(Guest post by Lance, while J$ is out teaching his newborn how to throw a football ;))
While I was in college, I had a bit of a beater car. It was pretty clear to me that I would need to get a more reliable ride, but the thing was, I didn’t want a car loan. So what did I do? I saved like crazy to have enough money to pay for a newer used car all in cash. I ended up having to save my money from college gigs and a ton of money from my first post college job too.
Once I finally had enough money saved up, I decided to start shopping for my car. This whole time I thought I’d be buying a used one, but instead I ended up coming up with some solid reasons not to buy a used car and in the end changed my mind. So what did I get? A brand spankin’ new 2010 Honda Civic! And while I could have paid for it all in cash, I took out a car loan instead. WHAT?!
Yup, I took out a loan and here’s why:
I Needed an Installment Loan on My Credit
One factor of your credit score is the types of credit you have held. This only accounts for 10% of your score, but is still an important factor. The types of credit include mortgage loans, revolving credit (credit cards), auto loans and student loans. I had just recently graduated from college and was extremely lucky in the fact that I didn’t have to take out any student loans. I did have a credit card or two in college, but I always paid it off.
I had never had a mortgage before, but I knew I’d want one in the next few years. In order to get my score as high as possible to get the best rate on my future mortgage, I needed to have an auto loan on my record. This was one of the factors I considered when taking out my loan.
I Got a Sick Interest Rate
Things had began recovering since the financial crisis, but definitely were not back to normal yet. Car loans were not easy to get. Even if you could get one, the interest rates weren’t normally great. Car dealerships weren’t selling cars though, and they had a lot of inventory due to poor sales. Thus, they advertised 0.9% APR for 24-36 months on all new 2010 Honda Civics!
These types of deals were pretty rare at the time, but I figured I might as well try for it. I had my checkbook with me in case I couldn’t secure the financing. After signing the application, they came back and said I just barely squeaked past their credit score limit and qualified for 0.9% for 36 months!
This was great news because at the time my savings account was paying 1.1% interest. Nothing fantastic, but more than enough to cover my loan costs, and even after taxes I would only lose a few pennies. To me it was more than worth it to get my credit score up for a potential future mortgage.
It is Nice to Have the Cash in the Bank
By taking out a car loan, it meant I got to keep the purchase price of the vehicle in my savings account. I already had a six month emergency fund, but you never know what the future has in store for you. It definitely wasn’t going to hurt me.
Thanks to ING Direct, I was able to set enough money aside to pay the car off in full in a savings sub-account. I then set up auto pay for my bill and haven’t had to think about it since. I do make sure the payments come out on time, but other than that it had been on autopilot.
So, is This For Everyone?
Definitely not. If you do come across the right circumstances though, sometimes it does make sense to take out a loan instead of paying cash. If I had gotten a 0% interest loan I’d even be making a little bit of money by keeping it all in my savings, but unfortunately I wasn’t quite that lucky. If I had any doubt about being able to leave the money alone, I would have paid in cash that day and I would recommend you do the same. However if you can avoid touching the money, it does leave a nice safety cushion in case of a major emergency that goes beyond your emergency fund.
What would you have done? Would you have written the check if you had the cash available?
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Lance is a mid-twenties financial professional who writes at Money Life & More. He is also a Yakezie Challenger in the Yakezie Challenge. Feel free to head over to his site and check it out!
[EDITOR’S NOTE: I would have done the same!! (And actually, I have!) I’m all about having a ton more in my savings than normal, and don’t mind losing a few bucks here and there by taking out a loan and spreading the costs across a few years rather than all at once. It’s definitely not for everyone as you mentioned above, but there’s nothing wrong with it if you’re *more comfortable* doing it that way instead. You can always pay off the loan in full any time you wish too if you change your mind later! :) Just make sure that it’s in the contract when you go to sign on the dotted line…]
(Photo by Junior Behrens)
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I think if you can get a 0% financing offer then getting a loan would be better and you could put that money into your retirement account or use it as an emergency fund.It’s just so hard to drop cash in this economy because you never know what might be around the corner. Great post!
Great highlights of financing a car. I can see the benefits, but the .9% financing came with buying an “over-priced car.” I understand the lure of a new car, but if you are looking at it strictly from a financial perspective (and not that you have to – sometimes it’s nice to splurge), it doesn’t make sense.
You’d think being in finance this kid would be intelligent enough to not support the finance game that consumes so many poor people. But, it appears he doesn’t really care. I assume that’s because he apparently got a great deal on the car, which is probably what the price of the car SHOULD be (probably bought it right before the new models).
Instead, car manufacturers jack up the price of cars then offer 0% financing to make people think they are getting a great deal, when really they are just over-paying big time for a car.
People, don’t be stupid. If you don’t have cash in hand, you don’t buy the car. And that’s on top of having your normal 6-month slush fund. Also factor in car maintenance costs.
In your situation, I would have done the same, but I won’t do that at this point in my life even if I can get 0% loan. Writing a big check every month is a big pain in the butt. I don’t have any car payment now and it’s a great feeling. I already max out my retirement contribution and my EF is doing well enough.
*Waits for more comments about the evils of cars, ESPECIALLY new cars*
Heh.
We just traded in our year old Subaru WRX STi last month for a 2008 BMW 335xi. Not sure how many new cars I care to buy in the future…. We spent more time worrying about warranty coverage in the event of a failure than anything. Thankfully, we were only $600 in the red compared to what they paid us for her & what we owed. Thank god those STis were, and still are, impossible for the dealers to keep in stock.
I’m more for Certified Pre-Owned. So I have learned. Though my next purchase will be all cash, because she gets to be a 100% toy….. Hehe.
Then again, cars are pretty much my life. For some of us, it’s a spending priority. :) I do eat a lot of ramen lately to save up my pennies…. Because the alternative is putting them towards my first Porsche 911. (New, I’d love… CPO I wish. But nah, a good Carrera from the 80’s fits my budget best!)
I just bought a new (2012) car and used a loan. It was at 1.99% for 5 years. At that rate, I would rather have my money working for me.
We lucked out with 0% financing on our first new car. It was a no-brainer…$300/month for a brand new car that does everything we want (Mazda3)? Sign us up!
If you have the discipline to actually have and keep the cash in the bank, it’s a good way to go. That way, you can always pay off the loan in an emergency. Some might not be honest enough to do that, and take out the loan without the collateral sitting in the liquid savings account.
Speaking of savings account, I’ve pretty much taken most of it and put it into preference shares which pay 8% and rarely go up or down, because their dividend is fixed. One month’s expenses stay in the savings account, because liquidating any of those shares takes about a week and a half.
omg I would totally do that if the interest rate was <1%!
I never thought about getting an instalment loan to build credit… I might actually need to do this at some point.
Interesting perspective. I like the idea of boosting your credit score, but other than that reason, I’d just pay cash.
I hated financing my car years ago. I just did not want someone else (the bank) owning “my” car.
@L Bee – I didn’t quite get 0% but it was close enough for me!
@20’s Finance – If you read the article I linked to in my post the new car was the better choice for me. I got a steal of a deal way below invoice for cheaper than I could get a newer used Civic… it was an odd time but it worked for me.
@RB40 Joe – The best part is I just have the money sitting in a specific bank account and the payments are auto drafted. I don’t even have to write a check!
@Meg – The new car just made sense to me. Sorry yours didn’t work out for you and I hope you enjoy the BMW :)
@Krant – I totally agree! I bet I could get more than 2% if I invested over 5 years.
@tuffbunny – As long as it made sense for you to buy new over used that is awesome! Congrats!
@William – I was disciplined enough and it is still sitting in my bank account! Only a few payments left :)
@Bridget – That was one of the keys to getting the loan although the interest rate would have been good enough of a reason for me.
@Jenna – Just depends on the person. Glad it worked out for me but each person has to do what works for them.
@Squeezer – If that is the case then it makes sense just the plunk the cash down. I don’t mind so much but that is just me. I get the title in a few months anyways.
I would have done the same thing. I firmly believe that if you can get a super-low interest rate (think 1-2%) on your car loan and can afford to keep the term to 3 years, there’s no sense wiping out your savings to avoid paying a couple hundred dollars in interest. Don’t get me wrong, I love not having a car payment right now, but I will definitely be financing my next car.
Sorry Dave (Ramsey).
@TeachHer – Dave is definitely rolling around but at least he’s still alive and with us. I do invest my money in a mutual fund for my next car. He’d like that. But it isn’t solely a growth mutual fund earning 12% or whatever insane rate he quotes.
Great points. I will probably consider taking out a loan for my first car just to build credit as well (if the interest rate is low).
If you had saved up enough money to pay for it in full with cash, couldn’t you have gotten the car earlier? That way you would be done paying for the car earlier. Time value of money says that’s more optimal.
I would take out a car loan because of the 0% interest rate. Think of it this way. You can pay $30k all at once, or you can spread that payment out over a few years and still pay no interest. It’s like being able to use money for investments without paying interest!
Nice job! I think that oftentimes people overlook at the value of how much interest you pay vs how much interest you can accrue by investing. If you can get a low enough interest rate that allows you to invest and make at or more the cost of interest owed why not do it.
cash, cash, cash, cash. Never had a car loan and never will. Whatever small amount you make in leveraging the money you lose in peace of mind and higher insurance rates. I have never had an installment loan, and yet I had no problem getting a mortgage. I’ve been able to both buy a house and refinance it (closing both – under 21 days). This idea that you have to have debt to foster your credit score is a silly one.
@Andrew – I ended up getting the car shortly after I saved the cash up. I didn’t want to be in a position where I couldn’t pay cash if I couldn’t get the good financing.
@Tony – You just need to make sure the 0% interest rate doesn’t influence you to buy a more expensive car than you would have otherwise.
@Adam – As long as your investments are pretty safe that works well. However, if you take big risks you could end up with enough to not pay the car off in the end without dipping into other sources.
@Diane – I don’t think my insurance company charges more if I have a loan or not. I’d still have the same type of coverage. I’ll have to look into this. I’m not saying you wouldn’t be able to buy a house without it but your interest rate might be higher if you haven’t established a great credit score yet.
I believe you made the right choice here. Obviously, the points you made are legit and since you had the cash to do so, it only makes sense to get a loan. I know that’s like an oxymoron but you really killed two birds with one stone with this strategy!
Couple of comments. I had similar reasons for getting an auto loan vs just paying outright cash. I have a CD making 3.4% (it makes me so sad compared the 8% I was getting on my previous CD) that is well over the price of the car (truck) that I bought. I also had pretty awful (non-existant) credit coming right out of college. So what I did is get a secured loan on my CD. It was significantly lower than the interest that was offered as my dad being a cosigner, and I didn’t need a cosigner for it! So I am now 16 months in and my credit score is in the lower half of the 700s which is awesome!
I would really never buy a BRAND NEW car because a car depreciates the most in the first 3 years. I only buy things 3 or more years old. I can sacrifice the warranty that I may never use for a significantly cheaper car that has 30k miles or under on it.
I recently had a meeting with a mortgage broker about an FHA loan and she pulled my credit and did all the calculations and informed me that I have “thin-credit”. I don’t know if anybody is familiar with this, but it is when you do not have 3 CURRENT credit lines in your name for over a year. So I have a USAA Auto/Renters policy for 16 months – 1, secured installment loan for 16 months – 2, and everything else is under 12 months. I am young and bills are not in my name (roommate) so I was in a tight spot. I recently got a new cell phone in October that my work pays me for so my old cell phone account didn’t count. It’s something that I didn’t even consider when walking into that mortgage broker office. If you’re looking to buy your first house using FHA make sure you fatten up your credit now by establishing yourself!
If you compare a new vs. 2 year old honda with a load of miles on it, you may be able to jiggle the numbers to make the newer one look like a better deal. It probably would have been a better financial decision to get one that was 5 or more years old, or kept your current car. Come clean for us; you just liked that new car smell =)
I think the interest rate is irrelevant when you compare to the money you’ll loose to depreciation.
@ Mr Pop – I actually had a mid 1990s honda accord before I bought the Civic. It was time for the Accord to retire though. I did like the idea of knowing the maintenance history on the new car but at the time the deal was so sick I couldn’t pass it up. KBB was way above my car value for a good 2 years after I bought it. It was insane. Now it has come down but that has a lot to do with the ton of miles I’ve put on it since.
A couple of years ago I decided to take the plunge and buy a used car. I had always owned new cars.
The whole “always buy used” is not for everyone. The one used car I purchased was nothing but a pain. And because I can afford it I cut my losses (about $1000) sold it and purchased the new one that I really wanted. Why?? Because it completely depends on the car model and how long you plan to drive it. The cost of a car is directly related to the cost per mile driven. And I’m going to buy the car that I can drive for YEARS. And things like rate of depreciation, tires, maintenance, gas, and other issues count towards that cost. If you get a great deal on a new car that traditionally has a lower depreciation rate and then drive it for 10-12 years, then you come out smelling pretty good. And if you maintain the car well then you can actually avoid a lot of the maintenance that you might not avoid buying someone elses car.
I also haggled my car purchases down to near the dealer cost. Its not that hard as long as you shop around and it makes a HUGE difference. I actually had a dealer running behind my car one time as I was leaving a dealership screaming that he could do better. I turned around and bought the car. That car had a low depreciation rate and I came out awesome in an insurance claim when someone ran into me 6 years into owning it. Its also very wise to avoid luxury vehicles and “limited” models. They depreciate like crazy and those features are a waste. Domestic cars also have terrible rates of depreciation.
Just my take. But I’ve never regretted my new car purchases.
@Kolton – Thanks!
@Chris – Interesting… good to know!
@Richard – Sounds like you got a good deal. You have to do what works for you.
This can definitely be a good strategy, something I would probably do too. Like you, I hate taking cash out of savings, just in case. But wouldn’t it be nice to pay cash and not have to worry?
@Kris – I’m not worried about the loan at all if that is what you’re referring to. If it did cause me any worry or stress I would have paid it off by now :)
@ Lance, not suggesting any worry, just wishful thinking that money was no object :)
My mom is trying to get me to do this. I need to start looking for deals from car dealerships. You have inspired me!
Lance,
It’s great that you showed responsibility and made it very clear that your stratedgy is not for everyone. But it can be a smart move–as you pointed out it will help to boost your credit score. in the long run it will help you get more favorable interest rates for other types of loans/credit
Thanks again for guest posting while I was out, Lance! I should have you do so every week – your article got picked up by MSN Money too! Congrats bud! Hopefully it all helps you grow your site even more :)
@Beth Anne – Only get a new to you car if you really need it! No sense in spending money if what you have now works for you!
@Ornella – Thanks! I’m glad that some people read disclaimers like you do!
@J. Money – Not a problem! I was very happy that my article got picked up and it definitely is helping my site grow! If you ever want another guest post you know where to find me!
Wow… I need to lighten up on the exclamation marks :)
@Lance, no problem
@Lance well right now my mom and I share a car. In the near future one of us will need to get another car.
@Beth Anne – Ah makes more sense now… good luck!
I took out car loan because Toyota finance offered me 0% interest on the loan. I got to keep my score up and added a loan history too, otherwise I had only revolving credit from credit cards. I set up auto pay on my car loan not to miss a payment.
Awesome!! That’s a killer deal indeed, I’d have taken it up myself :) I don’t mind interest-free loans when I know I can pay it off in time and keep my cash reserves strong at the same time, well done.
@SB that is definitely the way to get it done!
Another way to do well on a good, well-kept used car, if you can, is knowing someone who does estate work, as I do. The cars truly are driven by “little old ladies” (I hate that term but everyone uses it in terms of buying cars-usually lying). Every one we looked at had a careful maintenance history. Most of the time, the sellers already have cars and are looking to sell Mom (or Dad’s) car, often Camry, Corolla, Civic or Accords. They usually are kind of boring looking, the heirs already have cars they prefer, and thus the heirs don’t want them, just the money. When we were at the widower’s house (not my case), we saw how meticulous he kept his garage (and we thought ours was the neatest), how he had all the records and only sold it, honestly, at that still-raw time because my friend told him someone who does a lot for underdogs was looking…I went the used route this time because I didn’t want a new car because my car kept getting banged up in the parking lots at court, where parking is very tight, people are freaked out (Arraignments share the same lot as all the other courts out here in Suffolk), and just fling their doors open wide, even when I am sitting there getting my briefcase together (and no-too crowded-cannot park far away-lot fills to the ends). It drove my husband nuts every time the Camry, which survived NYC all those years, came back with another scratch or ding (and even a cracked bumper-I think Costco on that one). So, I decided to go used, as long as it was good under the hood acc to my very reliable mechanic, and even with a few dings, as long as no major accidents. We DID try buying used before this estate came up but it was a nightmare of shifty dealers pretending to be regular owners. I also worry about buying from an actual dealer and paying extra to have peace of mind when I know I won’t ultimately get that from these so-called service contracts and warranties because I see the way they weasle out of paying. If not for these estate opportunities, I loved the idea of buying new and did that myself last time but, finally, the 97 Camry hit 5X and had 270K miles had to go. It was driven hard-into NYC 70 miles each way, and the 5 accidents were from idiots, like the illegal cabbie/jitney in Chinatown that made an illegal left between the Camry and two police cars and didn’t quite clear the Camry. However, we bought it new and took excellent care of it so it lasted that long regardless, and still looked good. When we sold it, surprisingly, to a dealer from Fla, we got the Corolla for less money than the price received for the Camry that needed a new head gasket (and mechanic said all kinds of other stuff were about to happen and was surprised someone paid that much).
With interest rates at an all time low you have to be financially silly or have a very German view of credit to pay cash.
Or really hate debt ;) Some people are allergic to it.
Amen to that!
Scratch, scratch…
@Tom – There are a lot of people with that view, especially on personal finance blogs.
@William – I don’t blame you! Different people have different priorities.
HI,
Thanks for sharing your experience i needed to hear this, what if the car is less than the car loan offered? Do you have to spend the entire loan amount on a car? Also, the money not used on a car does would you give it back to the lender?
Thanks
I’d personally just not accept a loan that’s for more than the cost of the car! Banks will want you to do that all day long so they make more $$ off you regardless if you can afford it or not. So just don’t tempt yourself – only take out what you need! (And try local credit unions too – they typically offer lower % rates)