Why a car loan can beat paying cash
Adding a new type of loan to your credit history can raise your credit scores. Under the right circumstances, this makes great sense.
This post by Lance originally appeared as a guest post at Budgets are Sexy.
While I was in college, I had 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 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. 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 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 history.
One factor of your credit scores is the type of credit you have. This accounts for just 10% of your score, but it is still an important factor. The types of credit include mortgage loans, revolving credit (credit cards), auto loans and student loans. Even though I had just recently graduated from college, I was extremely lucky 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 them off each month.
I had never had a mortgage before, but I knew I'd want one in the next few years. In order to get my credit scores as high as possible to get the best interest 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. (Post continues below.)
I got a sick interest rate.
Things had started to recover from 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 normally weren't great. Car dealerships weren't selling cars, though, and they had a lot of inventory due to poor sales. Thus, the advertised rate was 0.9% APR for 24 to 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 I signed 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 raise my credit score for a potential future mortgage.
It is nice to have the cash in the bank.
By taking out a car loan, 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. Then I set up auto-pay for my bill and haven't had to think about it since other than to make sure the payments come out on time.
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 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?
More on Budgets are Sexy and MSN Money:
Wasn't it just yesterday that there was an article about the advantages of NOT paying off your mortgage? And now this. I truely hope no one comes here for financial advice. While there might be......MIGHT be someone out there they can take advantage of this ..... hmmmmm, let's call it unconventional....advice, I suspect they don't spend much time on this site.
Of course, about the only reason to come here anymore is to find romance.
I would not try to rationalize locking in 50% of my net worth into a (quickly) depreciating item all in the effort to try to buy something else. I would likely have paid off my house by now if I would not have fooled myself with the same logic that the writer lists when my family purchased two new vehicles in the last seven years. Those two new automobiles are in an essence rolled into my 15-year mortgage as I blew out the car loans and delayed knocking off the home.
50% of net worth is an ambigious number as I'm assuming that many youngsters (like me at that time) had to get a new(er) vehicle right out of college into that first job. So, $20k worth of car is very conceivable to be as high percentage of many folks' net worth.
I did it, I don't advise it AT ALL. Quit spending money you think you will make, future congresspeople.
I forgot to mention a couple of things. Always,always go car shopping when you don't need another car.This gives you time to compare and leverage price against dealers.At 0.9% the bank could not possibily make that much on your loan.To be honest,who cares? You got a great deal and paid far less than buying used and ending up with a vehicle that may cost you in the long run.I love American cars,some I like go back in the 60's and 70's. But to be realistiic,if you're after a car that has a great track record as far as re-sale value and less repairs, then you know your choice.
Another thing, why is this personal crap of dating and other posts looking for a partner allowed on here? If you want an honest relationship not based on greed, then be like the person that looks around and develop a friendship like most peropl do.Get real!
It's best to think about your finances as a series of priorities. For me, #1 priority is a paid-off house. #2 is an emergency fund, #3 is a retirement fund, etc. BASIC transportation is among these, but not luxury or new transportation. If you don't own a house outright, then you shouldn't be buying a NEW car.
This zero tolerance for credit is just plain idiotic. Pay yourself first(retirement, college, emergency savings), pay must pays second(Mort, medical, food, utilities, etc), then finance a toy if you want. Just don't over extend yourself. It's called common sense. People who over extend themselve have none and people who preach absolutely NO Credit have none either.
If I had triple the price of the car in the checking account, and I am working making a regular wage, I would still finance with say $5000 down, get the best interest rate. Then for the first 3 months just pay the payment. After that I always at least pay the payment, but if I feel like it I double and even triple the payment to hurry the payoff. This way you dont touch what you had, except the down payment, and you use your' new earned wages to pay it off.
Given the same circumstance and retired, I would have paid cash. Or still using the same car I retired with.
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