Should You Pay Cash for Your Next New Car?
For years, most personal-finance experts have said, "Of course it does!" It seems like a no-brainer: Car loans add interest payments and fees to the principal, and those can add up to big bucks over the life of the loan.
But in today's environment, when interest rates are low and cheap financing deals are common, the answer is a little less clear. Does it still make sense to buy a car the old-fashioned way?
The Argument for Paying Cash: It Has Become Very Tempting to Overspend
Personal-finance experts have long argued that paying cash is the best way to go when buying a new car or truck. By paying cash instead of taking out a loan, you'll avoid interest charges and financing fees, which can add thousands of dollars to a car's purchase price.
That's true even at today's low interest rates. On a loan of $30,000 with a 60-month term at 4 percent interest, the interest payments add up to $3,149.68 over the life of the loan. If there are fees associated with the loan, you might pay even more.
That extra $3,000-plus is a big part of why many advisers suggest paying cash for a car if you can. And there's another reason to consider the save-up-and-pay-cash approach: Simply put, it's a lot harder to overspend.
That's important, because the swift pace of technology has made it tempting to spend more for a more lavishly equipped model. And many consumers have been giving in to that temptation.
The Argument for Financing: New Cars and Trucks Have Become More Expensive
If it seems like cars and trucks have become more expensive in recent years, that's because they have. The average transaction price for a new "light vehicle" -- a car, SUV, or pickup truck -- in the U.S. has risen quite a bit. According to Kelley Blue Book, the average transaction price for a light vehicle sold in the U.S. rose to $33,340 in June. That's up 2.5 percent from a year ago.
Some vehicles have risen even more sharply. Ford (F) said that the average transaction price for a new F-Series pickup was over $44,000 in June. Surprised? If so, it's easy to understand. After all, the base model F-150 starts at under $26,000. But Ford -- like just about every other automaker -- offers plenty of desirable options and packages that can add tens of thousands to the basic truck's sticker price.
That strategy has been great for Ford's profit margins. But it has led many consumers to feel like new-car prices have outpaced inflation -- and like they need a loan to be able to afford a new car at all.
It has also led to financial innovations intended to help consumers "afford" ever-more-expensive cars and trucks, like longer-term auto loans. Longer loans help make monthly payments more affordable, but at an obvious cost: You'll be making those payments for five years or more.
Many people are happy to make the trade-off. The average term for a new-vehicle loan rose to 67 months in the first quarter of 2015, according to credit bureau Experian. That's over five years. And lots of loans are even longer: Experian reported that almost 30 percent of new-vehicle loans in the first quarter were between 73 and 84 months -- or six to seven years.
Are all those people crazy?
Understand the Costs Before You Choose
When it comes to paying cash for a new car, the good reasons that experts have been giving us for years are still good reasons. But it's also true that low interest rates have made longer loans much more affordable. Many buyers who take longer loans aren't crazy at all -- they're just willing to pay extra over time for the convenience of being able to buy the car or truck they want, right now.
As always, the right advice is to choose an option that you can comfortably afford. If paying cash feels like the right way to go, there's nothing wrong with that. But a low-interest loan that gives you a manageable payment on a new car that you plan to keep for a long time is also a reasonable option. Just do the math before you sign.
Motley Fool contributor John Rosevear owns shares of Ford. The Motley Fool recommends Ford. Try any of our Foolish newsletter services free for 30 days, and click here to check out our free report for one great stock to buy for 2015 and beyond.