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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.

By MSN Money Partner Jul 20, 2012 11:34AM

This post by Lance originally appeared as a guest post at Budgets are Sexy.

 

Image: Couple shopping for car (© Don Mason/Blend Images/Corbis)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:

61Comments
May 12, 2013 9:51AM
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With how much value you loser on a newer car, a "sick" interest rate doesn't matter at all when it comes to trade-in time.  If you buy a reliable cheaper used car and keep trading up with your savings (you should have money elsewhere), it works out much better. 
Aug 2, 2012 5:08PM
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obviously no one ever explained the difference in between SIMPLE INTEREST and COMPOUND INTEREST.... at the end of the day you lost NOTHING at all you gained money from the bank because the interest in your savings is compound interest.  If you run the numbers in a simple vs compound calculator this person made 95 over three years after covering the cost of interest.   Works even better over a longer term.  Let the bank work for you, and be smart do not pay cash unless u have a crappy interest rate.

Aug 2, 2012 4:23PM
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Why do we all need good credit? This is circular logic. You need to borrow money to build up your credit, so that you will be able to...borrow more money? Hmm... 

About the only thing you really "need" credit for in life is a mortgage.

If you have no debt (credit cards, cars, etc.), and you have some cash for a down payment, then your credit score will be fine. And banks will line up to lend you money on a mortgage.

But if you have too many debt obligations (such as car payments), it will actually be harder to get a mortgage.
Aug 2, 2012 4:13PM
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yes,paying cash is always better,nd also to have a emergency found if you knock those two tihings down you live in freedom.this is just a way to get you to run nd get a loan,no way.
Aug 2, 2012 4:02PM
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A money manager advocating financing a vehicle? Really? Even at a rate of .9%, you still are making payments on a vehicle you cannot afford because you don't have the cash to pay for the automobile.  You also lose interest on saving money for a car in interest on the loan, and increased principle from saved cash. Moreover, you must pay more in auto insurance for a financed vehicle as opposed to paying cash. Lastly, it is never good to borrow-especially for a severely depreciating asset in the range of $18,000-$25,000- solely for the sake of satisfying the FICO scoring formula. The formula is built for the credit industry, and  analyzes your credit worthiness based on how much more credit you can or cannot handle...and not what your financial well-being is.
Aug 2, 2012 12:11PM
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If you always pay cash you don't need credit.
Aug 2, 2012 11:56AM
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Always,always,always buy yur vehicle at the END of the Month.Quotas that havn't been met,gets you a better deal.Don't always act excited-tell them considering other deals.I know,I was a car saleperson.
Aug 2, 2012 11:12AM
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What is this? Somebody braggin about their financial luck and prowess? ridiculous article
Aug 2, 2012 10:42AM
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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!

Aug 2, 2012 10:32AM
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Getting a car loan makes lots of sense.Paying cash,especially close to retirement. is not good for you. Cash flow is much better if you can find a 0.9% loan,even 1.9/2.9 is way better than shelling out all that cash you may need in the immediate future.Getting a new car is a much better choice because,1) it's new and you have a warranty to cover it and 2) if you keep a car 10-12 yrs like we do, you have got that car for a long time without worry of something major going wrong with it. Leasing is the absolute worst thing any person can do.Unless you're 80 and don't drive much, even at that with health care costs and insurance costing more it's still foolish.
Aug 2, 2012 8:57AM
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He bought a Honda Civic, there's a shocker.  I wonder sometimes if guys right out of college even know that other car brands exist.
Aug 2, 2012 7:10AM
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Just freaking stupid. First, every lander looks for different things. Second why buy new when a 2 to 4 year old car could save you thousands. Third dealer are scams, same people that figured 1000 different ways to add interest.  Fourth if you can pay cash for a new car you have enough for a mortgage.
Aug 2, 2012 6:34AM
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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.

 

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BS Lance! You are full of Crap! MY DAD and Mom ALWAYS SAID, if you are paying money EVERY month to have something, YOU ARE RENTING! They can call it what they want but YOU ARE RENTING! My dad said ANYTHING they can TAKE from you, YOU DO NOT OWN, Period! The House, car etc. Cash is ALWAYS better and you can STILL save money! In fact, IF you PAY cash, you save MORE money because all you have to worry about is occasional repairs! SO the $200.00-$400.00 you are paying every month for a car payment is actually going into savings! Also, If you saved cash, who needs credit! I make $88,000.00 per year and my husband makes $92,000.00 and we owe NOTHING to NO ONE! The credit card bill is paid as soon as it arrives in the mail (average $350.00 and we only use them basically for rental cars when we travel and to make hotel reservations on line), our house is paid for, our cars are paid for (we buy 3-4 year old cars every 4 years and we both drive BMW's), our insurance is paid up for the year, so all we have is utilities, groceries, cable, property taxes and Internet. Oh, our kids are grown and on their own! We have $433,000.00 in CASH saved, IRA's, stock, mutual funds 401k's so what the heck are YOU talking about?
Aug 1, 2012 7:34PM
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There are a lot of reasons why borrowing can be better than paying in cash. I generally buy new and then drive for ten years, so I like to get the loan on my credit. I pay it off after a year with the bulk being in the first few payments. A car loan will eventually drop off your report so doing this every ten or so years keeps at least one loan history on the report. I would only recommend this with the great rates that the Dealers or Credit Unions give out. This is certainly not a new concept, rich people always borrow when money is cheap. It is tough to make money in business without the ability to borrow... so keep that credit score high. Of course, if you know you don't handle money well and find yourself with the cash somehow -- you are probably better off paying it off upfront.
Aug 1, 2012 6:37PM
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I think for me, buying a brand new car and paying cash for it is better for me than getting it finance.  I will be 62 soon, already retired (almost 10 years now), have over $300K in my retirement account, receiving a pension, will be collecting my Social Security in Oct., have a house that's already paid for (no mortgage), and the good part....Don't live in the U.S. anymore (Philippines).  So it would be best for me to pay cash where i can get a lower price on the car, and if not, i will just keep taking public transportation, and still be happy.  So, in my case, i "want" a car, but, i don't "need" a car.  And i don't "need" to established any type of credit especially at my age and the time of my life.
Aug 1, 2012 6:15PM
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I bought a new truck in 1991, I'm still driving it and will keep driving it for many years to come, unless it gets wrecked, hopefully that won't happen. I dread the thought of ever having to buy another new vehicle, since the price most likely has doubled on new vehicles since the early 90's. I would only buy used on my next vehicle. The prices on new cars has gone way out of sight and for the most part wages haven't kept up.
Aug 1, 2012 5:05PM
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I guess my question would be are you trading off the ability to obtain a lower price to get that advertised low interest rate? Plus how many people really qualify for that great rate they offer? Get you in the door, watch you fall in love with that new car smell and then the salesman returns with a sad look on his face to tell you "no go with the 0% financing" but "we can send you out the door today in your brand new car with the rate at only 6.9%. Advertised low rates seem like nothing more the the old bait & switch game unless one has a stellar FICO score.
Aug 1, 2012 4:55PM
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Please......

 

Just congratulate him on learning NOW!!!!

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