The Effects of Car Financing

For many people, financing a vehicle may be the only way to afford the purchase. Instead of having to come up with a large lump sum, the buyer can make a small or possibly even no down payment while paying the balance over time. Financing a vehicle can have several financial effects, which may be positive or negative.

Re-establishing Credit

If you've experienced financial difficulties which ultimately resulted in bankruptcy, obtaining an auto loan is a way to help re-establish your credit. Some used-auto dealers specialize in providing financing to people with poor credit histories, but you may pay an interest rate in excess of 20 percent to start. However, making timely payments will improve your credit score, and you may be able to refinance to a lower rate after a year or two.

Higher Cost

You'll likely end up paying more for a vehicle when you finance as opposed to paying cash because of paying interest. The only possible exception is if you are able to secure zero-interest financing, which some manufacturers offer to well-qualified buyers as an enticement to purchase a vehicle. In general, the longer the financing term, the more you pay in interest over the course of the loan, although stretching out payments may result in a lower monthly outlay.

Upside-Down Loan

The fact that vehicles begin to depreciate as soon as they're driven off the dealer's lot, as well as the tendency for some car buyers to roll an old car loan into a new one can result in owing more than the vehicle is worth, a condition known as being "upside down." One danger of being in an upside-down loan is that if the vehicle is totaled in an accident or stolen, you could end up having to pay the difference between the car's insured value and what you owe out of your own pocket. You may need to purchase a product called gap insurance to protect you against this situation.

Having Cash On Hand

By financing a vehicle instead of paying cash, you won't use up a large chunk of your cash reserves. As a result, you'll stand a better chance of having enough cash on hand to cover financial emergencies, and you may be able to avoid excessive credit card use. You can also help to solidify your financial future by investing some of the money to build a nest egg or by using the cash to make a down payment on a home.