Some financial advice websites are touting the virtues of paying cash for literally everything. From your home to travel, to college tuition, and cars, cash is supposedly the only way to go according to these wealth gurus. With your salary and financial plan, this may not be right for you. Some sage advice like “Save your pennies for a rainy day.” ring true through the ages, but some money advice just isn’t practical for the average consumer whose last name isn’t Buffett.
What some experts fail to mention is that there are many great reasons to take out an auto loan as opposed to paying cash on the barrelhead. We’re not talking about the old beater you buy from your neighbor with your pizza delivery money, this advice refers to your first real dependable car with involvement of a traditional lender, like a bank or reputable auto finance agency.
According to Budgets are Sexy, good reasons to avoid paying cash are building your credit history, protecting your nest egg and low interest rates. Let’s take a more in depth look at these.
Build Your Credit History
Having no credit history leaves you at a disadvantage when going for a big ticket item like a home mortgage for $250,000. A car loan for $15,000 to $20,000 is much easier to obtain for a newly minted graduate with their first job or a divorcee trying to establish credit in his or her name. For example, if a twenty something with their first real job buys an vehicle, even a small compact model that’s affordable, and pays on time religiously, they will be in a great position to get the best rate on a home mortgage loan when they settle down. For those new to budgeting, a car loan is a better first step into the debt world than credit cards, as it is much easier to manage a predictable payment each month, than opening a bill and wondering how much you actually ran up for take out and shopping on your Visa. Pay cash for the pizza, and the laptop, but finance the car. Your argument may be that you have student loan debt, but you need a car, and unless someone buys it for you as a graduation present, you will need to keep the savings you have for a cushion. Better to finance a dependable used or economy new car than pay cash for a lemon you found on Craigslist.
If a man or woman is newly divorced, finances can be tough to sort out. Once the papers are signed and the smoke clears, it will be time to rebuild a life. Hastily splashing an anticipated settlement funds on a sporty new car may leave you without a security deposit or down payment for a new home. Plus, a car paid in full is considered a nifty paid asset to haggle over, and if you purchase before the financial details are worked out, you may see your ex-spouse drive away in it. Your soon to be ex may not find your car so attractive if they also get a payment booklet.
Save Your Nest Egg
In these tough economic times, it’s advisable to have approximately six months worth of earnings to fall back on in case of layoff, illness or injury. If the unexpected happens, you won’t be able to eat your 2016 Honda Accord; however, if you financed the vehicle, the monthly payment may fit snugly in your emergency budget until your situation improves.
If you do apply for public assistance of any kind if it comes to that, owning a car title will be counted against you as a paid asset. The same with bankruptcy, where a judge may understand why you need to keep paying for that modest car that takes you back and forth to work, but may not understand how you had $30K cash six months ago but now can’t pay your credit card bills. Not buying the car outright in the first place may have helped the person avoid Chapter 11, as that person would have a cash reserve and may not have racked up those hefty card charges.
Remember too, that a car loses value the second you get the keys, so that huge investment of cash is dwindling by the mile. True that will happen when you finance a car, but you won’t have nearly everything you own invested.
Car Loan Interest Rates are Low Compared to Unsecured Debt
Bankrate.com gives up to date info on current car loan rates. As of the end of April 2016, the interest rates are:
60 month used car loan 2.63%
48 month used car loan 2.67%
60 month new car loan 3.35%
Credit Card Catalogue cites that the average market credit card interest rate for May 2016 is 18.72% which is significantly higher than financing a vehicle. That is because credit card debt is unsecured, and a car loan is secured with the product that you drive off the lot. A lender can’t repo that luxury vacation you took to Cancun, but they can bring a tow truck for your Toyota if you miss a few payments.
Take into consideration the high interest rate, even for individuals with perfect credit, possible over the limit fees and card usage fees etc., an inexperienced borrower can end up quickly in financial hot water. Anyone who knows a bit about finance can tell you that it’s better to finance your car and home, and pay cash for your everyday items. A person who bought cash for their car, may be using their MasterCard for grocery shopping and bleeding money in interest rates each month, even if it’s paid on time.
Do What’s Right For You
Just because Uncle Harold always paid cash for his cars doesn’t mean you have to. So what if his 1990 Corolla that he bought when he won Bingo is still going strong? Just smile, nod and continue with your plan. He’s retired and the doc says he’s not supposed to drive anyway, so his needs are different than yours.
With a clear picture of your finances (or lack of them) you can go forward and make the decision that will not only serve you now, but will help craft your financial future.