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Buying a car can be exciting but also expensive. This is why 80% of new car owners in the U.S. finance rather than pay out of pocket. What’s financing? It’s borrowing money from a bank, dealership or some other lender to buy your desired vehicle.
While financing can get you a car faster than saving up thousands, lenders don’t give out money for free. You typically have to make monthly payments with interest until the loan is paid off. If you enter a bad loan agreement, the interest can make repaying the loan far more expensive than the car.
So, should you finance your car? It depends on how quickly you’d like to get a car and how much of a monthly payment you can afford to pay it back.
Is financing a car a good idea just because it gets you a car sooner and most people do it? You should consider your specific situation and weigh the pros and cons. Here are some benefits that make financing an attractive option:
Financing lets you get a car immediately and spread payments over several months. The longer the payment term (time to pay back), the smaller your monthly payments will be.
Making small monthly payments instead of one lump payment can be more convenient, especially when buying a pricey car. It won’t wipe out your savings, leaving you with enough cash for other expenses and emergencies.
Timely monthly payments on a car loan can help improve your credit score and history over time. Building your credit makes it easier to qualify for other loans with favorable terms like low interest rates and higher borrowing limits. Even better, if your credit improves before you finish repaying a car loan, you can refinance to replace the existing loan with one that has better terms.
Unlike paying cash for a car, which may require waiting months or years to buy, financing lets you own a car much sooner. You can typically walk into a dealership and drive off with a car the same day.
Also, financing can help you get the car you want, even if it’s expensive. So, instead of settling for an outdated model, you can get the latest version of your desired vehicle.
While financing a car has several benefits, especially convenience, it’s not without downsides. Understanding these drawbacks is key to figuring out whether financing is right for you. To help you make the right choice, here are some of the disadvantages of financing:
Funds received through financing come with interest. The actual interest rate will vary between lenders and depend on factors like your credit score and the loan term. But regardless of the interest rate, it’ll increase the total amount you pay back.
For example, if you take a $30,000 car loan with 12% interest and a 36-month term, your monthly payments will be about $996.43. By the end of the term, you’d have paid back $35,871.45, which is $5,871.45 more than the car’s cost, thanks to interest.
In contrast, if you buy a $30,000 car with your savings, that's all you pay.
The most common loan terms when financing a car are 48, 60, 72 and 84 months or 4, 5, 6 and 7 years. During this period, you must make monthly payments to repay the auto loan. Each monthly payment will include the principal amount, interest and any other charges.
Missing a payment may lead to late fees, your credit score dropping and even repossession of the vehicle. As such, you must make timely payments to avoid problems, but this can become an issue if your financial situation changes. Fortunately, options like refinancing are available to lower your monthly car payments if they become too much of a burden.
Auto lenders typically offer loans that don’t exceed the car’s value. However, a car’s value can drop quickly after purchase, especially if you buy it new.
This depreciation can lead to having an upside-down or underwater loan — owing more than your car is worth. When this happens, you might have trouble selling or trading in the vehicle without paying the difference out of pocket. It may also leave you stuck with a car for longer than planned because you can’t sell or trade it in without first paying off the loan.
Whether financing your car is a good idea depends on various factors, such as your financial situation and personal goals. For example, if getting a car quickly and building credit are your priorities, then financing may be a good idea. On the other hand, it may not be the best idea if you want to avoid debt.
Here are some scenarios where financing may be the right choice:
You might be better off avoiding financing in these situations:
So, should you finance a car? You can if you want to get your desired car quickly without paying upfront. However, the interest will make repaying the loan more expensive than buying the car out-of-pocket.
How much interest you’ll pay on the loan will depend on the terms the lender provides. Fortunately, even if a lender offers a high interest rate and other unfavorable terms, you can refinance later to switch to a better loan.
How soon can you refinance an auto loan? It’s best to wait at least six months before refinancing. This gives you enough time to receive the finalized vehicle title in your name and improve your credit to qualify for better terms.
Qualify for auto refinancing faster and easier with RefiJet today!
Here are answers to some common questions about the pros and cons of car financing:
Paying in full is better if you can afford it and want to avoid debt. On the other hand, financing a car is a good idea if you want to build credit, keep your savings for other investments and can afford the monthly payments.
Financing a car can help build your credit if you make on-time monthly payments. However, missing payments will hurt your credit score. Hard credit checks by lenders during the loan qualification process can also cause a temporary credit score dip.
A long-term car loan often leads to lower monthly payments, which isn’t bad. But it also means paying more interest over time, making the loan more expensive and less attractive to some buyers.
Certified pre-owned cars are typically cheaper than new ones. Financing such vehicles makes sense if you can’t afford to buy outright. It’s also worthwhile because CPO cars usually depreciate slower than new vehicles and have warranties and lower interest rates than standard used vehicles.
Understand whether a car lease residual is based on MSRP or sales price and how it affects your lease deal, monthly payments, and future buyout options.
