It may seem like a smart idea: You're buying a car, and you can afford to write one check for the entire vehicle, which means you'll never have to make a payment. You should go ahead and do that, right? Not necessarily. We explain why it isn't always a great idea to buy a car with cash, even if you can afford to do so.
Cash vs. Financing
Before we get into the question of cash versus financing, a little background is in order for shoppers who haven't had much experience buying a new car.
If that sounds like you, here's the deal: When it comes to buying a car, you generally have two ways to go about it. You can either finance the car, which means you pay it off over time, or you can pay cash, which means you buy the vehicle outright as if you're picking up a new book at the bookstore and handing the clerk a $20 bill.
The advantage to financing is that you'll usually end up with a better car than you can if you're paying with cash. For example, if your car budget is $8,000, you'll buy a used car if you pay in full, but if you use that $8,000 as a down payment on a new car, you can expand your automotive horizons greatly. If you have good credit, you can easily afford many new models.
The only drawback is that you'll need to make monthly payments in order to pay off the loan that allowed you to buy the newer, more expensive vehicle. Included in those payments is interest, which is a fee you pay the bank for allowing you to borrow the money in the first place.
Isn't Cash Better?
The common thinking is that buying a car with cash is better than financing because you won't have to pay interest. After all, with a cash deal, you pay exactly the price shown and no more. When you're financing, you have to pay off the car with interest, and that means you'll end up paying an additional amount on top of the car's purchase price. So, is this thinking correct?
Our answer is: not always.
While we agree that buying a car with cash is generally preferable to financing, there are many situations in which that's not the case. The best example is if you qualify for a favorable interest rate. In that case, paying with cash may not be the smartest thing to do because you'll lose very little money by financing; you get to keep your cash for other projects or investments.
For example, say you want to buy a $25,000 car and you can afford to purchase it with cash. If you want to spend your cash, that's great: It means you won't have a payment or another care about the car's financing. But let's say you shop around for a good interest rate and end up with 1 percent financing for 3 years after a $5,000 down payment.
In that case, you'll keep your leftover $20,000, and while you have a car payment, the total interest comes to just $300. The question you must ask yourself is whether it's worth $300 to have that $20,000 in your bank account rather than tied up in your car. Most people would rather have the money in the bank or invested, where it's likely that they'll quickly earn back the entirety of the loan's $300 cost.
Shop Around Before You Write the Check
As our example shows, you should really think twice before paying with cash when you're buying a car. We admit that buying a car with cash is sometimes the right move, especially when you can't find a good interest rate or the car is relatively inexpensive. But we think that in most cases, it's best to shop around for a good loan before you write a big check for a new car.