Ask the Readers: Should You Carry a Loan When You Can Afford Not To?
Published on - July 6th, 2007 (by J.D. Roth) 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?
This article is about Ask the Readers, Cars, Choices, Debt
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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.
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“Ask the Readers: Should You Carry a Loan When You Can Afford Not To?”
No.
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> 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.
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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.
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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!
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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.
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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.
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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.
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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.
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What would boost your credit score more, a collateralized car loan or an unsecured personal loan?
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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…
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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.
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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.
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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.
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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.
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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.
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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.
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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
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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.
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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…
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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.
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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.
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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
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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.
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We actually did use a car loan when we could afford to pay cash. The interest rate for the car loan was under 2% and we were earning more than that on our assets. Also, our mortgage had been paid off early more than five years ago. We had no other debt in many years since we don’t carry balances or buy things on credit. Therefore, we had no recent credit history which can hurt your overall credit score. If we need to pay off the remainder of the car loan the money is available and earning interest. The result is we have a very decent credit score – important since they seem to use credit scores for everything these days, even for insurance policies and employment references!
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