Should you buy a car with cash upfront, or should you finance your purchase? It’s not a simple question to answer, and I won’t try to answer it. What I will do is educate you on both options so you can make the decision for yourself. This will also give you insight into what car payments you can afford when financing. Let’s first start with what it means to finance your car purchase.
To finance a car means to take out a loan for a car and repay it over time, along with interest. To learn more about interest rate and debt, click here. So why do people do this? Because cars can be expensive and you might not have all the cash necessary to purchase a vehicle. Lets go over some of the basics.
20/4/10 vs. 20/3/8 financing rule
Financing a car means you pay the price of the vehicle over time, plus a fee for borrowing money in the first place. This fee is called interest. A common rule of thumb is the 20/4/10 rule.
This rule states that your down payment on the vehicle should be 20% of the car price, the loan term of the borrowed money should be 4 years or under, and your monthly payment should be no more than 10% of your monthly take home pay. This can give you a solid understanding what monthly payment you can afford.
Here’s an example:
My monthly net income is $4,000
So my monthly payments should be 10% of that, which is $400 a month for 4 years. This comes out to a total of $19,200 ($400 x 4 years x 12 months/year)
With a 20% down payment, this means $19,200 is 80% of total car price, so total price is $19,200/80% = $24,000.
So, with my monthly net income, I would look for a car that is $24,000 or an average monthly payment of $400 for 4 years.
More conservative financial models suggest your rule of thumb be 20/3/8 rather than 20/4/10. This is how the above example would change:
My monthly net income is $4,000
So my monthly payments should be 8% of that, which is $320 a month for 3 years. This comes out to a total of $11,520 ($320 x 3 years x 12 months/year)
.With a 20% down payment, this means $11,520 is 80% of total car price, so total price is $11,520/80% = $14,400.
So, with my monthly net income, I would look for a car that is $14,400 or an average monthly payment of $320 for 3 years.
I prefer the 20/3/8 rule, if any. This is because I know how much additional costs can be, like insurance, maintenance, gas, and more. For this reason, it is always better to be conservative with a car purchase.
To learn more about the 20/3/8 rule, check out the blog by the money guy show.
Buying a car outright
My personal opinion, I prefer buying a car outright with cash over financing. There are many reasons, and you may disagree with my reasons. That’s okay, I’ll share my opinion and you can decide for yourself.
First, cars decrease in value over time. In the first year of owning a new one, the value has decreased by 20%. I rather purchase a car that is 1 year old for $15,360 than the brand new one for $19,200. ($15,360 is a 20% discount on a $19,200 car). Maybe even wait 3 or 4 years, and get a 50% discount! Cars spend most of their lives sitting around not being used. Why would I borrow money for something that is idle most of the time?
Summary
Sure, you should still put a considerable amount of cash towards a car if you want to get a valuable deal. Buying a $2,000 car may mean that the car is damaged, and you might spend a lot of money on maintainance. Instead, you can spend a few extra bucks upfront on a vehicle to make sure it is in proper condition.
If you don’t have a ton of extra cash, then it might be worth it to finance a vehicle. In this case, follow either the 20/4/10 rule or 20/3/8 rule, depending on how conservative you want to be with your cash.
My problem with financing a vehicle is that if I lose my job I don’t have disposable income to continue my monthly payments. My vehicle could get repositioned, which means my car gets taken away from me. Not only would I not have a job, I wouldnt have a car either, and my credit score would drop. This would make it difficult to borrow money again. To me, it’s not worth the hassle or the stress. What if I don’t even get fired, but I want to leave my job. Am I forced to stay at a job I don’t like because I must maintain my income to fulfill my monthly payments? I don’t want to be a prisoner of either my car payments or my employer, so I prefer to save up and buy a car that is a few years old.
For me, a car is something that gets me from point A to point B, nothing more. I don’t want to borrow money and be locked into car payments for something that will sit in my garage most of the time. Some may disagree because they like cars, or they don’t have enough saved up to buy a car outright. There is no one way to go about it. But by reading this blog, I hope you have the necessary tools to make the decision for yourself!