Should I pay all cash for a car, or take out a loan?

September 17, 2022
Topic of the week: If I have the savings to pay all cash for a new car (about $30k), should I just use that or get a loan for it?

- Lauren, 31, Nevada

Quick note - the details of this question were already addressed outside of the newsletter (such as her other savings goals, comfortability with debt, etc), so this is how I would think about it applied to anyone's situation:

Most of the time, you'll hear people say that you should avoid debt at all costs and generally, I agree. Debt can be costly but if used correctly, it can be viewed as a tool rather than a hindrance.

In this scenario, the three main questions I'd be asking myself are:

  • Is this money better used elsewhere?
  • Do I have enough income each month to cover the cost of loan payments?
  • How do I personally feel about debt?

Some people genuinely hate debt and will avoid any scenario where they have to take on more of it. It's understandable, but on the other hand - instead of paying all cash, what if you invested some of the money and it earned higher returns than the interest rate of the loan?

Or what if you put the money into your business and ended up earning more, making it even easier to pay off the loan?

When you run the numbers, the cost of a $25,000 loan really isn't that expensive in the grand scheme of things.

For example, if you put $5,000 down and took out a $25,000 loan at 5% interest for five years, you'd only end up paying a little more than $3,000 in interest over the course of the loan. That comes out to a little more than $50/month in interest.

Here's a breakdown:

View the Loan Calculator

So in this scenario, by taking out a loan and still having $25,000 to invest or use elsewhere, the total cost of the car only goes up by $3,306.85.

I don't know about you, but I'd rather take the loan and have that extra cash on hand rather than having a fully paid off car (if I could afford the monthly payments).

The nice thing about having a loan rather than paying all cash upfront is that you can always pay down the car faster than what the loan term is.

Paying it down early can save money on interest while also giving you time to save more and not burn through existing savings first. However, if you want to pay down a loan early, you need to make sure there aren't prepayment penalties and if there are, make sure that the interest savings are worth more than the penalties.

Having the cash savings to pay off a car in full can be tempting (and it can make sense for some people), but you just want to be sure that you understand the tradeoffs and the opportunity cost.

Last thing: Another trade-off to consider is that almost every lender will require you to have full-coverage insurance until the car is paid off. This can be costly and if you have a paid off car from day one, you could get by with liability-only insurance and save money on the premiums.

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Questions that are more in-depth/personal may not make the newsletter, but are welcome and actually, encouraged. The goal of this is to answer your most pressing financial questions for free, while sharing some of them publicly to help everyone learn.

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