Car Loan or Pay Cash?

Jul 16, 2013 by

Question markI paid cash for the first car I ever owned. Well, co-owned actually. The summer between high school and college a buddy and I split 50-50 the $250 cost of a 1963 Cadillac Eldorado convertible. Red with a white leather interior, the car was in great shape and unbelievable to drive. It also got 9 miles per gallon and demanded premium gasoline. At the end of the “summer of fun” we sold the car for $350.

I Get a Car Loan

After college, not just broke but also rather seriously in debt, I borrowed even more money to buy a new Dodge Colt, a cheap but serviceable car that I needed to commute in the Washington, D.C. area where I’d landed my first job. Why I bought a brand new car, I don’t know. In retrospect I’d say that was dumb, especially considering my circumstances (again: broke and rather seriously in debt). But hey, they don’t teach you that kind of stuff in college; I had to self-educate!

I Get Another Car Loan

After working for a couple of years, I soon fell victim to that mostly male affliction: car envy. I fell in love with the redesigned VW Jetta. Not only did I love the car, being of Teutonic heritage, I always wanted a German-made car and VW was the only German brand I could afford. I couldn’t resist the Jetta’s siren song, and my income had steadily increased so I could readily handle payments (though I was still in debt!). I made another dumb decision and got rid of the Colt though it had only 45,000 miles on it, so I absorbed the first two years’ depreciation then “traded up” to the Jetta. And I got another loan to help pay for the Jetta, though I did make about a 50% down payment on it.

Here’s where I started getting smarter. I began to better understand that debt sucks. I accelerated payments on the Jetta loan and paid it off in about 18 months. Even better, I loved that car. I kept it for over 10 years and put over 250,000 miles on it, then sold it for $500.

My Last Car Loan

First me and then my wife and I have owned a few cars since the Jetta, but we’ve saved until we could buy the car outright for cash. No more car loans. And with one exception we’ve bought used. I once bought a Hyundai Elantra wagon new because it cost $12,000—comparable to the price I was seeing for similar small wagons of other makes. And until a guy made—unfortunately right in front of me—an abrupt U-turn across four snow-covered lanes of traffic on the busiest street in Minneapolis, the Elantra was a good car for us.

Save to Pay Cash for a Car or Get a Loan?

I know very well that some folks simply do not earn enough to both pay their current bills and save up enough to pay cash for a decent (used) car. But for those who can make the choice, what do you recommend?

You may be working hard to become debt-free. Taking on a loan when you could—even if over the course of a few years—save enough in a planned savings fund to pay cash for a car may rightly feel like a step backward.

But what if one of those 0% or 1% financing offers comes along and you think to yourself, “hmmm, I could finance the car, invest the $10,000 in our car fund, and come out ahead, even with the debt!” That may make mathematical sense—if you don’t have bad luck with your investment—but you can’t help but feel that taking on more debt is the wrong thing to do, no matter what.

Paying Cash for a Car Ties Up Your Money

Also, depending on your cash resources, borrowing money cheap could make more sense than spending a large part of your cash savings on a car. You need an emergency fund. If you’ve got $12,000 saved but spend $10,000 on a car because you don’t like debt, you may be shooting yourself in the foot if one of the household breadwinners gets laid off next week, to give just one example. You may be able to take a loan out on the car after purchase, but maybe not if household income has dropped and surely at a higher rate and with more fees than you could have gotten at purchase.

What Do You Think?

Do you save up to pay cash for cars, or do you always get a car loan? Even if you had the savings set aside, are there circumstances in which you’d suggest a loan would be a better way to go?

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  • I currently have a car loan. I didn’t have the cash upfront to pay it off completely, but now I do and I just haven’t paid it off. I’m okay with my monthly payments. My interest isn’t that high. But I am paying it off really early.

  • John S @ Frugal Rules

    I think it depends on the situation, though if you’re already in debt then I would avoid the car loan. I think if you can get a really good rate then a loan would be ok, though I would keep it as short as possible. This is, of course, assuming that you’re not giving it to car envy and not overbuying for the car. We’re loan free and plan to drive our car for at least another 10 years and give it to our oldest when she’s ready to drive.

    • Yes, for some people, taking on even 0% or 1% debt would be a bad idea. The more debt payments you have, the less you can tolerate any interruptions in income, whether voluntary or involuntary. Even zero interest debt takes away some freedom and makes you a bit more vulnerable to any misfortune.

  • Joe

    I paid cash for our last car and I hope it last at least 10 years. I liquidated some investment to pay for it. We don’t have a car fund, everything is in investments. Next time I’ll take a longer look at used cars.

    • I think it’s reasonable to expect 10 solid years out of a car these days. Hope you can resist any ‘car envy’ that may come along better than I did!

  • With the car loans being so low, I don’t have a problem with a loan. I have one now and I am paying about 1%. I am making 10% in my investment account with the money that I could have used to pay for the car. That is the right move for me.

    • Wow–if you can consistently make 10% investing, maybe you ought to be borrowing money to invest!

      • Well, that is always a gamble I think. The car loan is fixed, but investment returns are not. I have always made more investing than what my loan is worth, so a car loan doesn’t bother me.

        • Nightvid Cole

          You’re being a bit inconsistent here. If you get a car loan in order to continue to hold an investment, your decision has the same end result as borrowing to invest. Surely you don’t really think having to pay some miniscule amount of capital gains taxes after selling your investments makes it worth keeping both the investments and the debt? Or do you?

  • jefferson @seedebtrun

    As much as I would love to pay cash for a car.. The reality is that this probably will never happen for me. There are many dealerships currently offering zero percent interest on new cars.. And while new cars certainly do have their downside (depreciation), getting zero percent is really not much different than paying cash.

    • Jefferson, I’ve never taken advantage of one of those 0% deals, but they are enticing. Might financing cost essentially be built into the price though? Let’s say you negotiated a price all while firmly telling the dealer you were going to pay cash. When the deal is done, you say to the salesperson, “you know what–I changed my mind. Let’s do that 0% financing deal you’re offering.” Would the price you negotiated or any other deal details change? Are there any upfront financing fees?

  • Your Daily Finance

    I pay cash for cars but then again I am buying cars that cost less than $2k. The only loan we have now is the wifey’s XC90 and that is a lot lower than the payments we had before so we are paying a lot less now. Don’t think I would spend 10k cash on a car unless I was loaded with money or planning to flip the car for a few thousand more.

    • I admire your frugality when it comes to cars! I’m wondering how long typically you keep a car for which you paid less than $2,000? And how about maintenance issues–how do you keep from getting burned?

  • Emily @ evolvingPF

    There’s no difference in monthly cash flow between saving up in advance and getting a car loan; stating that some people can’t afford to save up for a car so they are forced into a car loan doesn’t make sense. If that happened, all it means is that the person didn’t have the willpower to save and needed an outside financial institution to tell him to make the payment.

    I’ve only bought one car and I used a loan for it. I’m not super opposed to a very low-interest car loan, but I think I’d prefer to pay cash for future cars. I just don’t like the idea of having debt on a depreciating asset.

    • Great points Emily. I thought this would be the first day this month I’d get through without someone pointing out that something I’ve said or written doesn’t make sense, but I was wrong. 🙂

      • Emily @ evolvingPF

        Well the fact is that the situation you described happens all the time. Someone “can’t afford” to save for his next car while he’s driving an older one and then when the car breaks down and he decides to buy a new one, suddenly he can afford the payment. If only he had the motivation to find that room in his budget in advance so that he could have that true choice you were talking about.

  • Nice article Derek.

  • Martin @

    if I can get 0 down, 0.5% interest rate for 5 years, why not taking a loan?

  • MoneySmartGuides

    If I can get a loan for under 2% like Martin said, I’d take the loan. As long as I have an adequate emergency fund, it makes sense to me to invest the money in a short term investment and make my car payments from that investment.

  • MoneySmartGuides and Martin — do you think the caveat in my reply to Jefferson’s comment has any merit? Cheap financing is only really cheap if you can get the car for the same price as if you were paying cash and you’re not hit with a lot of upfront financing fees, yes?

  • Greg

    We just bought a car and took the 1% finance. We figured the money would be better served paying debt my wife’s med school debt at 6.7% If the financing was any higher, however, we would likely pay out right.

  • Nightvid Cole

    Most people with car loans are financially irresponsible (although
    perhaps not all). They don’t get a loan in order to keep their money
    invested. They do it because for the past 5 or 6 years they chose to go
    on expensive vacations, or eat out too much, or blow money on
    entertainment like the world will end tomorrow, instead of saving to pay
    for their car in full at the time of purchase.

    For these consumers, car loans are a “gateway” debt to more dangerous
    types of debt, such as appliance financing with onerous terms, credit
    cards carrying a balance from one month to another, pawn shop, and
    payday loans.

    • I would endorse your “perhaps.” Not everyone with a car loan is financially irresponsible.

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