Congratulations on looking into a car purchase! This is an exciting time, but can also come with the stress of making sure you get the best deal.
One of the key decisions you might be struggling with is whether to pay cash for your new whip, or finance it. It’s a common question for almost every car buyer. Things such as the cash discount, interest rate, and inflation all come into play.
So is it better to buy a car with cash or finance it? The answer will depend on your personal situation.
Let’s take a look at the things you need to consider, and arm you with the information to make the right call for your situation.
Key Factors in Deciding if it’s Better to Pay Cash or Finance a Car
How much of a cash discount would you be getting? You need to get a sizable discount for a cash purchase in order for it to make sense. We would recommend that anything less than a cash discount of 4% off is not worth it, and you should just finance the car if the interest rates are reasonable (we’ll talk more about a “reasonable” rate later in the article).
We called around several dealerships, and many of the manufacturers were offering cash purchase discounts of 5-7%. Of course, these incentives are not always available so we recommend that you look at buying a car in January when the dealers are trying to clear out their inventory.
Do you have better opportunities for your cash? You need to consider if you have any other potential uses for the cash? Is your bank offering a high interest rate savings account? Are the stock markets taking off and going to the moon? You’ll need to judge whether spending all this cash on a depreciating asset is the best use of your money.
If you have room in your 401K (USA) or RRSP (Canada), then you will likely be better off using this room and getting the guaranteed tax deduction.
With the 401K (USA), your employer will take your pre-tax salary and contribute it to the account. This means that you’re not paying taxes on the income that you contribute to your 401K. Let’s say the car you’re considering is $20,000. If you put that $20,000 into your 401K, then you’re essentially savings $5,000 of taxes if your marginal tax rate is 25%. $5,000 is likely more than any cash incentive you can get on a $20,000 car.
With the RRSP (Canada), you’re getting a tax deduction based on your tax bracket similar to the 401K. For example, if you contribute $20,000 to your RRSP and your marginal tax rate is 25%, then you’ll get $5,000 back. RRSP contributions are usually made with after-tax dollars so the government will be writing you a cheque (or direct deposit) for the tax credits.
What is the interest rate for a loan if you were to finance? This is another key consideration for whether it’s better to pay cash or finance your car. We would only consider financing if the interest rate you’re getting offered is at or lower than the inflation rate. Most of the time, the inflation rate is around 2% a year – but you can google the most recent inflation data when you buy your car. We got a quote for financing rates, and were offered between 0.48% and 0.99%.
We’ve seen people get absolutely destroyed by high financing rates ranging from 5%-10%. If this is the best rate you can get, and you are not able to pay cash for the car then this is not the right time to buy a vehicle. You’ll need to get your personal finances such as outstanding debt, credit score, and savings cleaned up first.
If the interest rate offered is lower than 2%, then you would likely want to finance the car over a long period (say 60 months) so that inflation can make the true cost of your loan smaller. Getting offered a good interest rate on a loan has a lot to do with your credit score. If your score is lower than 750, then we would recommend you get that boosted before applying for a loan.
Do you feel comfortable spending this much cash all at once? There is a comforting feeling that comes with having a large amount of cash sitting in your bank account. If paying cash for the car means that you have to dip into your emergency savings, then you’ll want to be very thoughtful about whether this is worth it. It’s going to be hard to sell your car for a good price and put the cash back into your bank account if you suddenly need the money.
Cash or Finance: Making the Final Decision
After considering all of these factors, are you still on the fence about whether you should pay cash or finance your car? If so, then consider the following sample personas of a cash buyer versus a financing buyer.
What does a cash buyer typically look like?
– The cash purchase amount for the car is less than 30% of their cash savings
– They have maxed out registered investment accounts such as the IRA (USA) and Roth IRA (USA) or RRSP (Canada) and TFSA (Canada)
– The current cash discount on the vehicle they want is high enough that they wouldn’t be guaranteed a higher return on investment somewhere else
What does a financing buyer typically look like?
– They have a credit score above 750 so that they can get the lowest interest rates offered
– They may not have enough cash to buy the car, but are still financially stable with a steady job
– They have investment opportunities for the cash that will give them a better return on their money than what the dealership’s cash discount is offering
– They still have room in their registered investment accounts such as the IRA (USA) and Roth IRA (USA) or RRSP (Canada) and TFSA (Canada)
Are you still not sure about whether you actually want to own a car? Check out our article on leasing a car, and see if this might be right for you.