(Guest post by Lance, while J$ is out teaching his newborn how to throw a football ;))
While I was in college, I had a bit of a beater car. It was pretty clear to me that I would need to get a more reliable ride, but the thing was, I didn’t want a car loan. So what did I do? I saved like crazy to have enough money to pay for a newer used car all in cash. I ended up having to save my money from college gigs and a ton of money from my first post college job too.
Once I finally had enough money saved up, I decided to start shopping for my car. This whole time I thought I’d be buying a used one, but instead I ended up coming up with some solid reasons not to buy a used car and in the end changed my mind. So what did I get? A brand spankin’ new 2010 Honda Civic! And while I could have paid for it all in cash, I took out a car loan instead. WHAT?!
Yup, I took out a loan and here’s why:
I Needed an Installment Loan on My Credit
One factor of your credit score is the types of credit you have held. This only accounts for 10% of your score, but is still an important factor. The types of credit include mortgage loans, revolving credit (credit cards), auto loans and student loans. I had just recently graduated from college and was extremely lucky in the fact that I didn’t have to take out any student loans. I did have a credit card or two in college, but I always paid it off.
I had never had a mortgage before, but I knew I’d want one in the next few years. In order to get my score as high as possible to get the best rate on my future mortgage, I needed to have an auto loan on my record. This was one of the factors I considered when taking out my loan.
I Got a Sick Interest Rate
Things had began recovering since the financial crisis, but definitely were not back to normal yet. Car loans were not easy to get. Even if you could get one, the interest rates weren’t normally great. Car dealerships weren’t selling cars though, and they had a lot of inventory due to poor sales. Thus, they advertised 0.9% APR for 24-36 months on all new 2010 Honda Civics!
These types of deals were pretty rare at the time, but I figured I might as well try for it. I had my checkbook with me in case I couldn’t secure the financing. After signing the application, they came back and said I just barely squeaked past their credit score limit and qualified for 0.9% for 36 months!
This was great news because at the time my savings account was paying 1.1% interest. Nothing fantastic, but more than enough to cover my loan costs, and even after taxes I would only lose a few pennies. To me it was more than worth it to get my credit score up for a potential future mortgage.
It is Nice to Have the Cash in the Bank
By taking out a car loan, it meant I got to keep the purchase price of the vehicle in my savings account. I already had a six month emergency fund, but you never know what the future has in store for you. It definitely wasn’t going to hurt me.
Thanks to ING Direct, I was able to set enough money aside to pay the car off in full in a savings sub-account. I then set up auto pay for my bill and haven’t had to think about it since. I do make sure the payments come out on time, but other than that it had been on autopilot.
So, is This For Everyone?
Definitely not. If you do come across the right circumstances though, sometimes it does make sense to take out a loan instead of paying cash. If I had gotten a 0% interest loan I’d even be making a little bit of money by keeping it all in my savings, but unfortunately I wasn’t quite that lucky. If I had any doubt about being able to leave the money alone, I would have paid in cash that day and I would recommend you do the same. However if you can avoid touching the money, it does leave a nice safety cushion in case of a major emergency that goes beyond your emergency fund.
What would you have done? Would you have written the check if you had the cash available?
Lance is a mid-twenties financial professional who writes at Money Life & More. He is also a Yakezie Challenger in the Yakezie Challenge. Feel free to head over to his site and check it out!
[EDITOR'S NOTE: I would have done the same!! (And actually, I have!) I'm all about having a ton more in my savings than normal, and don't mind losing a few bucks here and there by taking out a loan and spreading the costs across a few years rather than all at once. It's definitely not for everyone as you mentioned above, but there's nothing wrong with it if you're *more comfortable* doing it that way instead. You can always pay off the loan in full any time you wish too if you change your mind later! :) Just make sure that it's in the contract when you go to sign on the dotted line...]
(Photo by Junior Behrens)