The Pros and Cons of Getting a Car Loan: Should You Finance or Pay Cash?

Buying a new car is an exciting experience. Driving off the lot with that new car smell is a feeling like no other But before you can get behind the wheel, you have to decide how you plan on paying for your new ride Should you pay cash upfront or take out a car loan and finance your purchase over several years?

As with most big financial decisions, there are pros and cons to both options. In this article, we’ll break down the key advantages and disadvantages of getting a car loan so you can determine if it’s the right choice for your situation.

The Advantages of Car Loans

Here are some of the biggest benefits of financing your car purchase with an auto loan:

1. Allows You to Buy Now and Pay Over Time

The main reason people take out car loans is simple – it allows you to buy a car when you don’t have the full amount in cash available. By financing, you can drive the car home right away while paying for it in affordable monthly installments over a set repayment term, usually between 2-6 years.

This can be especially helpful for younger buyers or those with limited savings who need reliable transportation now but don’t have $20,000+ to drop on a car all at once. A loan makes ownership possible.

2. Spreads Out Your Costs

Instead of paying the full sales price at purchase, an auto loan allows you to divide the total amount borrowed across 12, 24, 36, 48, or even 60 monthly payments. This incremental approach helps make buying a car more affordable.

Rather than drain your savings all in one shot, a loan lets you pay for your car a bite-sized chunk at a time from your ongoing income. For most buyers, it’s easier to budget for a $350 monthly car payment vs shelling out $15,000 or more all at once.

3. Can Help You Build Credit

Since a car loan is considered a form of installment credit, making your payments reliably each month helps demonstrate to lenders that you can handle this type of credit responsibly This can in turn help build your credit score over time

As you build a positive payment history, it shows potential creditors that you honor your financial commitments and can make you eligible for better credit offers in the future, like lower interest rates.

4. Offers Flexibility

An auto loan gives you more flexibility compared to leasing since you own the car. Once your loan is paid off, you have the freedom to keep driving your car, modify or upgrade it, or sell it to help fund your next vehicle purchase.

With ownership, you also have more flexibility in your monthly payment amount, loan term length, whether to apply prepayments, etc. You can tailor the structure of your loan to fit your budget and financial situation.

5. Potentially Lower Interest Rates

Today’s auto loan rates are still relatively low compared to historical averages. Prime borrowers with excellent credit scores can often qualify for interest rates of 5% or less on new car loans.

By securing a low promotional interest rate, you minimize the total interest fees you pay over the life of your loan, saving you money vs just buying the car outright in cash.

6. Allows You to Preserve Cash

Using an auto loan means you don’t have to liquidate your checking, savings, retirement, or investment accounts to free up funds to purchase your car. This allows you to keep that cash working for you.

Rather than tapping your emergency fund or tying up money meant for other goals, financing lets you preserve your liquid assets while still getting the car you want.

The Disadvantages of Car Loans

Of course, financing a car purchase also comes with some potential drawbacks, including:

1. You’ll Pay Interest and Fees

The main downside of a car loan is that you’ll pay more overall compared to buying the car with cash, since loans charge interest and fees. This added cost is essentially the price you pay for the convenience of spreading out your payments over time.

Interest rates vary between lenders but expect to pay 3-20% APR or more, which adds thousands to the total paid depending on your loan amount and term length. There are also origination fees and other costs.

2. Possibility of Upside Down Loan

Since cars depreciate rapidly after purchase, your vehicle’s value may fall below what you still owe on your loan. This scenario is known as being “upside down” or having negative equity.

While upside down loans are temporary (assuming you keep making payments), it makes it trickier to sell or trade-in your car until you’ve paid down the loan balance sufficiently. Upside down situations are common with longer term loans.

3. Later Payoff Date

Choosing to finance means you’ll be locked into making payments for multiple years before you fully own your car, typically at least 24-36 months but potentially up to 6 years. Some buyers don’t like the idea of monthly car payments dragging on for years.

Until your loan is paid off, the bank maintains a lien on your car title. You don’t have the freedom to sell or trade in your vehicle because the bank owns a stake in it until you satisfy the loan.

4. Requirements and Stipulations

Since the lender is taking on risk by loaning you tens of thousands of dollars, auto loans come with requirements you’ll need to meet to qualify and rules you must follow. This differs from paying cash upfront.

For example, you’ll need a certain credit score, income level, and debt-to-income ratio to get approved. The lender may require you to carry full insurance coverage. Refinancing or prepaying your loan before maturity often incurs fees too.

5. Potential Repossession

If you fall too far behind on your monthly payments, the lender can repossess your car. They may give you a grace period to get caught up, but will eventually take back the vehicle if you default on the loan since they are a secured creditor.

Having your car repossessed makes it challenging to find affordable transportation to work, school, etc. It also causes significant damage to your credit standing that can take years to recover from.

6.dealer interest rates

Remember that dealership financing often comes with higher interest rates compared to loans from banks, credit unions, and online lenders. It’s smart to compare all of your financing options before signing any contract the dealer presents.

Dealers make a profit by marking up the interest rate on loans they arrange. This compensates them for facilitating the auto financing. So don’t assume the dealer offer is your best rate.

Key Questions to Ask Before Getting a Car Loan

If you’re thinking about financing your next auto purchase, here are some key questions to ask yourself before signing on the dotted line:

• How’s my credit? Your credit score and history plays a big role in determining whether you’ll qualify for a loan and what interest rate lenders will offer. Check your credit first so you can shop for rates you’re likely to get approved for.

• What’s my budget? Calculate your target monthly payment amount along with any down payment you plan to make. This will determine the loan amount and repayment term options to focus on.

• Should I buy new or used? New cars depreciate quickly, so buying used often makes more financial sense. But used car loan rates are often higher. Run the numbers for both options.

• How long do I plan to keep this car? Your planned ownership timeframe should guide your repayment term length. A longer 5-6 year loan risks upside down status but offers smaller payments.

• Can I afford the insurance? Remember to factor in the cost of higher auto insurance premiums before committing to a car loan and costly new vehicle.

• Should I pay extra each month? Paying additional principal each month reduces your interest costs and pays off your balance faster. Even small extra amounts helps save.

By taking the time to consider these key questions and weigh the pros and cons, you can determine whether taking out an auto loan makes sense for your situation and budget or if you’re better off buying your next car with cash. Being an informed buyer is the key to making a smart financing decision!

Alternatives to Traditional Car Loans

Beyond conventional auto financing from a bank or credit union, some other options exist too:

• Dealership Financing – Easy application and fast processing but higher rates. Best for those who need financing help due to bad credit.

• Personal Loans – Unsecured so may have higher rates but offer more flexible use of funds beyond just a car purchase.

• HELOC Loans – Utilize available equity in your home. Offers lower rates but home is collateral if you default.

• Peer-to-Peer Lending – Borrow from individual investors. Offers more options for borrowers with poor credit.

• Buy Here Pay Here Dealers – Limited selection but provide their own in-house financing to risky borrowers.

• Leasing – Doesn’t build equity but lower monthly costs and lets you drive a nicer new car. Tradeoffs vs traditional auto loan.

• Manufacturer Financing – Zero percent or