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Financing a Car: When Is Financing Better Than Paying With Cash?

We hear it all the time: It’s better to pay for something with cash than to borrow money to buy it. But are there circumstances when that isn’t entirely true? We happen to think so, especially when it comes to financing a car.

Low Interest Rates

The primary situation in which you should finance rather than with cash comes when interest rates are especially low. In virtually every case where you’re offered zero percent interest, for example, you should take it. In these cases, the bank or car company isn’t charging you a thing for the privilege of spreading out your payments rather than paying entirely up front.

But zero percent interest isn’t the only situation in which you might want to seriously consider financing. If you’re given a rate as low as 1, 2, 3 or even 4 percent, you should think about financing your vehicle rather than paying with cash. There are a couple reasons for this: It allows you to keep around extra cash that would otherwise be tied up in your car, and you could instead invest the money and earn a high enough return to cancel out your interest payments.

As an example of our second point, consider this: If you put $5,000 down on a $30,000 car and pay 2 percent interest on $25,000 over the next 3 years, your total interest payments will equal just $710. However, if you invest that $25,000 and earn a conservative 5 percent annual return, you’ll earn $1,250 in the first year alone. That’s a far better place for your money than paying cash for a car.

Getting a Better Car

Sometimes there’s another good reason for financing a car rather than buying it with cash: You can get more car for your money.

If you only have $5,000 to spend on a new car, for example, you can purchase a used vehicle for $5,000 in cash, but it will likely be an older car with higher miles and few modern gadgets or safety features. Use that money as a down payment, however, and your possibilities will increase. Suddenly, you’ll be looking at cars that cost $10,000 or even $20,000, and you’ll get more safety features, more equipment and better long-term reliability.

The next time someone tells you that you should try to pay for your car with cash rather than a loan, just remember: Sometimes, having a car payment can be a surprisingly smart financial decision.

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