0308, or you can visit Laura D adams.com just like Ryan did, and send me an email using my contact page. That’s all for now. I’ll talk to you next week until then here’s to living a richer life. Money girl is produced by the audio wizard, Steve Ricky Berg with editorial support from Karen Hertzberg. If you’ve been enjoying the podcast, take a moment to rate and review it on Apple podcasts

Ryan S. says:

I’m looking into buying a car and have enough cash to pay for it. But someone mentioned that I should get a loan to get a lower price and just pay off the loan right away. They also said this could increase my credit score—is it true? 

Thanks for your question, Ryan! Buying a vehicle is a big purchase, and I’m glad you’re giving it careful consideration. This post will answer your question by reviewing the upsides of financing and paying cash for a car. Before spending your cash, it’s critical to understand how it will affect your finances.

Should you pay cash for a car?

It’s terrific that Ryan has enough savings to pay for a car. But just because you have money in the bank doesn’t mean spending it is the right move. First, let’s review three advantages of paying cash for a car.

1. You avoid interest and financing charges

Paying cash means you save money by avoiding years of interest payments on an auto loan. Depending on your loan amount, interest rate, and term, your savings could be thousands of dollars.

2. You might buy a less expensive vehicle

If you only have a certain amount of cash to spend on a car, you’ll have to stick to your budget. That can help you avoid overspending or getting talked into financing a higher-priced vehicle than you planned.

3. You avoid getting “upside-down”

The average new car depreciates about 20% within the first year you own it. That loss of value can be a big problem if you take out a loan and end up owing more than a car is worth, which is known as being upside-down. But when you pay cash for a vehicle, you’ll always be able to pocket the full market value when you sell it or do a trade-in.

Also, paying cash for certain cars may be your only option if they can’t qualify for financing. That could apply to an older car, an antique, or a collectible car. Some lenders won’t finance vehicles purchased from private sellers, and those that do may charge higher interest rates.

Should you get an auto loan?

While paying cash for a vehicle comes with advantages, here are three upsides of getting an auto loan.

1. You maintain your cash reserve

If paying cash for a car would leave you with no or too little emergency savings, it’s a bad idea. Draining your bank account to buy a vehicle could leave you unprepared for an emergency, such as a loss of income or a high unexpected medical bill. Unless you would still have a healthy reserve left over, think twice about spending your cash on anything except a real emergency.

The right amount of emergency money is different for everyone, depending on your work and family situation. But a good rule of thumb is to accumulate at least 10% of your annual gross income as a cash reserve. For instance, if you earn $60,000, make a goal to maintain at least $6,000 in your emergency fund.

You might use another standard formula based on average monthly living expenses: Add up your essential costs, such as food, housing, insurance, and transportation, and multiply the total by a reasonable period, such as three to six months. For example, if your living expenses are $3,000 a month and you want a three-month reserve, you need a cash cushion of $9,000.

2. You might pay a lower purchase price

The advice Ryan received about using an auto loan to get a lower purchase price on a new car may be correct. Many dealers offer rebates when you finance a vehicle through their company because they make money on your loan, even when it’s 0% APR.

So, if you’re considering paying cash for a new car, ask the dealer for a side-by-side comparison of its financed versus cash cost. That will help you understand the potential savings and if doling out your cash is worth it.

As Ryan mentioned, if you take out a car loan with a dealer to qualify for purchase incentives, you can always pay it off early. Again, I don’t recommend it unless you’d still have plenty of emergency money in the bank.

3. You can build credit

Ryan mentioned the possibility of an auto loan helping his credit, which is also true. To build and maintain good credit, you must have credit accounts in your name and manage them wisely.

Having a mix of credit accounts, such as revolving and installment loans, is one factor in your credit scores. That means taking out an auto loan can boost your credit if you make payments on time.

Questions to ask before paying cash for a car

Before you spend cash on a vehicle, ask yourself the following questions:

  • Would I still have enough emergency savings? Since the future is unpredictable, never raid your cash reserve without a valid reason. Without emergency money to fall back on, using credit cards and racking up debt could be the only way to manage a hardship.
  • Am I saving for retirement? Before spending cash on a car, make sure you’re saving regularly for retirement. The sooner you start, the better. Not only does starting sooner give you more time to contribute, but it puts the power of compounding interest on your side. For example, if you contribute $500 a month for 35 years and have an average 8% return, you’d end up with more than $1.2 million to spend in retirement! But if you wait until ten years before retirement to start saving, you’d have to invest over $5,000 a month to accumulate $1 million. A good rule of thumb is to invest at least 10% to 15% of your gross income for retirement. For instance, if you make $60,000, it’s wise to contribute at least $6,000 per year to a tax-advantaged retirement account, such as an IRA or a retirement plan at work, such as a 401(k) or 403(b).
  • Do I have high-interest debt? If you have expensive debt, such as credit cards or payday loans, paying them down could be a better use of excess cash than spending it on a vehicle. For instance, you’d come out ahead by paying down a credit card that charges 27% APR and getting a lower rate auto loan. 

Ryan didn’t mention if he has a healthy emergency fund, is regularly saving for retirement, or has high-interest debt. But if his finances are in good shape, there’s nothing wrong with paying cash for a car. Nor is there a reason not to finance one to get a better price and then pay it off early. However, as I mentioned, that won’t help your credit as much as making payments as initially agreed.

If you’re considering using all or most of your cash cushion to buy a car, the takeaway is that it can make you vulnerable to potential financial hardship. Plus, plunking down cash may cause you to pay more for a car than financing it.

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About the Author

Laura Adams, Quick and Dirty Tips

Laura Adams, Quick and Dirty Tips

Laura Adams is an award-winning author of multiple books, including Money Girl’s Smart Moves to Grow Rich. Her newest title, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, is an Amazon No. 1 New Release. Laura’s been the writer and host of the popular Money Girl Podcast, a top weekly audio show in Apple Podcasts, since 2008. She’s a frequent source for the national media and has been featured on most major news outlets including NBC, CBS, ABC FOX, Bloomberg, NPR, The New York Times, The Wall Street Journal, The Washington Post, Money, Time, Kiplinger’s, USA Today, U.S News, Huffington Post, Marketplace, Forbes, Fortune, Consumer Reports, MSN, and many other radio, print, and online publications. Millions of readers and listeners benefit from her practical financial advice. Her mission is to empower consumers to live richer lives through her podcasting, speaking, spokesperson, teaching, and advocacy work. Laura received an MBA from the University of Florida. Visit LauraDAdams.com to learn more and connect with her.

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