In my case, it's a 2010 Toyota minivan costing $29,000. It should hold its value fairly well, and I plan to keep it for as long as possible (maybe 10 years.) I qualify for a loan at 2.95% and plan to put 10,000 down if I do finance it.

Even if I pay with cash, I will still have enough reserve on-hand for emergencies. The cash itself is in a money market savings account right now.

I'm in the United States, Georgia.

What are the factors to consider when making this decision?

  • Where is the cash you would pay with sitting currently? Savings account? Money market? Investments? – MrChrister Nov 5 '11 at 20:01
  • It's a money market savings, getting about the best rate you can get under those circumstances. – Chris Vesper Nov 5 '11 at 21:24
up vote 4 down vote accepted

There are several factors here. Firstly, there's opportunity cost, i.e. what you would get with the money elsewhere. If you have higher interest opportunities (investing, paying down debt) elsewhere, you could be paying that down instead. There's also domino effects: by reducing your liquid savings to or below the minimum, you can't move any of it into tax advantaged retirement accounts earning higher interest.

Then there's the insurance costs. You are required to buy extra insurance to protect your lender. You should factor in the extra insurance you would buy vs the insurance required. Given that you can buy the car yourself, catastrophic insurance may not be necessary, or you may prefer a higher deductible than your lender will allow. If you're not sufficiently capitalized, you may need gap insurance to cover when your car depreciates faster than your loan is paid down. A 30 percent payment should be enough to not need it though.

Finally, there's some value in having options. If you have the loan and the cash, you can likely pay it off without penalty. But it will be harder to get the loan if you don't finance it. Maybe you can take out a loan against the car later, but I haven't looked into the fees that might incur.

If it's any help, I'm in the last stretch of a 3 year car loan. At the time paying in cash wasn't an option, and having done it I recognize that it's more complicated than it seems.

Unless you are getting better than a 2.95% return on that money market account. Pay cash.

That's the purely logical way to make the decision.

However if it were me I'd pay cash anyway just because I like the idea of not owing money and having the hassle of dealing with a payment every month.

One additional reason to pay with cash rather than financing is that you will be able to completely shut down the dealership from haggling over finance terms and get right to the point of haggling over the cost of the car (which you should always do).

  • 4
    I finished the price haggle, and after that effort, was handled by a second slime ball who tried to do a hard sell on financing. I had the cash and told him that anything higher than zero interest didn't appeal to me. When I said he was about to lose a sale, he made it clear he was only the finance guy. Crazy system they had. – JoeTaxpayer Nov 7 '11 at 2:32

I'd pay cash.

Car loans are amortized, so sometimes you can get upside-down on the loan between 18-30 months because you are pre-paying interest. This can get you into trouble if you get into an accident.

Given the low rate and the type of car you're buying, you're probably fine either way.

  • I'll ask you - are car loans' interest not calculated same as HELOC, daily interest, or mortgage, monthly interest calculations? – JoeTaxpayer Nov 7 '11 at 2:28
  • 1
    Unless you're depositing 20-30% of the car's price, you'll be upside-down the moment you walk off the lot, and it'll take a while to pay off enough principal for that to change. – jprete Nov 7 '11 at 3:44

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