You’ll meet lots of people who warn that you should never, ever fall into debt.
But I disagree. I think a small car loan is okay … as long as the interest rate is reasonable, and you’re doing something productive with your money.
Here are a few reasons why I think it’s fine to finance a car.
#1: Low interest rates. Let’s imagine that you can finance a car at 2 percent APR, and you can invest your money into your 401(k) and get an automatic 50% employer match on every dollar that you contribute. Why wouldn’t you double your money in the 401(k)? That’s an obvious choice, as compared to saving the 2 percent interest rate payments.
#2: It saves your liquid cash. Don’t raid your emergency fund to pay for your car. Keep that fund intact, and take out a low-interest loan on your car. You’ll be thankful that you did so, when you don’t have to rely on credit cards to get you through the next crisis.
#3: It helps build credit. An auto loan helps you build your credit score. This can be very beneficial when you’re trying to buy your first home. Mortgage companies will see you have already taken out a loan to cover a large purchase, and that you have paid it back in full. This provides them with evidence that you will be a responsible homeowner.
#4: It’s a more flexible way to buy. Financing a car lets you decide what monthly payments you can afford. It also allows you some negotiating room with a dealer. If you pay cash, on the other hand, you’ll need to fork over all of your money immediately, and the dealer might be less willing to negotiate (since he earns money on the financing).
#5: Potentially zero interest. If you have a very high credit score, you may qualify for zero percent interest on many cars. Some smaller dealerships, as well as credit unions, offer this as an in-house financing option.
#6: It provides you with transportation. Sick of paying to ride the bus or subway? Tired of catching a taxicab to the grocery store, and then tipping the driver to wait outside while you run through the store as quickly as possible? Then finance a car! You’ll save on the cost of cabs and public transit, while also building yourself “equity” within your new asset.
If you’re devoting hours to riding an inefficient public transit system, I think you’re better off taking out a small loan for a used car, and using that vehicle to drive to a second job, where you can earn enough money to pay off that car as well as build additional savings.
If you have the option to either take out a low-interest loan on a car, or invest that money towards your retirement, I think you’re often better-served by building your retirement nest egg.
And if you’re trying to build a credit score, and you have the option to get a low-interest car loan, consider leaping at that opportunity. If your credit score is high enough that you can shave even 0.5 percent off the cost of your home mortgage, you will have saved tens of thousands of dollars.
A Note From Derek: I obviously have an opposing view to this post because I often advise against taking on a car loan. For me personally, I already get my full employer match, so #1 is irrelevant. Taking a loan would free up money, but I already have a large emergency fund and don’t wish to pay interest on a loan, so #2 is out. My credit is already impeccable – #3 is out. I don’t like monthly payments because it reduces my monthly cash flow which I am trying to raise – #4 is out. Even at 0% interest, I still don’t like owing money to someone else because I may have a financial downfall and be faced with the inability to pay off my debts – #5 is out. Finally, public transportation isn’t so bad – it can actually allow you to be more productive because you can work while travelling!
What do you think? Is it ok to finance a car?
Kennedi writes about fitness, food and finance. Read her post on 10 Celebrities Who Aren’t Broke.
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.