Updated on: July 25, 2021
After weeks (or months) of research and test drives, you've finally found the new or used vehicle that perfectly fits your needs and wants. But you have one major question left to answer: How will you pay for your next car? Will you pay cash for the car or finance it with an auto loan? The answer isn't always simple. In some cases, cash may entice a seller to lower the purchase price. In other situations, a fixed monthly payment may be better financially for a buyer.
Let's take a look at scenarios when it's better to apply for an auto loan versus when it makes more sense to pay cash for a car purchase.
Cash Isn’t Always a Negotiating Tool
Contrary to common belief, most dealership salespeople won't jump with joy at the prospect of selling a car to a cash buyer. Granted, cash deals are relatively easy, since they avoid finance applications, but financing is actually a decent source of income for the dealership. Unlike when a buyer comes in pre-qualified by their own bank, credit union, or other lender, a salesperson has the opportunity to mark up the annual percentage rate (APR) when using one of the store's preferred lenders. And while the buyer is already signing the paperwork, the finance manager can upsell additional highly profitable products and services (warranties, service contracts, etc.). Though these add-ons do raise the cost of the car, they are more palatable to a buyer when the amount of money is spread over 60 or 72 monthly payments. A cash buyer is much less likely to pay for these extras, as they'll need to be paid in full at the time of sale.
On the other hand, when buying a vehicle from a private seller or from a small dealership that doesn't offer financing, a cash discount is a real possibility. Sellers who want to unload a vehicle with as little fuss and delay as possible may be willing to make pricing concessions for a cash sale. Private party sellers in particular are typically looking for straightforward transactions, meaning a buyer prepared to hand over a cashier's check for the full amount will be more desirable than one who needs to consider financing options and will need the time and possibly extra documentation to secure a loan.
Financing Can Get You a Lower Price
As noted previously, larger dealerships see dollar signs when working with a buyer who needs financing (or, more precisely, a buyer who needs the dealership's financing). Buyers who walk into a deal with pre-approval from their own lender will invariably be asked if they'd be willing to switch to one of the dealership's lenders if it can match or beat the pre-approved interest rate. Salespeople may be more flexible with the price of the car, lowering the amount by perhaps $500 to then make $1,000 on the loan they'll secure. The net result is a buyer saving $500 and the dealership earning a profit that would've otherwise gone to the buyer's lender.
When dealing specifically with new-car dealerships, the best prices are often linked to finance incentives reserved for buyers with an above-average or excellent credit score who borrow directly through the automaker's finance division (Toyota Financial, Ford Credit, etc.). Be sure to ask your salesperson upfront about incentives or rebates that may be available for the particular new vehicle you're interested in purchasing. If your lender doesn't charge a penalty for paying off your loan early (pre-payment penalties are illegal in many states), you may find it would cost you less money overall to accept the incentivized loan, benefit from the savings, and pay off the loan soon thereafter (especially if it's a loan with a high APR).
Don’t Discount the Power of Having Cash on Hand
Not every car buyer has the kind of available cash required to purchase a car, but for those who do have enough money to pay cash, they should first consider their full financial situation. What would life be like without quick access to that $10,000, $50,000, or more? If that's your emergency fund, and its absence would be felt should a sudden job loss or medical emergency pop up, it may be best to keep that money in your bank account and opt instead to make monthly payments.
It's also worth considering how much that cash could earn in a high-interest savings or money market account. If, for example, you have a savings account that pays 2.5% and a car loan that charges 2.0%, the sensible choice is to earn 2.5% on your money and make the interest payments on the 2% car loan. That said, be sure to plan for down times by leaving yourself with enough readily available funds on hand to cover at least 6 months of car payments.
Auto Loans Are Great for Building Credit
Good credit makes the world go round. Far beyond making it possible to open a credit card with a low interest rate, a good credit score also allows people to rent apartments, buy houses, or add one more positive attribute to an already glowing online dating profile. Paying cash won't impact your credit score, but as it turns out, regularly making punctual payments toward an auto loan is a great way to keep that score trending in the upward direction (or improve a less-than-stellar credit rating). Worried about the punctual part? Talk to your bank about setting up automatic payments, so you won't need to stress about sending a late check or running out of stamps.
The Bottom Line
There's no single answer to the cash versus loan payments question; as is often the case in car buying, there are many factors to consider. Look at the incentives that are (or are not) available to you as a cash buyer, where your money will offer you the greatest rate of return, and what solution works best for you without overextending yourself. Most importantly, be sure your decision will keep you financially secure if the road of life becomes unexpectedly bumpy.
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