Is it a good idea to finance a car?
Key takeaways
Paying cash for your car may be your best option if the interest rate you earn on your savings is lower than the after-tax cost of borrowing.
Financing can help in emergencies, paying for large purchases, building your credit score, and freeing up money to invest. Cash is still king when it comes to buying non-essentials, keeping track of your monthly budget, and staying out of debt.
When you use an auto loan to buy a car, your credit score will likely take a slight hit due to the increase in your debt load and the hard inquiry that results when the lender checks your credit. Thankfully, the credit score should only dip a few points temporarily.
Financing is a key profit center for dealerships, which collect a portion of the interest rate or a fee when they arrange a loan on behalf of a bank, auto company or other financial firm. The financing also makes it easier for dealers to sell high-margin add-on products like insurance.
Reduced Opportunities. When you take cash out of your accounts to purchase a car, you reduce your potential investment opportunities in stocks, mutual funds, etc. A loan might make more sense to save your cash for investments. Remember that a new car's value depreciates as soon as you buy it.
Key takeaways
An auto loan can benefit you because it spreads out the expense of the car, leads to ownership and can help you improve your credit score. Some drawbacks to watch out for include being stuck with the same car for longer, possibly expensive monthly payments and the risk of damaging your finances.
Your best bet is to buy between October and January 1st. December is particularly ripe for deals, discounts, rebates and other incentives as well. This is because car salespeople are aggressively working to meet their monthly, quarterly and yearly quotas.
According to our research, you shouldn't spend more than 10% to 15% of your net monthly income on car payments. Your total vehicle costs, including loan payments and insurance, should total no more than 20%. You can use a car loan calculator to calculate a monthly payment within your budget.
Just because a lender is willing to offer a 100% loan doesn't mean that the potential borrower should take it. The risk premiums protect lenders. Borrowers bear more of the costs of their failure than the lenders, and sometimes their communities suffer as well.
What is a good interest rate for a car?
A good interest rate for a car loan is typically below 5.18% for new cars and 6.79% for used vehicles.
As described above, buying a car with cash has its pros and cons. If you have the funds, and if avoiding debt is important to you, then paying cash could be a great move. If, however, you need to build your credit, then consider going with a loan instead, particularly if you can get a good interest rate.
The credit score required and other eligibility factors for buying a car vary by lender and loan terms. Still, you typically need a good credit score of 661 or higher to qualify for an auto loan. About 69% of retail vehicle financing is for borrowers with credit scores of 661 or higher, according to Experian.
A lot of new credit can hurt your credit score. While many factors come into play when calculating your FICO credit score, you may start to see your auto loan raise your credit score in as few as 60 to 120 days. But remember, everyone's credit situation is different, so your results may vary.
If your credit score dropped by 100 points after you paid off debt, this could be due to changes in your credit utilization ratio or credit mix. It's also possible closing the account reduced the average length of your credit history, or that the drop in your credit score had nothing to do with debt payoff at all.
Paying cash may hinder your chances of getting the best deal
(If only all of us should be so lucky to have that kind of coin lying around.) If you do intend to pay cash, Bill tells us that's something you may not want to say right up front.
Some car dealers who issue auto loans (Opens in a new Window) in-house do prefer you finance with them, because financing is part of how they make money.
A down payment may help you to more easily qualify for an auto loan, especially if you have lower credit scores. Without a down payment, the lender has more to lose if you don't repay the loan and they need to repossess and sell the car. Cars can begin losing value as soon as you drive off the lot.
There are plenty of benefits to paying cash for a new car. Some of these advantages include: Spending less money: When you purchase a car in cash, you avoid paying interest on a loan and other lender fees.
Car dealers and auto lenders that do accept credit cards as a form of payment may also charge a convenience fee. This fee is often designed to cover the transaction fee mentioned above and can range from 2% to 4%. You should take this into consideration if you decide to purchase a car with your credit card.
Why should you avoid interest rate deals like zero percent interest?
Zero interest car loans usually come with a higher price tag, expensive extras and strict repayment terms. If you miss even one payment, you lose your 0% interest rate and get charged late fees.
Car payment statistics
The average monthly car payment for new cars is $726. The average monthly car payment for used cars is $533. 39.20 percent of vehicles financed in the third quarter of 2023 were new vehicles. 60.80 percent of vehicles financed in the third quarter of 2023 were used vehicles.
Pay with cash
Paying for your new or used vehicle in cash eliminates your interest costs and finance fees, which can save you thousands. It also means you will not make monthly car payments, which lowers the “transportation” line item in your monthly budget.
To make the cost more manageable, many drivers choose to finance their car with an auto loan. When you finance a vehicle, you pay for the car in monthly installments, rather than one lump sum. While an auto loan can help you afford a car more easily, there are also some downsides to consider.
January Comes After December
This is the top reason why January is the slowest month for car sales. It's not about the cold weather, but it all has something to do with the month before that – December. The last month of the year is the busiest, with the holiday season and many people go shopping.
