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8 Reasons Why You Should Pay Cash for a Car

One of the biggest line items in a typical household budget is car expense, and one of the reasons it’s so large is because of car loans. After decades of easy credit, we’ve been conditioned to think of car loans as a normal part of the car buying process. Not many people even think to pay cash for a car anymore. I have a car, therefore I have a loan.

But is that the way we should be thinking? Are there deeper risks to having a car loan that we tend to gloss over? I think so. The loan you sign on for when you’re safely employed can quickly become unsustainable after just a few months of unemployment. And with job losses and extended periods of unemployment becoming the “new normal” we should be changing our assumptions about car loans.

What are some of the reasons you should avoid a loan and pay cash for your next car?

A loan puts your car at risk

8 Reasons Why You Should Pay Cash for a Car

8 Reasons Why You Should Pay Cash for a Car

Unlike credit cards—where the lender has no specific claim on your assets—it you fall behind on your car loan, your car can be repossessed. This reason alone should remove any casual notions we have about car loans. They’re higher risk than almost any other loan type! Even if your house is foreclosed on, there is an extended period of due process that can take a year or more in many states, giving you valuable time to maneuver. No such protections exist for a car loan; stop paying and the repossession process is pretty swift.

A car is a survival asset for most people

For most people, a car is critical to their ability to earn a living, if only for commuting. If the car is lost—which is much more likely during a period of extended unemployment—your ability to earn a living will be greatly impaired. You can lose your wide screen TV, your $3,000 deluxe treadmill or even your home and still be able to earn a living. Not so with a car; lose it and your job prospects collapse immediately.

The double car payment trap

One car loan is bad enough, but as a testament to the casual way people often see them, many households have two or more. All of the problems of one car loan are multiplied by the number of loans outstanding. In some households total car payments can exceed the monthly house payment.

High cash flow drain

A car is an expensive proposition to begin with; you already have insurance, gas, repairs and maintenance. A car payment magnifies all of this. In fact if you total up all the expenses you pay each year to own a car you’ll see why your money just seems to disappear into thin air. For most people, a car is the second most expensive budget item, after a home. By paying cash for a car, you cut this expense considerably.

Owing more on the car than the car is worth

This is also referred to as being “upside down”–for obvious reasons. Cars depreciate rapidly, so it’s possible to be upside down shortly after purchase, even after making a 20% down payment.

This situation creates at least two problems that I can think of. First, it limits your options if you want to sell the car or refinance the loan—you’re no longer talking about an 80% loan, but maybe a 110% or 120% loan. Or you could face a loss on sale.

Second is an insurance claim. In the event you’re involved in a crash and the insurance company totals your vehicle, they will only cover an amount up to the value of the car before the crash. That may mean a settlement that is not enough to payoff the loan, let alone provide for the down payment on a new car. Gap car insurance exists for this purpose, but few people purchase it unless the car is leased or the car is purchased with little or no money down.

Owing less on the car than it’s worth

On the surface I’ll admit that this one doesn’t seem to be a problem. But let’s imagine that you’ve been unemployed for about a year and you’ve fallen behind on your car payments. Your car is worth $15,000 but you still owe $5,000 on it, and the bank is repossessing it. You’ll lose a $15,000 car and the $10,000 equity you had in it will evaporate for the inability to pay a $5,000 loan.

Equity for your next car

The equity in the car you own today will probably make up most of the cash you pay on the next car you buy. By owning your car free and clear, not only do you maximize the amount of cash you have for the next purchase, but you also keep your options open to make the buy at any time. You won’t need to wait until the loan is paid, or worse, having to deal with the complications that come with selling an indebted car.

You don’t need a car loan if you work from home

Millions of people are now working from home, whether they’re self-employed or telecommuting. You don’t need to have a car loan if you work from home, in fact you don’t even need much of a car at all. A ten year old “beater” that works for short local hops is really all you need (you can rent a car for long trips if you don’t trust your beater to get you there). It makes no sense to borrow to pay for a car you’re hardly using.

 
What’s the alternative? Most obviously, don’t borrow to buy a car—paying cash is the way to go. Fortunately, there’s a car for every budget, especially if you can overcome the dreaded affliction newcaritus. And there are other ways to deal with car loans in the event you already have one.

  1. Buy only as much car as you can afford to pay cash for; it that’s $2,000 for a 15 year old car, then that’s what you can afford.
  2. Dedicate a savings account specifically to accumulate money for your next car.
  3. If you have a car loan now, make paying it off a priority, even ahead of your credit cards.
  4. If you have loans on two cars, make a priority of paying off the smallest as soon as possible—then go after the bigger one.
  5. If you do use a loan to buy a car, make the largest down payment possible and the term as short as possible, then pay it off early.

Have you ever thought about the risks of financing a car? What do you think about paying cash, even if that means buying an older, less expensive one?

( Photo from Flickr by JMRosenfeld )


13 Responses to 8 Reasons Why You Should Pay Cash for a Car

  1. Samantha says:

    Your tips rule! Buying a car is like marrying someone. You need to make sure that it is the right person before getting trapped for the rest of your life.

  2. Kevin M says:

    Hi Samantha–I don’t think it’s nearly as bad as marrying the wrong person (though the analogy is a good one!). But it can cause a number of short term problems that can easily be avoided.

  3. Couldn’t agree more with you Kevin. I’ve lived through 2 car loans in my time and by the time I had them both paid off my wife and I agreed that we would never take out a car loan again.

    On another note my company was recently out on the prowl to buy a new work truck and instead of buying a slightly used vehicle we went with a 1998 Dodge which we got for $4250.

    It was an older vehicle but we got an awesome price on it and we were able to pay cash upfront for it. The truck was in great condition for it’s age and came with all the extras. On top of that it allowed us to negotiate on the price and get a little better deal in the end.

  4. Hi Chris–By buying the truck they way you did you’re company is keeping it’s assets debt free, which is good for all the same reasons it is for an individual. When hard times hit, being able to keep the cash flowing in (without corresponding debt) will but a business ahead of most of its competition.

  5. Randy says:

    Good points. Especially,#2 – the idea of losing a survival asset. As for owing less than the car is worth, I would think a company repossessing the car would have a legal obligation to sell the car for a “reasonable” price and then refunding you any overage. While this makes it sound like a repo isn’t a bad thing, they typically don’t bargain for the best price and also charge additional fees, so you still lose.

  6. Hi Randy–We don’t normally think of survival when it comes to a car, but is a factor almost unique to cars as far as personal possessions go. We need them to make a living. Computers are increasingly becoming another survival asset, but they don’t usually come with big loans/debt payments.

  7. When all was said and done I paid cash for my vehicles back in the Uk and in Canada. I hate owning money to people especially for something like a vehicle. My wife on the other hand bought brand new at 0% but she still risked anything happening with her job etc and having an almost $500 car payment. I’d rather save the cash then pay for it up front but that’s just me. Mr.CBB

  8. I get what your wife did going for 0% financing, from a financial standpoint it makes abundant sense. But I’m with you, there are non-financial factors that are more important, which is the whole purpose of this article. Owing money on a car isn’t risk free.

  9. These are some really good points everybody can definitely use. A lot of people should really give it a thought. It is better to buy inexpensive car but pay in full, because like described above in case you lose a job and payments become too difficult to make, them it is going to be very sad to be left without a car after all. Very good article!

  10. Thanks Alice. In the unstable job market of today we should never asssume we’ll always have a steady paycheck to pay a car loan with. But even if we don’t we’ll still need a car. It’s a matter of thinking strategically.

  11. MyTurnQuips says:

    Kevin, I really enjoyed this post and as someone who recently “did the deed” of buying a new car via financing it made me crack a guilty smile. I have come full circle somewhat on the issue of buying a new car. For most of my life, I have always purchased a used car and was firmly in the “it depreciates so much when you drive it off the lot” camp. While I believe that remains true to an extent, everyone needs to evaluate his/her own situation in regards to this decision. First and foremost, a car is an expense; not an investment. As you have covered well, you also need to evaluate your financial situation and job security. In my situation, I was willing to take on the additional monthly (predictable) expense ($247 by the way) as opposed to assuming the risk of a costly repair to a used car. It should be noted that while used cars are more affordable off the lot, they do not come with the same level of warranty as a new car. Car repairs are not like the “old” days where you’d pull up to the neighborhood garage and they might have mercy on you so that you leave with a bill of only $50 or so. If I need to take a car in for a repair today, I feel lucky if I get the car out of the garage for less than $200. While I am enjoying my new car, I would not buy a new car at any cost. I share an office with a colleague in the same income bracket as myself and she, too, makes me smile when she vents about her car payment which is around the size of my mortgage payment ($850 ish).

  12. Indiana Teacher says:

    I buy (reliable) cars for cash and keep them 10 years or 150k miles. My current car is 10 years old but has only 101k miles on it, so we will hang out together a few more years. :-)

  13. That’s “old school”, and a way that I think never should have gone away (I think that’s still the rule in Europe). I’ve read and heard from different quarters that cars are build better today (than 20-30 years ago) and with proper maintenance they can last 200,000 miles. A good friend of mine drove his Saturn for nearly 300,000 miles, so it’s doable.

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