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Do you need a car loan to buy a car?


Published February 1, 2021

Buying a new car is a major investment and every dollar makes a difference. The most important question is whether you should get a loan, or buy the car outright. Letís take a look at how these methods compare and which one would be a better option for you.

Cash Purchase

The most straightforward way of buying a car is paying with cash. If youíre capable of saving the amount in a short period of time, then it can be worth it to hold off on getting a loan, and you might even get a better deal.

Consider the amount of time itís going to take you to save for the whole amount. Do you have a reliable car to use in the meantime, or are you spending money on public transportation? You might be in a situation where a loan would not cost you more on a yearly basis but would give you the benefit of driving a new car immediately.

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Getting a Loan

According to the statistics provided by the Kelley Blue Book, an average cost of a light vehicle was $39,259 in November of 2020, which is a sizable sum. Financing is a way of splitting that cost over several years as if it was rent or a utility bill.

The obvious upside of financing is not having to save up thousands of dollars to pay for the car outright. However, just like with any loan, the interest rate raises the total price of the car. Current happenings led to interest rates dropping to as low as 0%, because of a severe decrease in cash purchases.

Interest Rate and Loan Term

The time it takes you to pay off the loan is called a loan term. As the term lengthens, the monthly fee decreases, but the total cost of the car increases. If you opt for a shorter term, then the monthly fee will be higher, but the additional cost goes down.

This comes down to the interest rates how interest rates (or APR) work. To illustrate how it works, letís say that a car costs $50,000 and thereís a 0% interest rate. We want to pay it off over 84 months, so weíd just divide the numbers to get a monthly rate of $595.

Now, letís put the interest rate at 5% which doesnít seem like a lot, but the monthly fee would now rise to $707, for the total car cost of $59,388. But if we shortened the term to 60 months, the monthly fee would be $944, however, the total car price goes down to $56,640.

Budget

The benefits of getting a loan would be pointless if youíre unable to pay them off regularly. Even though short term loans will save you money, a loan that takes longer to pay off comes with fewer. For the best balance of the monthly fee and additional costs, a 60-month term is advised, but if the rate is too high, donít hesitate to get a longer one.

Down Payment & Trade-In

Just because you canít save up for the entire amount doesnít mean you shouldnít do it. Down payments are a great way to reduce the total cost of the car. Letís take the previous example of a 5% interest rate over 84 months for a car worth $50,000. By putting $10,000 as a down payment, not only does the monthly fee come down to $495, but the total cost of the car is now $51,580, which is a great improvement over $59,388.

If you donít have enough disposable cash, you can trade-in your old vehicle. Depending on the make and model year, the price will vary, and if you think you can strike a better deal by selling it yourself, go for it. You can then use that money as a down payment.

Additional Fees

Whether youíre buying a car for cash or with a loan, always keep in mind the additional costs, such as sales tax, insurance, registration, and maintenance. Aside from a few exceptions, the first three are unavoidable, however, getting a car with a warranty is a great way to save on future repairs and service.

Read the fine letters and ask a lot of questions when inquiring about a loan. Itís important that youíre fully aware of all the circumstances regarding the interest rate and penalties for missing a payment. Once youíve done all of that, compare the numbers to your budget one last time, and if youíre certain you can safely afford the monthly fee, get the loan.

Summary

While you donít need a loan to buy a car, one would certainly help. With a partial down payment and trade-in, you can get a new vehicle at nearly no additional cost, and enjoy driving it from day one. Once the loan term has expired, or if you wish to do so sooner, you could trade the car in for a brand new model, at the same cost. We hope this article has helped you in making the decision on how to buy your next car!

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