Are Car Loans for Dummies?

Much of the United States depends on car loans to finance their vehicle purchases. According to credit rating agency Experian, over 80% of new cars and roughly 55% of used car purchases are financed. So if everybody’s doing it, it must be smart, right?

Taking out a Loan

The obvious advantage of financing a car purchase is being able to get a nicer, newer car than you would have been able to afford with strictly cash. You’ll be able to afford a car with more bells and whistles, better safety features, and perhaps even better gas mileage. Your newer car will probably also spend less time in the shop than an older one you would have had to buy with only cash. So is using financing a no-brainer to get the car you want?

 

Not necessarily. The most obvious downside of car loans is the interest you end up paying. Earlier this year, for the first time the average car loan topped $30,000! You would end up paying over $2300 in interest on a car loan of that size over a 5 year loan with a 3% interest rate. If your credit score is anything less than stellar, you could easily be looking at a 5-6% interest rate with total interest of $4,000. That’s almost a $1,000 a year just in interest! That’s in addition to all the other hidden costs of a newer car, such as high depreciation and higher comprehensive insurance rates.

Taking out a loan also makes a huge assumption on your future. When you take out a loan, you’re committing to 5 years of fixed monthly payments. You’re assuming that your income and finances will continue to be able to support those monthly payments for 5 years. A lot can change in 5 years. You can lose a job or be cut hours. You could have a child. Sudden medical expenses can pop up. The list can go on. If something suddenly comes up and you’re unable to make payments on your car, you jeopardize your car and your credit.

So What About Leases?

The lower payments on car leases may sound attractive, but these are even worse than traditional car loans. Leases are basically long-term rental agreements. You make payments for a set amount of time but are left with no equity after the lease is up.

It’s also easy to forget that a leased car isn’t yours when you drive it every day and park it at your house every night.  At the end of the day, the dealer owns it and will want it back in good condition. This leaves you on the line for expensive penalties at the end of the lease if the car does have any cosmetic damage. The dealer is also going to require you to put more insurance on the car than you would have been able to get by with if you had owned it outright, leaving you stuck with higher premiums.

Cash Only

Only buying cars with cash means that you never have a car payment. Not having a car payment makes things easier when your financial situation takes a sudden change for the worse. Unlike car payments, you can always put your car savings on hold and keep your current car for a little longer.

Using only cash to buy a car also means you avoid paying interest. In fact Instead of paying interest over the life of the car loan, you’ll be making interest work for you as you contribute to your car savings fund.

Using cash to buy a car also gives you more leverage in negotiating price with car dealers. If you’re planning on buying with cash, its much easier to walk out on a dealer if you’re not getting the deal you’re wanting. If you’re relying on the car dealer for the loan, they’ll often try to spring extra costs on you part way into the loan signing process, making it harder to ditch the deal.

In general saving up cash for your vehicle purchases will give you the most bang for your buck, and save you plenty in stress and worry.

 

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- While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.