Should I Finance or Pay Cash for a Car?

How Does Paying Cash for a Car Work?

The process of buying a car with cash works the same as financing one, with the exception of how you arrange payment. In other words, you must find the vehicle you like and negotiate to arrive at an agreed-upon sales price. When you pay cash, however, you'll pay for the entire cost of the vehicle upfront—forgoing payments and the interest that comes with them. Dealerships may allow you to use physical cash to pay for a car, but it's safer and more convenient to use a cashier's check, personal check or wire transfer.

If you're saving to buy a car outright with cash, remember to calculate your other expenses on top of the sales price, such as the dealership fee, sales tax and vehicle registration. It's also a good idea to make sure you have sufficient insurance coverage to drive the car off the lot ahead of time.

Pros and Cons of Paying Cash for a Car

Pros

• You won't incur debt. You can enjoy the peace of mind of knowing you're not taking on new debt. If you run into financial trouble later, you won't have to worry about making your payments on time or defaulting on the loan.
• You'll own your car outright. You can drive off the lot with complete ownership of your vehicle and never owe a single payment. If you decide to sell the car, you won't have to use any of the proceeds to pay off a loan.
• You can save money. When you pay cash for a car, you can avoid auto loan interest charges, which can range from around 5% to over 20% of the loan amount. You also may bypass other lender fees, such as the loan origination fee, typically 1% to 2% of the total loan amount.
• You won't overspend. Paying cash for a car reduces the chance of overspending on a car priced outside your means or getting talked into dealership add-ons.

Cons

• You'll have less cash on hand. Purchasing a car is a significant expense, and you could leave yourself financially vulnerable if you use savings you might need for current expenses or future emergencies.
• You'll miss out on a credit-building opportunity. Although paying cash helps you save money, you'll miss out on an opportunity to build credit. Making consistent, on-time payments on an auto loan can be helpful in improving your credit score.
• You can't take advantage of dealer incentives. Dealers commonly offer incentives to finance a vehicle through them. For example, you may qualify for a low-interest loan or cash rebate that narrows that savings gap compared to paying cash for your car.
• You could face an opportunity cost. Using your cash savings could cause you to miss out on other opportunities that may be important to you, like paying down high-interest credit card debt or saving for retirement.

How Does Financing a Car Work?

When you finance a car, you receive the money upfront to cover the vehicle's cost. You then must repay the loan, with interest, by making fixed monthly payments. Your payment amount is based on your total loan amount, loan term (typically 36 to 72 months) and the annual percentage rate (APR). Generally, lenders reserve the lowest rates for borrowers with the highest credit scores and vice-versa.

Keep in mind, the car you purchase also serves as collateral on the loan. In other words, if you default on the car loan, the lender has the right to repossess your vehicle to help recoup its losses.

Since lenders factor in your creditworthiness for your interest rate, consider checking your Experian credit report and score for free before car shopping to know where you stand. Address any issues you find in your report and take steps to improve your credit before you apply.

Pros and Cons of Financing a Car

Pros

• You can spread out the cost of the vehicle. Making monthly payments over time may be more manageable for your budget than paying the full price upfront.
• You can build your credit. When you make on-time car payments, your credit report shows that your auto loan is current or paid as agreed. Since your payment history accounts for 35% of your FICO^® Score^☉ , these timely payments could positively affect your credit score. Similarly, if you don't have any other installment loans, financing your vehicle with one could add to your credit mix, a factor that makes up 10% of your credit score.
• You could purchase a car sooner. Financing allows you to purchase a newer car that might otherwise take a long time to save up for.
• You may qualify for a better car. Financing a car could help you fit a better car into your budget, ideally with monthly payments you can comfortably afford. One rule of thumb is to make sure your vehicle expenses, including your car payment, aren't more than 10% of your monthly income.

Cons

• You'll have to pay interest charges. Interest charges significantly add to the total cost of your loan. For example, a $40,000 car loan with a five-year term and a 6% interest rate would incur nearly $6,400 in interest.
• You'll have higher auto insurance obligations. When you finance a car, the lender generally requires you to carry full-coverage auto insurance, including comprehensive and collision coverage. Consequently, you may pay more on your monthly premiums. If you paid for your car with cash, you can choose to carry only the minimum insurance required by your state, which may save your money.
• You'll have to make monthly payments. Monthly payments could be difficult to make if your financial situation unexpectedly changes. Having excellent credit and making a large down payment could bring down your monthly payment amount. According to Experian data from February 2024, the average monthly car payment is $644.
• You could become upside-down on the loan. A car's value typically depreciates faster than the loan balance decreases, meaning you could end up owing more than the car's value. In this case, if you wanted to sell your car, you'd need to come up with the difference between the sales price and the remaining loan balance out of pocket.

Is It Better to Finance or Pay Cash for a Car?

Deciding whether to finance a car or pay cash for it depends on your goals and attitudes towards debt.

The Case for Paying Cash

If you want to save as much as possible and are averse to carrying debt, buying a car upfront with cash is likely your best bet. You're also more likely to buy a car that fits your budget and less likely to overspend on a more expensive vehicle. You'll own the vehicle free and clear, with no risk of repossession for missing payments.

The Case for Financing a Car

On the other hand, you may prefer to finance your car purchase if using cash would deplete your savings for emergencies and necessary expenses. You might have other financial goals you wish to achieve with your savings, like making a down payment on a new home, paying off high-interest debt or investing in other assets.

The Case for the Middle Ground

Alternatively, you may find a middle ground between these two options by putting a large down payment on a car. A larger down payment lowers your loan amount and, consequently, your monthly payment and interest charges. Putting a large amount down also lowers your lender's risk, which could result in a lower interest rate. Additionally, a lower loan amount and a shorter loan term could mitigate the risk of owing more than the car is worth.

Yet another option is to finance the vehicle and use your savings to pay down the loan balance more quickly. This option could help you limit interest costs while building credit with timely payments. With excellent credit, you may qualify for a 0% APR car loan to wipe out interest charges.

Check Your Credit Before Car Shopping

Whether you finance or pay cash for a car, make sure the cost of ownership, including insurance and maintenance, fits comfortably with your budget. If you do decide to finance, it's important to prepare yourself for the process.