Buying a car can be an overwhelming process. You have to choose the make and model you want, take test drives and do research. Then there’s also the financial aspect.
When it comes down to it, there are really only two options when deciding how to pay for a car: with cash or with financing.
If you’re getting into the nitty-gritty, you can also, of course, lease a vehicle, but that is a whole different story, so we’ll just leave that option to the side for now.
If you’re like most people, paying for the entire purchase price of a new or used car in cash isn’t possible. Even if it is possible, you might not want to empty out your entire life savings to buy a vehicle.
Before we get too far down this rabbit hole, it’s important to distinguish what it means to buy with cash, what it means to finance and why a lot of people use a combination of both.
Buying a car with cash
Buying with cash is pretty self-explanatory—you head to the dealership, choose your vehicle (hopefully after you’ve done a lot of research and test driving), agree on a price with the seller, figure out the total after taxes and any add ons or rebates, then hand them a cheque for the total amount.
Financing a car
Financing is a bit more complicated. Financing means you require a loan from a financial institution that will help you cover the bulk, or all, of the vehicle cost. This could be a loan from the bank or credit union you currently use, or even one right from the dealership you’re buying from (if that’s a service they offer). You then pay back the loan, with interest, over a set payment period of months or years, which is more common.
Most consumers use a combination of both cash and finance. They pay a cash down payment to decrease the principal amount they will be paying interest on, and then use financing to cover the rest.
If this is confusing, don’t worry—you’re not alone! Here’s a breakdown of when it makes sense to pay cash, when it makes sense to finance and the pros and cons of each.
Using cash to buy a car
If you’ve been saving your pennies for a long time or have a Daddy Warbucks in your life, you may be able to pay for a vehicle outright in cash.
While it may seem like a fool-proof option, there are pros and cons to paying in cash just as there are pros and cons for financing.
Pros: Paying in cash means you don’t really have to worry about interest rates, maintaining payment schedules or increasing your debt load. It’s one-and-done and the vehicle is yours. It also saves you time in the following ways:
- You don’t have to research and meet with a bunch of different lenders to figure out which one has the best payment plan for you.
- You don’t have to worry about going through your credit report to make sure your credit score is high enough to lock down a car loan.
- You don’t have to continue to make payments on an asset that depreciates by the day.
One other sneaky pro of paying in cash is that sometimes a dealer will offer a significantly lower price than what’s listed because they know the full payment will be in-hand right away. There is no concern about the reliability of the buyer as a credit user and since it’s not possible to default on a loan that doesn’t exist, they may be willing to offer a lower base price as incentive to pay cash, up-front.
Cons: There aren’t a lot of cons to paying in cash—it’s just that most people can’t afford to. One thing to keep in mind is that just because you have the cash, it doesn’t mean it’s always your best decision to use it. Would that money make you more in interest sitting in a bank than what you would pay in interest for a car loan? Do you have enough cash left over to pay for insurance every month? Do you have enough cash to cover regular and emergency maintenance if that should come up? If paying for the entirety of the purchase price in cash is going to leave you absolutely strapped for the foreseeable future, it might not be the most practical option.
Also, paying in cash won’t help you boost your credit score. The only way to build credit is to use credit, so if you’re just out of college or have had some credit-related issues in the past, maybe try financing to buy a car rather than cash. If you are certain you can keep up with the payments, it’s a great way to start building back your credit. A good credit score will come in handy later; if you need to take out a mortgage or another type of personal loan in the future, your interest rates will be much lower if you have a solid credit history to stand on.
Using financing to buy a car
When you’re using financing to buy a car, there’s a lot more to think about.
There are several ways to finance your car. If you have good credit, you should be able to get a loan through your bank or credit union should you want to go that route. If you have a good relationship with your bank and you have good credit, your interest rate should be on the lower end of the scale, around 4 to 6 per cent. Credit unions typically have lower operating costs and can offer lower interest rates, but you may have to be a member to take advantage of that.
Interest rates actually play a pretty big role when it comes to financing so it’s important to understand how your credit affects them. Here’s a good idea of what you can expect when it comes to interest rates relating to your credit score (from bankrate.com):
|Credit Score Range||New Car Loan||Used Car Loan|
|Super Prime: 781 to 850||4.19%||4.69%|
|Prime: 661 to 780||5.01%||6.38%|
|Nonprime: 601 to 660||7.91%||10.91%|
|Subprime: 501 to 600||12.17%||16.78%|
|Deep Subprime: 300 to 500||14.88%||19.62%|
If you have bad credit, you can still get a loan, but it’ll be a bit harder and your interest rates will almost certainly be higher, as noted in the chart above. There are lenders who specifically work with folks who have bad credit to create a payment schedule that will work for them, but you have to do your research to make sure you’re working with a reputable lender who isn’t out to take all your cash and leave you with even worse credit than you started with. Unfortunately, those with bad credit have a bit of a target on their backs when it comes to scams, but if you’re vigilant with your research and ask thorough questions, you’ll be OK.
Another option—mostly for those who have bad credit, but not always—is to get a close friend or family member to either cosign a loan with you or give you a personal loan. This is a great option if it’s available to you but a potential con could be the strain borrowing money can put on a relationship. If you think taking a loan from a loved one will cause a lot of personal problems, it’s best to avoid it.
Something that may come up during your search is the offer of “zero per cent financing” but there are a few things to watch out for here. First, you’ll have to have a pretty stellar credit rating to even be considered for zero per cent financing, and even if you are approved, it’s important to read the fine print of the agreement. In many cases, you’ll be expected to pay for the remaining balance of the vehicle at the end of the loan term, which is often 24 or 36 months, rather than the more typical 60 or 72 month longer loan period.
If you don’t have that cash payment on hand, you’ll have to take out another loan which has a high probability of being more expensive. But if you’re sure you can pay off your car in that shorter loan period, zero per cent financing can be a good deal for you if you can get it.
Pros of financing: Financing allows you to have a bit more financial leeway when it comes to paying off your vehicle, which is especially important for those who need transportation but are on a tighter budget. It also allows you to build your credit if you’re new to the game (or need to improve your credit score) and are able to make your payments on time each month.
Most obviously, it also means you can have a car! Without financing, most people would be out of luck, stuck driving an older and potentially unsafe vehicle or relying entirely on other forms of transport, but financing allows you to get in a vehicle without having to save up tens of thousands of dollars in cash first.
Another pro is that in most cases, you can get the car you actually want rather than something that will just do the job for the time being. It may not be possible to jump into your dream car right away, but there will be a bit more room financially to get something you love.
Cons of financing: One of the biggest cons is that interest payment you’ll be making each month, which, depending on your credit rating, can be a sizeable amount of extra money going out the door every 30 days. The payment aspect in general can also be considered a con for some, who would rather pay off the total amount in cash right away rather than carry a debt.
Another con of financing is if you’re unable to keep up with those payments, your credit score will take a major hit. There is always an inherent risk to taking out a large loan, and that is amplified if you know you’ve had trouble being financially reliable in the past. Some self-reflection may be required before jumping into a financing agreement, as it may only cause you more problems in the long run.
One of the other cons of financing is the mental toll and all the research involved in making sure you’re getting the best deal. If finances aren’t your wheelhouse, knowing you’re making the right decision with the right lender and the right interest rate can be an anxiety-inducing process. Popular culture has taught us to be skeptical of car dealers, so that constant feeling of being somehow duped or swindled is a hard one to get over, especially when industry slang is being thrown at you in an environment you don’t feel comfortable in.
Something you can do is ask around your friend and family circles to see if anyone has had a positive experience with a lender. Word of mouth is always a good way to connect with a reputable lender or dealer.
Remember, just as not every vehicle will be the right match for everyone, no one payment strategy is a blanket solution for everyone. There is no right or wrong option—you have to decide what works best for you, your financial situation and your goals.
If you’re unsure of anything surrounding the payment process for a new or used vehicle, the best thing you can do is speak to a financial advisor who you trust. They will go over all of your options and let you know which path they think makes the most financial sense for you.