Pros and Cons of Financing a Car are essential because purchasing a new or used car is one of the biggest financial decisions many people face. While some opt to buy vehicles outright in cash, most people need to finance their car purchase through an auto loan.
Financing spreads the cost out over months or years through a lending agreement, making vehicles more accessible and affordable upfront.
However, financing also comes with downsides and risks to weigh. It is a major financial commitment that impacts your budget and credit for years to come. Before signing on the dotted line, it is essential to carefully consider both the pros and cons of financing a car to make an informed decision.
Pros and Cons of Financing a Car
Financing a car, whether through a loan or a lease, has its own set of advantages and disadvantages. Here are the pros and cons of financing a car:
Pros of Auto Financing
Auto financing, whether through a car loan or lease, comes with its own set of advantages. Here are the pros of auto financing:
More Affordable Payments
The top reason to finance is to make the cost of a car purchase more manageable through monthly payments. Few individuals have tens of thousands available upfront to buy a car in cash. Financing amortizes the total price over a set repayment period, usually between 24 and 72 months.
Instead of a single huge payment, financing allows owning a vehicle through predictable, budget-friendly monthly installments. This makes vehicles accessible to more consumers.
For example, financing a $30,000 car over 60 months comes to around $500 per month. That fits better within a monthly budget compared to paying the lump sum upfront for most buyers.
Build Credit History
Managing an auto loan responsibly helps establish a strong credit history and scores. Lenders report your repayment activity to the credit bureaus each month. Making consistent on-time payments shows you can handle major credit obligations.
Over the life of the loan, regularly meeting your obligations improves your credit profile. This can help qualify for future loans down the line at better rates.
Drive Newer Model Vehicles
Because financing spreads payments out over time, it makes owning newer model cars a possibility. New vehicles often have the latest features, technology, and design that buyers want. Financing enables access to these vehicles that might be out of reach otherwise.
This also provides the dependability and warranty coverage of newer automobiles. The average age of vehicles on the road is 12 years old, so financing offers the chance to drive a much newer car.
Lower Initial Cash Outlay
Perhaps the biggest benefit of financing is requiring a much smaller down payment upfront compared to the full purchase price. Often 10-20% down is enough when financing a car. This conserves immediate cash for other needs or goals.
Rather than tying up $30,000 in a vehicle right away, financing can lower the initial cash needed to just $5,000 or less. This flexibility is valuable for many buyers.
Cons of Auto Financing
Auto financing, whether through a car loan or lease, also comes with some disadvantages. Here are the cons of auto financing:
Paying More Over Time
The trade-off for smaller monthly payments is paying more overall compared to buying outright in cash. This is due to interest charges on the auto loan. The amount of interest paid depends on factors like loan amount, length, and APR. But expect to pay 10-20% above the car price by the end of the loan.
For example, at a 4% APR on a 5-year $20,000 loan, you will pay approximately $22,800 total with the extra $2,800 being interest. So financing costs more over time.
Risk of Upside Down Loan
If the value of the vehicle drops below the loan balance before it’s paid off, you can end up “upside down” or “underwater” on the loan. This usually happens because cars depreciate as they age. If the depreciation outpaces the principal paydown, you may owe more than the car is worth.
This makes the vehicle very difficult to sell or trade since you would have to provide extra cash to cover the difference. Being upside down ties you to the loan.
Missed Payment Penalties
Making late or missed payments on an auto loan damages your credit and leads to fees. A 60-day delinquency can lower your score by over 100 points. Late fees are also expensive, often $30-50 per missed payment.
If payments go unpaid for too long, the lender can repossess the vehicle, leaving you without transportation. So financing puts responsibility on the borrower to never miss installments.
Being Tied to Loan Term
Because vehicles depreciate over time, being tied to a lengthy auto loan prevents you from selling it earlier to avoid further depreciation losses. If you want to sell after 2 years but have a 5-year loan, you would need to refinance the balance.
Trading in the car earlier also usually means absorbing the most rapid part of the car’s depreciation. So auto financing locks you into the agreed loan term.
Financing a car purchase allows you to enjoy driving a nicer vehicle more comfortably within your budget. However, the additional costs and risks that mean buying in cash should still be carefully considered. Avoid “upside down” situations, read loan terms thoroughly, and budget diligently to make financing successful. With careful selection, auto financing can be very advantageous without being financially damaging.
Let me know if you would like me to expand or modify any sections of this article draft. I can provide more details on calculating financing costs or avoiding pitfalls. Please feel free to provide any feedback to improve the article.
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