When You Should Get a Car Loan Instead of Paying Cash

It seems like every personal finance guru agrees. If you’re looking to buy a new car, you should start saving diligently before you need it, to ensure you have the cash on hand to purchase it when the time comes.

But maybe the gurus are wrong. Here’s the logic in taking the car loan instead of paying cash.

0% financing

During the financial crisis of 2008-09, auto manufacturers tried everything to get people to start buying again. They offered steep discounts, generous trade-in allowances, and other goodies.

Probably the biggest incentive was offering 0% financing. Giving customers the option to stretch their loans out to six and seven years also helped make vehicles more affordable.

It’s easy to see the logic in taking a 0% loan if it’s offered to you. You could stick the cash you have saved up for the car in a high-yield savings account and even at 1% interest, be ahead of the game. You could even invest that money in riskier assets like the stock market, provided the income was there to support the loan.

Even at 1.99% or 2.99% financing, there’s still the argument to be made that the liquidity is more important than the interest paid.

Pay down debt

Say you’re in a situation where you need a new car, but also owe money on student loans with a current interest rate of 5%.

In that situation, taking the car loan at 0% makes all sorts of sense. You’d then make only the minimum payment on the car, while throwing every extra cent towards the debt that’s accumulating interest.

If we’re looking at credit card debt, the savings are even greater. We’re fans of using balance transfers to help pay off credit card debt; just think of getting a 0% car loan instead of paying cash as a form of that.

The dangers of cheap credit

Cheap interest rates seem great, but you’ll want to tread lightly around them.

I once went into a local dealership and inquired about a car offered at 0% financing. I was told the price was $25,000 if I was looking to take advantage of the 0% offer. Less than five minutes later, I had the salesman ready to sell me the car for $19,000 if I paid cash.

Needless to say, there was an implied interest rate in that loan that was much higher than 0%.

These days, 0% financing isn’t terribly easy to come across. I tend to only see ultra-low interest offers on
cars that dealers still have on their lots, like with 2015 models right now or with certain types that just aren’t selling. This might be a plus for someone looking to get a deal, but it likely won’t work out for someone who has their heart set on a popular model.

Plus, the benefits of investing the cash are offset by the potential for loss. If you stick the money you had set aside for a car in the stock market and it goes down 20%, you probably won’t be too happy with the decision. And if you take the safe route and keep the money in a savings account, the reward isn’t very exciting. $20,000 invested at 1% is less than $20 per month.

There are certainly benefits to borrowing to buy your next car, assuming you can take advantage of a cheap rate. But like with anything, make sure you realize 0% financing comes with conditions attached.

Image Courtesy of Adobe Stock