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Car-Buying Dilemma: Pay in Cash or Get an Auto Loan?

6355251231_830459dc50_zWhat’s the wisest way to pay for your car? Get an auto loan? How about pay in cash? Not many car buyers realize this but either option has its own costs and benefits. You need to sit down and do some math before walking into a dealership to purchase a car. Here are some factors you need to look at when weighing your payment options.

Costs

The most obvious advantage of paying for a car in cash is you don’t get to pay interests and finance charges. If a car costs $30,000, you’ll pay only $30,000 and the other required fees and taxes.

But let’s say you took out a 60-month new-car loan with 4.18% interest rate (the national average for 60-month new car loans according to the latest data from Bankrate) to finance the same car. And you also managed to pay 10% down payment that is, $3,000. After 60 months or five years, the total interest you will be paying is $2,966. All in all, the auto loan cost you $32,966. This figure could increase if your credit is less impressive and the repayment period is longer.

You skip that extra cost when you pay in cash. But you have to keep in mind as well that a car is a depreciating asset. Your $30,000 could be somewhere else more profitable. Keep reading to learn more about depreciation.

Depreciation, Resale Value and Upside-Down Situation

What does depreciation and resale value have to do with your car payment options? Every car buyer should be aware that a new car loses value as soon as it is driven off the dealer’s lot. According to the Kelley Blue Book, the most depreciating car in 2013 is the Nissan Leaf which is likely to retain only 18% of its value five years from sale. That means you can’t make much money from such cars that depreciate substantially in just a matter of few years—or just after you have paid off your auto loan.

With this in mind, purchasing your car with an auto loan could get you into an upside-down situation where your debt is greater than your car’s worth. You won’t have to worry about this risk when you buy a car in cash.

Your Credit Standing

According to My Fico, the types of credit you have and the number of new credit each account for 10% of your credit score. Paying a car with an auto loan looks like the better option in this light especially if you are trying to establish good credit. It will also be easier for you to get approved for your next loan if you have shown excellent payment behavior in your auto loan.

But if you miss payments and incur bad records in your credit report because of your auto loan, you credit will be in bad shape.  It would also be hard for you to make another big-ticket purchase in the future if your credit does not look great anymore.

Photo credit: 401(K) 2012 / Flickr / CC BY-SA 2.0




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