Purchasing a Car With Cash Vs. Credit

There are a lot of factors to consider when deciding whether to purchase a car using cash or financing the vehicle. Sometimes the decision will be made for you. If your credit history is extremely bad, many dealers will refuse to finance a car purchase, while dealers who will take the risk will charge exorbitant interest rates. Your personal financial situation will be the determining factor. Weighing your cash reserves against the prospect of acquiring debt and a monthly payment is crucial, as is calculating the total cost of the car over the life of a potential loan.

Maintaining Cash Reserves

This initial consideration has less to do with deciding how to finance a new car and more to do with your cash position. If paying cash for a car leaves you with little or no money in the bank, it may be a bad decision. Regardless of the interest rate, a car loan may be your best---maybe only---option short of leaving yourself vulnerable to a rainy day. Don't empty your bank account to buy a car.

Comparing Credit Purchases

If you're currently mulling several purchases that involve loans, pay cash for the higher-interest-rate item. Let's say the financing rate on a loan for a car is 10 percent over four years and translates to $2,000 in interest payments. You're also considering a similarly priced home-improvement project at 5 percent over five years that totals $1,200 in interest payments. You can only pay cash for one item. Pay cash for the car. The numbers speak for themselves.

Actual Total Cost

On first blush, it seems that paying cash for a car will save you a lot of money in financing charges, even if you get a good interest rate on the car loan. Whatever the financing charges, you won't have to pay them if you pay cash. But you also have to take into account the money you'll lose by not having your money collecting interest of its own, either through a savings account or other investment vehicle. For example, let's assume that instead of a four-year loan for a $10,000 car at 10 percent interest, you choose to pay cash. The financed car would cost $12,174.24---the interest payment is $2,174.24. By paying cash, you won't have an interest payment of $2,174.24, but you also won't be collecting interest on your $10,000. A 5 percent interest rate on $10,000 over four years compounded annually yields a total of $2,155.06---virtually the same as your car loan interest. Compounded quarterly, the same $10,000 yields $2,198.90. So you have to compare the auto loan rate against your money's interest-bearing rate and decide which is the better way to go. A low car financing charge actually can save you money.

Establishing Credit

If you have no credit history, or a poor credit rating, you may want to take out a car loan simply to establish---or re-establish---your credit score. Perhaps a hefty down payment is in order so that your monthly payment doesn't swamp you. But you can use a relatively short-term financing instrument like an auto loan to establish credit or begin repairing bad credit.

Peace of Mind

If you're averse to debt of any kind, paying cash for your car may be your best bet. Not having to deal with a monthly payment over a two-, three- or four-year period can provide you with something money rarely can buy---peace of mind.