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Ask the Readers: Should You Carry a Loan When You Can Afford Not To? Print
Friday, 6th July 2007 (by J.D.)This article is about Ask the Readers, Cars, Choices, Debt
Monday’s collection of car links sparked more discussion than any link dump I’ve ever posted. A lot of you have strong opinions on the subject. Katie writes that all the talk about cars made her think about her own situation.
My husband and I have both saved enough money to cover the price of the new car that we want (plus taxes and fees) and have a comfortable amount left over — at least three months’ living expenses plus a good cushion in savings. We’re also at least five years away from buying a house, due to the transience of early jobs in academia.
A good friend of mine — also a grad student some years away from home ownership — recently bought a car, and her bank recommended that she take out a loan even though she could pay for the vehicle up front. The bank’s logic was that regularly paying off a car loan would build her credit rating, and thus leave her in a better position to buy a house down the road. I’m a bit skeptical about this logic, though — is it really worth negotiating for years of car payments that aren’t even necessary, just for the sake of possibly boosting my perfectly OK credit rating?
My gut response is that the bank is just pulling a boondoggle. Of course they’re going to recommend a loan — they don’t make any money when people pay cash! On the other hand, it is true that carrying a car loan can help build your credit rating. But if you already have good credit — as Katie does — then the benefits seem minimal (or non-existent).
Have you ever financed a purchase when you could have paid cash? Would you do so if you could? Wouldn’t it eat you up inside to pay interest when you know you didn’t have to?
July 6th, 2007 at 8:27 am
Can you invest the money at a better rate than the car loan?
If you can do that, and make the payments on time, then why not take advantage?
July 6th, 2007 at 8:28 am
The only time I have ever financed something when I could pay cash is if I had a 0% interest offer - then I paid it off before the interest kicked in.
I can also see financing if you have the cash to cover the cost, but it leaves you with little savings. But then I would only finance a portion of the purchase to keep my payments smaller and get it paid off sooner.
July 6th, 2007 at 8:29 am
If you can negotiate a loan rate less than the rate you’re earning in savings, perhaps one of these 1.9% car loans vs the 5% for online savings accounts, then you’re making money on the loan.
July 6th, 2007 at 8:30 am
If the car costs $20,000 and I have $25,000 in the bank saved up, then I would take the loan.
July 6th, 2007 at 8:31 am
While the bank is correct that making the monthly payments can have a positive effect on your credit score, it’s definitely not worth it.
A car is usually your second most expensive purchase. Use online calculators and figure out how much that car will actually cost you. Unless your money is making more than the interest you’ll be paying, it’s not going to be worth it.4 year loan @ 7% on 25k will cost you around $3800 in interest.
I’d look for a 0% loan from the dealer if available. That way you can just pay it off whenever while still taking advantage of your money drawing interest.
July 6th, 2007 at 8:32 am
One area where I carry debt is my student loans. I took out almost $48K for grad school & I am paying it back over 25 years, interest rate 3%. The real rate is even lower when you factor in the tax deduction for interest & also the effects of inflation. Now I do have that amount to pay it back, but choose to leave it invested b/c I make more than 3% on my investments.
July 6th, 2007 at 8:49 am
I bought my first car with cash (that I got from a windfall), instead of financing at 0% interest, and I do not regret it in the least. As someone who does not manage her money well, not having to worry about a monthly car payment has been a big relief.
July 6th, 2007 at 8:54 am
My instincts here would be to finance the car, keep your cash in a CD that will pay near the interest you are paying and then in a year or so pay it off. This will drive your credit score up enough that when you buy your house you ought to qualify for a better interest rate.
Think of it as investing in a lower interest rate for your future self.
Having a lower rate on a 15 or 20 year mortgage will reap more money for you over your lifetime than not paying some interest now.
July 6th, 2007 at 8:55 am
Her bank pulled a fast one on her. She can accomplish the exact same thing by actively using a credit card and paying if off in full every month.
I’d say go to the bank TODAY and pay that loan off in full.
The only exception would be if it’s a 0-4% interest rate loan, which I doubt.
July 6th, 2007 at 8:57 am
Take out a loan, and immediately pay it back as soon as the 0% interest period ends.
It builds a little bit of credit history. (not as much as monthly payments), and you suffer 0 interest.
Not having a car payment is a wonderful thing.
July 6th, 2007 at 9:12 am
It will help your credit rating, which could in turn help you negotiate a better rate when financing a house. When a mortgage company looks at you, they like to see a nice debt to income ratio. However, they also like to see responsibility when it comes to credit, and a structured loan like a car is a good way to show this.
Ultimately, if it makes sense will depend on a few things:
1) How much more will it cost you to finance as opposed to paying cash. If you can get a finance rate of say 4%, and you’re money resides in an account earning 5%, you will earn more money than it costs.
2) If it’s about the same to pay cash or finance (or if financing costs a minimal amount more), you should look at your credit history (not just your score). Do you a decent amount of credit history (i.e. credit card payments, structured loans, etc…)? Mortgage companies look at this too, not just your score.
Play around w/the finance terms. Perhaps see if you can get a 1 or 2 year loan. That will help keep the cost of financing down, while still adding history for a structured loan.
In the end, you have to look at all possible situations, and see which one makes the most sense for you.
One place to look for information is fool.com. They have some calculators (http://www.fool.com/calcs/calculators.htm?source=LN)
including one for “should I finance or pay cash for a car”.
July 6th, 2007 at 9:13 am
Ask for a line of credit instead. Use it to buy the car. Pay off in three monthly installments. You should thus have an excellent credit rating for a total cost of $450, based on $20k at 9%. Alternatively, pay mostly cash and borrow $5k on the LOC. Now your cost is $113.
However, I’m not sure it’s all that necessary. What kind of credit rating do you have now? How high are your incomes? My husband and I had only ever had lines of credit and credit cards, which we paid off monthly before interest accrued, and we had no trouble getting a mortgage at a preferred interest rate.
Try to find a credit card that has a line of credit attached. That’s what I have. I can buy something on the card, get 1% back in rebates, and then pay it off before the interest grace period ends. As a result, I actually make money while building a great credit rating. (I’m not sure, but I suspect a line of credit is rated differently than a regular credit card. Not sure, though.)
If you had a line of credit attached to a credit card and it was a rewards card, you could get 1 or 2% back on your purchase. That’s $200 on $20k. You could use that to cover the interest for paying just a portion the first month. Or you could just pay it all off, keep your $200 and have your credit rating build anyway. That’s what I did/do.
July 6th, 2007 at 9:26 am
Katie and her friend need to learn not to take financial advice from bankers. Especially about credit! Talk about conflicts of interest!!!
July 6th, 2007 at 9:28 am
“Mr Barber, do you think I need a haircut?”
Putting aside the fact that people tend to be way more focused on their credit scores than is justified, there are only three ways a car loan can help them: consistent payment history, utilization percentage, and variety of debt.
When you look at the FICO breakdown that they choose to share (the specifics are a trade secret) you see that 65% of a score comes from simple history & total debt, neither of which REQUIRE a car loan. You can have a history free of blemishes and with the 10-30% utilization that is considered best having never taken a car loan.
Another 25% has to do with how long a history you have and how much you’ve gotten recently. If the car loan isn’t the first credit someone gets then it’s not going to help with length of history in any way. It can, however, HURT if it’s credit someone gets within a short period of time before they want that home loan.
So in a nutshell, the bank is suggesting that auto loan - which has the potential to hurt if it goofs up their utilization or they make a late payment or it’s still ‘fresh’ when they try for another loan - for the sake of improving 10% of their FICO score, a total of 85 points.
Even if we claimed that without that auto loan they wouldn’t get -any- of those 85 points, which is not true, that makes 850 - 85, or 765 - still within the highest category they break out on this page. The reality is that even lacking that one kind of credit it’s likely a person with otherwise good history will still get a decent percentage of those points.
All that said, if they really want to get one more type of loan under their belt then they should just pay 75% of the car in cash and finance a few thousand dollars. 7 to 10% on a $4,000 loan isn’t peanuts but it is a small amount compared to the possible savings if you get a 0.5% improvement on a home loan. There’s also nothing stopping them from increasing the amounts of some of their early payments when the interest calculated is highest, provided their safety cushion allows it.
July 6th, 2007 at 9:28 am
i’m usually just a lurker, but reading the comments to this post just about made my head explode.
wow, the bank recommended getting a loan? stunning, just stunning.
not as much as someone AGREEING with that strategy, but pretty stunning.
honestly, if this isn’t a perfect illustration of how far off the beam we are in this country…first of all, no new car is worth it. ever. katie should get a two-year-old model of the same exact car for a huge discount. pay cash. put the rest into a cd, or your retirement, or college fund, or an eel farm. whatever. then drive her used car with pride and laugh her ass off at the morons in new vehicles - they want you to look at them, after all…that’s why they bought them.
and secondly - on WHAT PLANET is it worth it to PAY someone to improve a credit score? anyone with the discipline to save the money for a new car is 99.99% likely to have a good credit rating.
rant over.
July 6th, 2007 at 9:30 am
Run the numbers.
If you can negotiate with the car dealer when paying cash, take that into account. If you can make higher interest in a safe way than the loan interest, take that into account.
And: let the bank people expain to you in which way taking out a loan would increase your credit score. Make them commit to it: “if you do X now to build your credibility, you will save Y% on your mortgage”. Make them sign it.
Oftentimes, banks are unspecific and/or won’t commit to what they say - because they can get away with it.
July 6th, 2007 at 9:30 am
Some people say that if you can invest and get a better return than the rate on the loan then do it, but I personally don’t agree. This is a personal decision, but my thought is buy a 1-2 year old car for cash. Save yourself the 40% depreciation in the first 2 years, the interest on the loan, and the hassle of having a loan.
Think about how each choice will affect you, motivate you, cause worry, etc…
July 6th, 2007 at 9:39 am
It *is* true that having installment loans on your record will improve your credit rating. This a different type of debt than credit cards (revolving vs installment), and I think will boost your credit score in a way a card can’t, especially if you’ve never had an installment loan. (you should research this, as I’m not 100% sure)
But is it worth it? MAYBE, if you ensure there are no pre-payment penalties, and pay it off very quickly, within a year (or less!). I would also pay most of it as a downpayment, and finance only a fraction of the car, reducing your cost even further. If it actually does reduce your mortgage rate by any ammount, it might save you a lot of money in the long run.
Also…. 0% financing isn’t a free deal–the cost of that is built into the price of the car you are buying!
July 6th, 2007 at 9:48 am
S jean - yes the 0% interest isn’t “free” on the macro level, but unless you can swap it for a deduction in price, it is “free” on the individual/micro level.
My advice would be not to buy a “new” car at all. Cars now are well built, and a 2-3 year old car will have take the depreciation and still run well. There are exceptions of course, but to not consider this would be foolish.
I bought a 6 yr old luxury car for 21% of its original MSRP. Now, 2 years later, and only $500 in maintainence, i can sell it for just a few hundred less than I bought it for.
July 6th, 2007 at 9:51 am
I think given the transient nature of academia, and the potential that there may not be the work that you would like, I would say invest in the car and get it over with. That way, if hard times fall later on and you may not have a job, you have your means of finding a new one without having to worry about monthly payments. When the time comes when you do buy a house, I would think that having one less payment to worry about would be beneficial.
I’m surprised that no one has talked about the value and depreciation of buying a new vehicle as well - if we are really looking at the best bang for your buck, I would think that buying a brand new car off the lot, where it will depreciate immediately at what 25%, is not the wisest decision… buying a newly off-lease car or a newer car where someone else has taken that depreciation hit might be a better idea? You save a bit more money, insurance will probably be less, and you can get a good car that will be just as reliable.
And then that left over money you can use towards the new house… or a vacation someplace!!
July 6th, 2007 at 9:52 am
(ha ha, as I was drafting up this post, the fella above me did talk of the car depreciation!! great minds, hey?)
July 6th, 2007 at 10:00 am
I would take the loan, but pay double payments every month. This will help you save money for your emergency fund (if you don’t have one)
July 6th, 2007 at 10:04 am
I wasn’t going to comment on the new vs used car since both my cars (the daily driver and the hauler) are now old enough to be in high school and graduation is imminent for one. However anyone pondering the matter who isn’t dead-set on a new vehicle should buy and read Tom and Ray’s booklet “Should I buy, lease, or steal my next car?”
If you’re too cheap to pay I’ll tell you what their conclusion was: that between buying new, 3 year old or 7 years old, the most economical choice is to buy a three-year old vehicle. The cheapest is actually to buy a reliable old car and only spend money on the necessities vs cosmetic and luxury fixes but they recognize that’s not for everyone.
July 6th, 2007 at 10:17 am
I believe the debt of the car loan itself would lower the maximum mortgage you are eligible for. AFAIK, this goes for any debt, whether it’s credit card, school loans or a car loan.
July 6th, 2007 at 10:18 am
Make it simple. I would look at the sum of the interest over the life of the loan v. interest made at reasonably liquid market rates (3 or 6 mo CD?) But the term debt will improve your credit score much better than increasing limits on your credit cards or getting other forms of revolving credit.
July 6th, 2007 at 10:21 am
I do like what Dave Ramsey says when people ask him these questions “Would ever borrow money to invest it?” That is essentially what is going when the bank proposes that. Kinda silly. If you can pay cash PAY CASH!
July 6th, 2007 at 10:22 am
The bank makes money either way, having $25K in a bank account instead of investing it lets them lend it to others instead of you.
July 6th, 2007 at 10:47 am
The only time it makes sense to get a loan is if it’s an appreciating asset or if it’s tax deductible. Otherwise, just pay cash.
July 6th, 2007 at 11:07 am
The governing principle in my financial life is that debt is bad, and should be avoided if at all possible. If you have the money to pay cash for the car without putting any financial strain on yourself then that is what I would recommend, and what I did myself.
Others have brought up 0% or very low percentage car loans. If you can get that while at the same time getting a great price on the car, then that is an option worth considering. However, if you have to pay full list just to get a low finance rate then the cheaper option will probably be to pay cash.
Once you get the car I would start making “car payments” into an investment account. I bought my current car for $18,000.00 and made $20,000.00 of car payments into a treasury fund. With reinvesting the dividends I will have cash on hand when it comes time to replace it. If you plan on buying a house in 5 years I would also start making “house payments” as well. Not having a car payment may, in some small way, lower your credit score. I think that would be offset by coming in with a very large down payment.
Others have brought up the option of saving money by getting a used, but recent, car. If you think that you will want to be replace the car in several years, then a used car is the best choice. I buy new cars and run them into the ground. I’m 45 and have only ever owned 4 cars.
July 6th, 2007 at 11:09 am
Ignore for a moment the issue of pay cash or take a loan.
The best financial advice anyone could offer Katie is to not buy the car new in the first place - buy one that is a year or two old. Suddenly there are no fees and someone else has paid the depreciation. Even if she pays cash, she pays less and has more left in savings for the house in 5 years.
July 6th, 2007 at 11:10 am
I would definitely recommend not doing this, especially on a car. If you feel the need to get a loan for something you can buy, don’t do it on something that loses value.
July 6th, 2007 at 11:12 am
I’d take a smaller loan to cover part of the car. Why? Using the above example:
$20,000 for the car with $25,000 in savings - expenses can creep up (hence, the unexpected nature, and the need to have savings). this is a drastic example (maximum effectiveness!) but let’s say you’re left with $5,000 in savings. Suddenly, you wreck it. You need $5,000 to cover repairs. Or Medical expenses, whatever. Point is, you know may need to start borrowing money.
Same situation, but you have $10,000 left in savings. Now, after your wreck/whatever, you still have $4,000 JUST IN CASE.
Your mileage may vary, but it’d be nice to have a little bit more of a back-up.
July 6th, 2007 at 11:32 am
I have about a year worth of payments left on my car, but if I had the ability to pay in full, I would’ve done it.
One thing to consider is car insurance. My loan requires me to carry full coverage, and while it’s always good to have full coverage, for a male in his early twenties, it’s definitely not cheap. When I first got the car at age 20, my car insurance was nearly $1600 for a six month policy. Now, at 23, I’m paying just over $900 (which I consider a steal) with $1000 deductables at the cheapest insurance company I could find. Keep in mind I have a clean driving record.
July 6th, 2007 at 11:32 am
We are in almost the same exact situation. We’ve decided to go ahead and get the loan, we got .7% at 36 months from the dealership. I put the numbers into the fool.com calculator recommended above (there’s a “Should I finance or pay cash for a vehicle?” calculator) and it says, and I quote, “Paying cash for a vehicle will _cost_ you $464 more than financing over 36 months.” Good link–thank you!
So I guess we made the right decision. Well, maybe not according to the people who think buying a new car is silly. But here are our reasons:
1. We can’t buy a 3 year old car that is as fuel efficient as this one for the same price. We will save significant money in gas every month. More as gas prices continue to rise (see #3).
2. We are tired of shelling out money every year for repairs on a 6-year-old car, and even more to get it fit to meet inspections every year. With a new car instead of a 3yr old one, we will have three more years theoretically before we have to start spending money on this sort of maintenance.
2.5. We don’t do car maintenance ourselves, and don’t intend to learn how. This is a choice and an assessment of our abilities, we do better with books than cars and know that others are much handier than we are; it makes more sense to pay more for a car that won’t need as much maintenance for the first few years of ownership, paying more upfront and less for maintenance.
3. We plan to own the car for 8-10+ years. I have a car that is 13 years old. It was in a whole lot better condition three years ago than it is now. Those three years do make a difference in the long run, and I sunk too much money into that car the last three years than I should have, it would have been better to part with it sooner. It was also worth 2-3 times more at 10yrs old.
4. The new car will fulfill the needs that are currently filled by both our cars. (Enough space to carry large loads, skis, and to travel–my car–and good gas mileage and reliability–my husband’s car.) By buying this car (which is a new model, we couldn’t buy a 3yr old one b/c they weren’t made three years ago) we will only be paying one insurance bill, one state inspection, one license renewal, etc…
Maybe all these factors don’t add up to saving the difference in price between a new and 3yr old car, but I’d bet they come pretty close.
July 6th, 2007 at 11:36 am
I’ll have to say that I did the same as what the bank recommended.
I really didn’t have credit at all. I had paid off my student loans but those surprisingly have basically no bearing on your credit rating, at least for me. Taking the loan that I did for 2500 (had to have a cosigner for example). Helped my credit rating a ton. I was able to get a credit card at that point that I used for gas..and that was basically it.
Between those two I was able to build up a nice credit score over the last 4-5 years of responsible credit use, Paying the car off directly from my account each month..I never had to look at it, it just was directly taken, and paying off the credit card every month.
I would take it just simply for the fact that it’ll do a big help to your credit rating which will help when you go to buy that house. You can do Payments for 1 year and then pay the rest off as a lump sum. It still helps your credit.
July 6th, 2007 at 11:49 am
im probably asking for it, but
if you are looking to buy a car and a new one is say 20k, and a used, couple years old model is 17k with 50 thousand miles, does it make more sense to buy the new one?
July 6th, 2007 at 12:49 pm
A couple of points.
First, it is true that your score can increase. Somebody above already mentioned it and even quantified it (up to 85 points).
Banks don’t look only at 1 number (the FICO score) they look at the whole credit history. So it is true that even though your score might not go up by a lot it might still make a difference in the interest you get for your house.
On a 200K loan even a 0.1 interest difference on a 30 year loan is the equivalent of saving $4680. I live in the bay area where loans can be easily 500 to 600K, that’s $12000 in savings from a interest difference of 0.1%.
As for the car loan, the best suggestion I’ve seen is pay something up front, finance the rest. Maybe half and half. Get a 2 year loan and pay it off in a year.
For those worried about the payments, remember that they have the money in the bank, they shouldn’t have trouble paying the loan. The cost of the loan itself will be minimal given that they can earn interest on what they have in the bank.
Say a 6% interest on 10K will be $600 for financing (on a 1 year loan), if you can invest your money at 5% you’ll make $500 and the real cost is $100 for a possible savings of over $4K for every 0.1 you reduce your interest by. Hey, even a 0.01% reduction in interest will be worth $431 (30yrs 200K).
Now on the subject of cars, not all cars depreciate fast. The first thing to note is that MSRP is not the real cost of the car, no wonder they depreciate “fast”. The price of a new car is Dealer invoice.
The Dealer gets the car for 20K, sells it to you for 25K, so when you drive out, the car drops in price 5K (20%). Only fools pay MSRP. Do some research, get the consumer reports car report (with all prices, kickbacks, promotions, etc) for the car in question, then negotiate with the dealers (multiple dealers).
2 years ago we bought a 2005 Accord, sold it last year for a bit more than we paid for it. Yes, we’re good negotiating, and yes, we did “lose” the taxes, but hey, we had a new car for a year, cheaper than leasing.
You can buy a 25K MSRP car for 22K easy. Remember to bring your own financing to the dealer, don’t let them fool you into negotiating financing and the price of the car at the same time.
July 6th, 2007 at 1:02 pm
That is hilarious. Talk about letting the fox guard the hen house!
July 6th, 2007 at 1:11 pm
I’m ALMOST DONE paying for my car! My gut says to pay it off right way, but if you can leverage a good interest rate and and put it in a 5% online savings account, you can’t really loose.
Wohoo! I’m almost done paying for my car!!!
July 6th, 2007 at 2:22 pm
It can be worth it to “buy” a credit rating. Lots of savings may not mean much to lenders. When I applied for my first credit card, the bank didn’t want to give one to me, because I didn’t have a high paying job or any credit history. I pointed out that I had $10k in my savings account and that I doubted many 18-year-olds had accomplished that after paying their way through first-year university. No dice. But then they relented and offered me a secured credit card (I had to put down $600 for my $500 limit.) I’ve never carried a balance on anything — not even a line of credit — and I had no trouble getting a mortgage. Still, if you have no history, sometimes you have to do things to get that first loan/card.
July 6th, 2007 at 2:24 pm
If you can earn more in interest at the bank than the loan costs, then you have a logical argument for taking the loan.
That said, I REALLY LOVE having paid for cars. They are MINE. There is no monthly deduction from my account. This is an emotional decision that could cost me a couple of hundred bucks over the life of a car loan but for me the peace of mind is worth it.
Same for the house.
July 6th, 2007 at 3:09 pm
One idea I haven’t seen mentioned is what my credit union calls a “share-secured” loan. They’ll give me a loan at 3% over whatever interest I’m earning on the account that secures the loan. As academics, you should have access to some sort of credit union through the school. Check and see what they’ll do for you. My CU also used to charge just simple, not compound, interest. This may no longer be true, but check into it.
July 6th, 2007 at 3:12 pm
Nacho - I think you pointed out the exceptions I was talking about. It seems like on moderately high demand cars, such as the accord, odyssey, mini, xb etc there is not nearly as much depreciation.
Again, buy smart. My first 10 years of car ownership I bought a different car every 6 months ( I had 2 at atime for most). Only 1 time did I spend more than 100-125 a month in depreciation and maintenance (my first self purchase an s-10 blazer that needed an engine rebuild, ac rebuild etc). About 1/3 the cars I MADE money on.
I’m not a super wheeler dealer type. I just did the following
1) Researched the cars - for most cars today there is an enthusiast website - ask there for what to look for
2) Be Flexible - on my last car i was looking for a sporty/luxury car in reasonable good shape in any color except maroon. Be willing to look outside the box. Ie you may not have looked at an Isuzu trooper new, but now that they have taken the depreciation hit, you can get a deal.
3) Look towards resale - try and find low mileage clean looking vehicle.
4)Buy cheap! There is a lot more elasticity of demand for $5k cars than $15k cars. If you buy it for $5k, you can sell it for close to that.
BUt getting back on topic - make sure you pull your credit score first to see if it is worth it. Also, a bonus to buying used is that you establish payment history, but pay less interest because you borrow less.
July 6th, 2007 at 3:26 pm
One person above claimed that paying off your credit card balance every month raises your credit score. This is actually not true. Carrying a balance each month actually increases your credit score (assuming that you always pay the minimum on time). Since I don’t want to carry a balance, what I do is once in a while pay everything but a few dollars (since the interest on a few dollars is so insignificant). This way I can increase my credit score without increasing my debt.
But back to the topic at hand - I’m in a similar situation, on the verge of a job in academia, and I’m so glad to not have a car payment. I have never had a car loan or any other type of loan (other than student loans), and I managed to have great credit that enabled me to buy a house last month with a decent 30 yr fixed interest rate. Don’t listen to the car salesman.
July 6th, 2007 at 3:33 pm
if you had the cash, couldn’t you take out the loan, put the cash into a savings account with a higher yield than the loan’s APR, and simply make automatic payments from your savings to your loan? You’d be paying interest, yes.. but you’d also be earning interest.
July 6th, 2007 at 4:02 pm
//For those worried about the payments, remember that they have the money in the bank, they shouldn’t have trouble paying the loan.//
//I would take the loan, but pay double payments every month. This will help you save money for your emergency fund (if you don’t have one)//
I would hope that if someone has enough cash to pay for a car,they’ve already secured an emergency fund for themselves… that would be my hope at least.
But this whole take the loan thing, I believe, is the kind of thinking that *can* get some people into trouble with money. Thinking they are making big money or cheating the system by trying to work this bank against another…. I honestly don’t think the average person will win that game. The only way to win is to get out while the money is good, own some assets, and have some emergency funds in place if something awful, God forbid, were to happen.
I don’t disagree that when you have money, you should apply for some credit that you’ll never use “just in case” something dire should come up… but I think that should be in the form of a line of credit that is a bit more flexible than a fixed-term loan. Plus if you have that asset that you own outright, as another reader pointed out, the balance of that loan won’t become a liability.
I think it is a matter of personal preference, and it is a bit scary loading that much cash into an asset, but if you are a buying a $20K car, you are buying that car… it is a big amount of money. I think what the loans are good for is easing people into the idea of spending that much on one thing. $300 a month doesn’t seem like much at all… and can be justified. $20K in one lump for a car is a HUGE sum, at which I would be thinking is there another way I could spend this money? Which I also think is the whole point of paying in cash, you have a better idea of where your money is going.
July 6th, 2007 at 4:41 pm
This is hilarious — especially that so many people are taking it seriously. “Uh, yeah, I’d finance when I could pay cash…”
July 6th, 2007 at 5:05 pm
It’s just astonishing how many people are not just wrong about how a credit score is computed but so sure in their misconception.
Paying or not paying your balance every month on a credit card may or may not raise your credit score. What you’re talking about is total utilization. Your score suffers hugely if you’re using almost all your available credit. Your score suffers a little if you’re using NONE of your available credit. Best is somewhere in the 10-30% total usage but if you had to pick an extreme you’re way better off at the 0% used.
July 6th, 2007 at 5:16 pm
Jill said: “Carrying a balance each month actually increases your credit score (assuming that you always pay the minimum on time). Since I don’t want to carry a balance, what I do is once in a while pay everything but a few dollars (since the interest on a few dollars is so insignificant).” Please check this very carefully. Credit card companies are not known for their generosity and caring. I believe that if you do not pay off the entire balance, you pay interest on the entire balance, not just the remaining balance. Someone who knows better can correct me, but here’s what I believe: (simple example, interest 1%/month for simplicity’s sake) you charge $100 this month and pay $99, leaving a balance of $1. Jill thinks you pay only $1.01 next month to zero out. I think that since you didn’t pay the balance in full, they charge you interest on the entire $100 and next month you have to pay $2.01 to get back to zero ($100 x 1%, plus $1 x 1%) With a small enough balance, it may not make any significant difference, but it could add up for a larger initial balance. If you plan to do this, it might make more sense to pick some month when you have a very small balance to not pay the card in full.
July 6th, 2007 at 5:47 pm
I agree with Jay and the other posters who recommend buying a used car for cash. A couple of years ago my spouse took a job that reimbursed for mileage, averaging about $6500/year. Rather than running out to purchase an over-priced luxury car like many of his peers, he paid cash for a 1998 Subaru. Yes, it was a little banged up, but he’s not overly concerned about appearances, and the large trunk is great for hauling around the computer equipment he needs as an IT consultant. Plus, we don’t have to worry about the kids scratching the paint when getting their bikes out of the garage. Even better, thanks to his employer’s generosity, we’re left with a nice tax-free chunk of cash at the end of every month (after paying his gas & maintenance bill).
BTW, of course the bank is going to recommend that you take the loan! They’d rather you pay them interest than vice versa.
July 6th, 2007 at 6:52 pm
Car loans are totally evil. I don’t think one should ever take a loan on a massively depreciating asset. Sounds like another bank trying to line their pockets instead of ours. It is true more loans will build credit history, but there are better ways to do that than financing a purchase you don’t need to finance. Just open some credit cards and throw them in a safe and never use them. That works too.
July 6th, 2007 at 7:27 pm
“Ask the Readers: Should You Carry a Loan When You Can Afford Not To?”
No.
July 6th, 2007 at 9:13 pm
> One person above claimed that paying off
> your credit card balance every month
> raises your credit score.
I’m not sure if I’m the one you’re paraphrasing. But what I meant is that, if you want to establish a track record of using credit, you could just pay off your balance every month, as opposed to never having a credit card or never having ever used one.
> Since I don’t want to carry a balance,
> what I do is once in a while pay
> everything but a few dollars (since the
> interest on a few dollars is so
> insignificant).
I don’t know what your credit card rules say, but mine charges interest on the original balance, not the remaining few dollars.
July 7th, 2007 at 12:08 am
My fiancee was in the same situation (got a car loan to try to build her credit). In the end, she couldn’t take it after a few months and just paid it off because it was kind of stupid to pay interest for nothing.
July 7th, 2007 at 7:31 am
My husband and I make over $200k per year and are always broke. We have loans and credit up to our ears. Pay for the car in CASH!
July 7th, 2007 at 8:44 am
I had very similar experience and what came out of it boosted my credit rating, so I thought I would share it with you.
I was a new immigrant, so my credit rating was similar to a college grad , very little history - very low.
In 2003 I bought a new Honda, and though I had enough to pay cash for it, I chose to finance it. One month later, I realized how stupid it was to pay 7.5% while my own money in the bank are earning me 3.4%, I paid it off. My credit rating jumped.
One year later I was buying a house, and my credit rating was extremely good, and apparently the best thing that boosted it up on it was that Honda loan.
The program that calculated credit rating took it as the biggest loan I ever took and paid, and , whether it is bug or not, I benefited from that experience.
…. If this is not a concern, and there is no way you can invest the money with interest higher than the loan, I say go for the purchase.
July 7th, 2007 at 9:29 am
A line of credit is a great solution, since you don’t pay penalties for early repayment. And you could pay it all back within days of taking it out.
July 7th, 2007 at 10:22 am
No, No, No
I wouldn’t do this. I save money every month and put that into an interest bearing high yield savings account and make large purchases from that. Id rather pay myself interest than pay it to others.
I think its a bad idea all around, especially the bank’s inimation that we need to worship our FICO scores.
July 7th, 2007 at 12:16 pm
depends. as everyone said, if you can get a good rate, one that you can earn more by investing in a safe investment, then in a heart beat I would do it. Especially if you get 0% financing. The BIG 3 are offering 0% financing again this summer if you are inclined to buy from them. There is no reason not to finance at 0%.
sure the bank wanted to get a loan out of the grad student, but the bank didn’t lie about building credit. it would do just that. whether the person need to build credit is a different story. there was no pulling a fast one.
i’m also not a big fan of down payments either if you can get a good rate. if you have the cash, invest it in something secure and earn a profit off it.
the bottom line is to be informed.
July 7th, 2007 at 12:40 pm
What would boost your credit score more, a collateralized car loan or an unsecured personal loan?
July 7th, 2007 at 3:59 pm
I can afford to pay cash for most things these days. But would I? No. Why? Because it’s better to let my money work for me - to generate more cash.
If my long-term investment return is say, 12% annually, then it’s better for me to take an auto loan and pay 0%-9% interest; allowing me to keep my cash invested.
Of course if finance fees are close to or over 12%, then I’d pay cash. This would be like getting a gauranteed return on my money.
This said, just like the typical “Millionaire Next Door”, I tend to buy low-mileage-slightly-used vehicles, care for them well, and drive them until they’re all used up…
July 7th, 2007 at 4:11 pm
What I find interesting is how some people use the words “used car” and “$20K” together.
To me a used car is 8K maybe, maybe 10K.
I would argue (don’t take literal guys) that if a new (zero miles) car cost 20K and a “used” one with 10K miles cost 17K (ish) then what really is the difference? Money wise…
I have heard and believe that car payments are the #1 killer to budgets and savings. But if you are paying cash for a 15-20K car then you and I have different ideas of saving and what the definition of a used car is.
There is nothing wrong with anyone paying what they want, but again everytime I see a “new vs used car” thread it looks like to me that their are people wanting to justify buying that $20K by calling it “used” just because it is a 2005 model.
I own a 96 S10 and a 95 F150. Those are used…
To each his own.
July 8th, 2007 at 8:42 am
At age forty, with NO debt and enough fully owned real property, savings and business inventory to put me in the top 5% of wealth in the US,I was refused a $15,000 home equity loan to insulate my aged house.
Why?
Because I had no credit rating because I had never owed money or missed paying off my credit cards on time in full.
What a shock that was. Over time that has changed radically but the importance of having a history of paying debt can not be emphasized enough as silly as it sounds
If I were you, I would forget the
‘car I want’ and get a good three year old car (or even older) with low financing. Drive your less than dream car a few years and watch you credit rating rise. My now 12 year old Taurus has never had a repair other than those resulting from a fender bender and that was covered by insurance.
Find out your credit rating and track it each year. Pay for things with one of the airline mileage bonus cards and take a trip to Europe in a few years.
July 8th, 2007 at 12:46 pm
I got tired of paying debt. Felt that I was “owned”. I should look up my credit rating but just don’t want to play “their” game anymore. I have no problems paying cash.
July 8th, 2007 at 7:56 pm
aj, unless you bought all your rental properties in cash, or in your company’s name, and not in your name, then i don’t believe you.
maybe your home didn’t have any equity to loan against.
July 9th, 2007 at 6:00 am
Read the post.
I had over $500,000 (appraised not cost)equity and no outstanding debt. But I had no history of repaying debt so I was denied a small loan.
July 9th, 2007 at 7:30 am
2 Roy:
“I got tired of paying debt. Felt that I was “owned”. I should look up my credit rating but just don’t want to play “their” game anymore. I have no problems paying cash.”
By not maintaining your credit score (i.e. paying cash all the time) you deny yourself one of the options that you may eventually need: money borrowed. It’s a useful option at times.
I know Russian millioner who bought everything for cash. When ONCE he needed to borrow small amount to pay for the funeral in his family, he couldn’t, because his credit history was non-existent.
To maintain credit history, it is enough to buy $10 worth of groceries or stationery on credit card, and repay on time regularly.
The point is - play by the rules of the game and use your discretion to NOT get in debt. You never know when you may need to use the opportunity to borrow money.
July 9th, 2007 at 10:46 am
We bought a car last December that we could have paid cash for, but we chose not to.
Our reasoning was as follows:
- While we could have paid cash for the whole thing, that would have left our available cash reserves below a level I would have felt comfortable with.
- Through my credit union, I was able to get a 3-year loan with a rate of 4.5% which is less than the 5% rate of my online savings account - technically my money would make more money sitting there than going towards the loan
- I wanted to have it show on my credit history, but didn’t want a lot of debt. So I figured I’d pay most of it in cash and leave a smaller amount (1/3 or so) financed. My history is nearly perfect, except for a few issues that came up from my mom missing a couple payments on a gas card I hadn’t realized I was an authorized user on. I’ve taken myself off the card, but I’m hoping this will help repair some of the fairly drastic damage that did a bit faster. (I went from 800+ to below 700)
Even though I’m technically making money at a rate faster than I’m losing it to the loan via my savings account, I’m still not happy to have any debt at all. I’m 5 months ahead on paying off the loan, and would pay it off by the end of the year, but unfortunately my wife has a massive pile of student loan debt (@8.5%) that I need to focus on first
July 9th, 2007 at 2:23 pm
I would go ahead and finance. You can get a great rate on just about any American car these days what with their dire need to sell a couple of cars. On the other hand, I recently bought a new Honda Accord and they are well known for not having very enticing financing deals since they have such a reputation that they don’t usually feel a need to compete in that manner.
Even they have 0.9% on most cars and 2.9% on Accords right now, though. The catch is that you have to finance for 36 months or less. If you can afford to pay cash, you can afford to pay in 36 months. Invest the rest in the mean time, and in the end, the car will have cost you less than if you had paid cash, even with the finance charges.
In addition, it really can help you in the long run even more: as was mentioned before, it positively affects your credit score to carry a car loan in good standing and if your score is already good, then it’s the little things like that that are the only things left that can help it (this is the case I was in).
More immediately tangible is another advantage that I was only recently made aware of. When I applied for car insurance a few months before I bought the new car I was told that I did not receive the lowest rate because of the lack of a car loan in my credit history. I reapplied after getting the car (rather than simply renewing) and received a much better rate and the difference on car insurance alone covers the small finance charges from such a low rate.
Add on top of that the investment returns and financing a car has actually MADE me quite a bit of money.
July 9th, 2007 at 6:58 pm
yeah, i read your post. it just doesn’t work that way now, or ever.
otherwise, how would any young kid ever get a loan?
there’s something you are not telling us. you have credit cards, so you have a line of debt that you just haven’t used, and you have a credit rating.
you can also get a bank loan with collateral, ie, by signing on the loan that you will give up some piece of property (a rental, your car) if you don’t pay. they look at your credit history a bit yeah, but they look at more than that.
Another fishy thing is you are using the term “business inventory” in lieu of actual income or savings. my dad’s business probably had a few hundred thousand in inventory, and had a few hundred thousand yearly in revenue, but also a few hundred thousand in expenses, and an average net of only around $20k in personal income. it wasn’t a good business, but he could get a loan for anything because he had collateral.
so it may have happenend, but there was another reason, because simply not paying interest on a credit card doesn’t make sense. you are also sort of insinuating that you are the only one who has never not paid their credit cards in time and never not carried a balance, which is what you think makes you out of the ordinary, which is somewhat odd…
July 10th, 2007 at 1:36 am
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July 10th, 2007 at 5:02 pm
Yes all the time. DH bought his first and only car with a loan to build his credit (new to country) and to not be dead broke and wipe out his savings entirely (again he saved a ton before moving here).
We’ve also financed things at 0% with a Best Buy CC like w/d, fridge because we didn’t have the cash liquid when we bought our house. Mistakes were made during the purchase tying up all of our free cash, a substantial amount. Then when we got it back about 2 weeks later, we just decided to leave the financing. That’s how we got hooked on it.
Anyway though our mortgage problems came because we weren’t married, and applying for a mortgage when we couldn’t on the wrong visa type. So it wasn’t our fault, we didn’t know until too late.
July 11th, 2007 at 11:33 am
If the credit rating was already good enough, the loan shouldn’t be necessary.
The only reason to borrow would be to reduce the ‘opportunity cost’ of the money you have in hand. If the interest on your savings is 5%, for example, and the car loan is less than that (maybe 3.9%), you actually end up ahead with the cheap loan and high savings rate.
July 11th, 2007 at 3:06 pm
I could pay the car in cash, but I would need to liquidate some mutual funds and incur some capital gains tax.
I know this is not a popular choice here.
But I chose to finance it instead. I was able to get a 5.39 % 60 month loan. This is because financing allows me flexibility with my finances.
I only have a mortgage, and this new car loan. I pay off my credit cards every month.
Here’s why I financed.
PAY CASH scenario.
Say I have 18k cash. I want to buy a 17k car. So if I paid cash, then I would have only 1k left. Suddenly next month I lose my job. I would now only have 1k left for gas, mortgage, food, etc. I would probably have many sleepless nights. And maybe have to sell the car I just paid for in cash.
FINANCE scenario.
I start with 18k cash. I finance it and only have to pay $330 a month. Suddenly I lose my job. But I still have 17k cash, so I can easily pay for my mortgage, food, gas, while I look for a new job. I can still drive my car as long as I can pay only $330 monthly.
So I would rather have peace of mind, and have control of the 17k. If in the future, I get a new job, I can chose to pay off the car loan early.
Yes the car loan will cost you money, but you are paying for flexibility, and the peace of mind in case an emergency job loss, or illness occurs, or maybe even an unexpected accident and you are out of work for a couple of months. Would you rather have 17k available or 1k?
btw, I was able to get a 2007 Corolla for $750 under invoice. If you are interested in more details, see my blog at http://buycorolla.blogspot.com
November 13th, 2007 at 10:02 am
As long as the rate is very low, I wouldn’t have a problem taking the car loan for a short term. Really it depends on current rates, and how I could put the money to use elsewhere.
If the rate was bad I would just write a check for it and be done - no sense paying too much interest. Having a lower monthly output is a good thing, and gives you more flexibility long term, I think.