The amount of auto debt that Americans are taking on is staggering. Auto loans account for one of the largest categories of debt, with $1.2 trillion dollars owed in 2020. Total auto debt has nearly doubled from 10 years ago, and delinquencies are at a record high. When buying a new or used car, it's important to think ahead and consider the risks. By taking on more auto debt than you can manage, you risk destroyed credit and vehicle repossession. One simple way to ensure you won't fall into a dangerous cycle of auto debt is to skip financing altogether and pay cash. We cover the top 3 reasons to pay cash for a vehicle and the top 3 reasons to finance so you can make the best choice.
3 Reasons to Buy a Car in Cash
Buying a car in cash is a practical way to save money on interest and get the peace of mind that comes from owning the vehicle outright. It is also a solution for car shoppers with compromised credit to get into a vehicle if they have been denied an auto loan in the past.
1. Save on Interest
Depending on the interest rates available to you, the total financing costs of an auto loan can add up to thousands of dollars over the course of the loan. Although the national average for U.S. auto loan interest rates is 5.27%, shoppers with subprime credit can expect much higher rates. According to Nerdwallet, a 60-month $20,000 car loan with a 9% interest rate will result in total interest costs of $4,910. Buying a car in cash allows you to avoid these extra costs.
2. Buy a Vehicle You Can Afford
It's easy to get caught up in the excitement of buying a new car and choose a vehicle you really can't afford. Car salespeople may also incentivize shoppers to buy a more expensive model or add options by stretching out a car loan to offer a lower monthly payment. The problem with financing a vehicle that's outside of your budget is the risk of falling behind on car payments. This leads to damaged credit and vehicle repossession. Even if the car payments seem manageable initially, a job loss or emergency expenses can put you at risk of default. Buying a car in cash makes it easier to budget, save, and only pay what you can afford. An added bonus is that you'll own the title to the vehicle outright when it comes time to sell or trade-in.
3. Your Credit Score Won't Be a Roadblock
Car shoppers with bad credit often encounter obstacles to getting an auto loan. According to Experian, about 16% of the U.S. population has a "poor" score between 300-579 which puts them at risk of not getting approved for a car loan at all. 17% of the population has a "fair" score (580-669) which is considered subprime and will result in higher interest rates. Subprime shoppers can expect to pay interest rates in the double digits, while those with good credit are able to obtain an average interest rate of 3.6%. By bypassing the auto financing process and paying in cash, car shoppers with rocky credit histories can get the vehicle they need.
3 Reasons to Finance a Vehicle
While there are several solid arguments for buying a vehicle in cash, there are also some drawbacks to consider. With the average new car price surpassing $40,000, it's likely you'll have to choose an older used car when paying in cash. There is also an opportunity cost to putting a large sum of money into a car purchase instead of keeping it in savings. Finally, dealerships count on auto loans to increase their profits and may charge more for a vehicle if they learn you're paying in cash. Here are 3 reasons why financing a vehicle could be a better alternative.
1. Keep More Money in Savings
With an average price tag over $20,000, even a used car can be a major drain on your saving. Paying for a vehicle outright prevents you from earning interest on that amount and could leave you without an emergency fund. You should weigh the cost of putting the money into a car purchase all at once instead of keeping it in the bank or using it for investment opportunities. When you finance, you can spread the cost out over a longer time frame, keeping more funds accessible to you.
2. More Negotiating Power
Dealerships will be more willing to negotiate with you if you plan to finance the vehicle vs. pay for it in cash. According to KBB, A dealer generally makes 1% of the auto loan’s value for contacting the financial institution and handling the paperwork. For example, the dealer makes $300 on a $30,000 loan. Additionally, financing gives the dealer an opportunity to sell options and accessories by adding them to the monthly payment. When a dealer hears a customer wants to pay in cash, he likely won't budge on the price of the vehicle and may even charge a premium.
3. Better Selection
Most vehicles that are priced low enough to be purchased outright are older used models. This means you'll be sacrificing some of the latest tech and safety features. In some cases, this also means having to settle for a high-mileage car that isn't in the best condition. A quick search on CarMax reveals the cheapest car in our area is a 2012 model with 111,000 miles for $8,000. The cheapest SUV is also a 2012 model with 89,000 miles for $10,000. By choosing to finance instead of pay cash, you may be able to expand your options and find newer vehicles with the features you need while avoiding the high cost of repairs that come with older models.