Deciding how to pay for a car
Using cash or savings will nearly always be the cheapest way to buy a new or used car, but isn’t possible for everyone. Before deciding whether to pay cash or to borrow, make sure you consider the following points to help you avoid financial headaches in the future.
As long as you’d have enough savings left to cover any other major purchases or unexpected costs in the future, paying cash is the best way to buy your car. Here are the main reasons why:
- Buying your car with cash means you own it straight away, so if you got into financial difficulties you could sell it. You can’t do this if you have a car finance agreement such as leasing or hire purchase.
- While interest rates are low, it often makes sense to use savings rather than borrowing at a higher rate of interest. For example, if you have £1,000 in a savings account it will only earn you around £20 in interest in a year. If you borrow £1,000 to buy your car, you’d have to pay around £90 interest on the loan in a year. So you’d end up £70 worse off than if you used your savings to buy the car.
- If you don’t have enough savings to buy the car outright, you could use them to give you the biggest deposit possible so you spend less on loan interest.
- If you use a credit card some car dealers charge a handling fee (sometimes as much as 3%). You’ll need to pay off the card bill in full the next month to avoid being charged interest. Also, not all dealers accept credit cards.
- However, if you pay part (a minimum of £100) of the cost of your new car by credit card you benefit from purchase protection on the full amount.
- Look ahead before deciding to pay by cash – are you planning any other big purchases over the next few years, such as buying a house?
Before applying for a loan or a dealer finance plan such as hire purchase or a personal contract plan, remember that:
- You’ll only get the best deals, such as 0% special offers, if you have a good credit rating – find out how to check and improve your credit rating.
- If you opt for a car finance plan, the finance company owns your car during the contract. If you get behind with your repayments, you may lose it.
- You’ll need to build up an emergency fund to cover any unexpected costs or drop in income. That way, you’ll be able to keep up with your payments no matter what’s going on elsewhere.
Examples of good and risky borrowing
If you take out a loan, make sure it isn’t secured against your home – otherwise the roof over your head will be at risk if you don’t keep up your loan payments.
Sarah is a teacher who travels to work by bus each day. She gets a better job at a new school paying a higher salary, but she can’t travel there on public transport. She wants to buy a car but doesn’t have enough savings to cover the cost so she needs to borrow some money. This is good borrowing because Sarah’s new job pays more than her previous job, so she will recoup the cost of the car, including the money she borrowed to buy it.
Andrew wants to trade in his old car for a new one. He thinks he’ll need to spend £5,000 to get a reasonable car. He doesn’t use his car for work but likes the freedom that it gives him. He can get £500 for his old car and if he borrows the rest he can afford to pay back £100 a month. It will take him five years to repay the loan, by which time he’ll have paid £5,923 for the car, or £6,423 including the trade-in.
Andrew should think very carefully about taking out this loan as he would end up paying an extra £1,423 for his car and have to make loan repayments for the next five years. If his situation were to change (say his hours were reduced or he lost his job), he might not be able to keep up the repayments.