Should I buy a car with cash?

Whether you should buy a car with cash depends on multiple factors, including how much you’ve saved, the interest rate you’d qualify for if you got a loan, and any special offers you may be able to get.

When it’s time to buy a new car, there are two ways to pay — with cash or an auto loan. If you’re able to save up enough money to pay cash, it may seem like the better option, since you’ll avoid paying interest. And it might be.

But depending on your financial situation, it may not make sense to use your cash reserves to buy a car.

Before you decide whether you should buy your next car with cash or finance your purchase, let’s explore the potential benefits and drawbacks as well as how to pay in cash if you decide it’s the right choice for you.

• Benefits of buying a car with cash
• When buying a car with cash might not make sense
• How to buy a car with cash

Benefits of buying a car with cash

Whether you’re ready to trade in your old car for a newer model or buy a set of wheels for the first time, there are financial benefits — beyond avoiding a monthly car payment — to buying a new vehicle outright instead of financing it. Here are a few to consider.

It can help prevent you from overspending

When you buy a car with cash, you must use the money you have on hand to pay for it, so you’ll be forced to stick to your budget. When you finance your purchase, it’s easy to spend more than you planned, especially if you focus on the monthly payment instead of the total price of the car.

For example, let’s say you plan to finance no more than $25,000. But then the dealer begins running through the list of add-ons, like all-weather floor mats, a heated steering wheel or splash guards — and some are hard to resist.

Let’s say those features add another $2,000 to the price of the car. If you got a 60-month loan term and 5% interest rate, this would mean that your monthly payment would increase from roughly $472 (with a $25,000 loan) to $510 (with a $27,000 loan).

That monthly increase may not seem like much, but you’d end up paying $264 more in interest over the life of the loan, on top of the extra $2,000 you didn’t plan to spend.

You won’t pay interest

If you don’t finance your car purchase, you’ll save money by avoiding interest payments on an auto loan. For example, if you buy a car that costs $30,000, make a $5,000 down payment and finance the rest, you’d need a $25,000 loan. If the loan came with an interest rate of 4.5% and a 48-month loan term, you’d pay $2,364 in interest over the life of the loan.

You won’t become upside down on your loan

Cars depreciate quickly. In fact, the average new car can lose more than 20% of its value the first year you own it. If you finance your purchase, you might eventually owe more than the car is worth, especially if you have a long loan term. And being upside down on a car loan can make selling or trading in your car down the road difficult. When you pay cash, you don’t have to worry about it.

Limited financing options don’t matter

If you’re planning to buy a used car from a private seller, your financing options may be limited. Some lenders don’t offer private party car loans, and some lenders that do charge higher interest rates for a loan to buy a car from a private seller instead of a dealership. If you plan to pay cash, you don’t have to search for and secure financing.

When buying a car with cash might not make sense

While buying a car with cash has benefits, there are some potential drawbacks to consider.

If it drains your savings

Depending on how much money you have in your savings, paying cash for a car could drain your savings account, leaving you unprepared to handle an emergency.

Unless you’ll have a financial cushion left over, it may make more sense to use some of the money you saved for a large auto down payment, which can reduce the amount you end up paying in interest. You could put the rest in a savings or money market account, where you might earn some interest and can easily access it if you need funds to pay for unexpected expenses.

If investing your cash may be a better option

If you have solid credit and can qualify for a low interest rate on a car loan, it may make sense to invest the cash you’ve saved and finance the purchase of your car. If the return on your investments is higher than the interest rate you’d pay on your auto loan, you could come out ahead, even while you pay interest.

If you could save more with special financing or other offers

Car dealers often provide special financing and cash back or rebate offers for people with good credit. But those offers are typically only available if you get a car loan through the automaker’s financing company.

To find out if these savings make it worthwhile to get an auto loan, compare how much you’d save in interest if you paid cash with the savings you’d receive through any special offers provided by the dealer.

Let’s say you plan to buy a $35,000 car. The automaker’s finance company is offering a special 0.9% annual percentage rate offer for a 48-month loan term, plus $500 toward the purchase of the vehicle. With this special offer, you’d end up paying $638 in interest over the life of the loan — $138 more than the $500 bonus you received. So even with the deal you’d pay more than if you paid cash.

How to buy a car with cash

How to buy a car with cash will depend on the seller. The process will be different if you’re buying from a dealer, private seller, or at an auction.

If you decide that paying with cash is the right choice for you, you’ll probably need to get a cashier’s check. You can typically get a cashier’s check from your bank or credit union after you’ve negotiated the sale and settled on the purchase price.

Also keep in mind that if you pay with cash and the price of the car is higher than $10,000, the car dealership is required to report it to the IRS. This may result in extra paperwork for you at the dealership.

What’s next?

Buying a new vehicle is a big decision, regardless of how you pay for it. Before you decide which payment method is right for you, take an honest look at your finances to determine how much you can afford and how paying cash versus financing will impact your financial health.

If you do decide to get a car loan, getting preapproved could provide the best of both worlds in the car-buying process: Financing (if you’re approved for the loan) with the ability to shop like a cash buyer.