When a Car Loan Might Be Ok

Should you take out a loan so you can look as cool as this guy? No, but there might be another reason to do so.

Conventional wisdom re:car loans in personal finance literature is “DON’T DO IT!!” This overexcited and often underinformed knee-jerk reaction is a result of the typical scenario everyone has heard about. Young guys or gals going off to their first real jobs, getting starry-eyed after seeing their first real paycheck, running to the dealership and buying that flashy new Mustang/Mercedes/Tesla/whatever. I’m not saying this doesn’t happen, in fact I’ve seen it with my own eyes. Don’t be one of those guys. That said, there are situations where a car loan might be a good idea. Read more to figure out if yours is one of them.

General Advice

I’m approaching this from the perspective of a recent grad looking to buy his or her very first car. Some of this advice might be applicable to other situations, but that’s what I’m aiming at. There are a few basic things you should consider about the search for a new (to you) car and thereby car loan:

  • Figure out how much you can afford before you start your search.
    • If you’re getting a big signing or relocation bonus at your new job, maybe think about investing in something gently used or new that is very reliable rather than finding an old clunker with the $2k in savings you have leftover from undergrad. Might save you money in the long run on maintenance.
    • Just to give you an idea, you’ll be able to find a reasonably low-mileage used vehicle for around the $10,000 mark. Higher mileage cars will be cheaper and if you find a good one it could serve you very well.
    • If your budget is sub-10k, you’ll want to Google around for more advice on how to ensure you’re not getting a lemon, because it’s in this price range that you might get a car with some issues (there are good ones out there too, you just have to be more careful in finding them).
    • New cars, on the lower end, will be something like $15k for a compact-size car, hatchback, coupe, or small sedan. It goes up from there.
  • If you happen to know how to drive stick: congratulations, that skill just saved you several thousand dollars.
  • If you go with something reliable, not flashy, you will save a lot of money in the long run
    • VW bugs are adorable but the maintenance costs on those cars are much higher than a good ol’ Honda or Toyota
    • You really don’t need a big SUV (not convinced? Read this.).
    • Mustangs are cool and all but they’ll just drive up your insurance in addition to being expensive to purchase and maintain
  • The “buy a couple-year-old used car for lots cheaper” strategy is not as profitable as it once was before Cash for Clunkers. Used cars maintain their value a lot better these days, so buying new might not be as bad as conventional wisdom says. That said, if you do buy new, make sure you drive that sucker for a looooong time so you can squeeze all the good, relatively-problem-free years out of it. Look around and see what will give you the most bang for your buck (but don’t exceed your budget).
  • Do your research. Look into the reliability, safety, and cost of maintenance for the model and year you have your eye on. Use sites like Edmunds and Kelly Blue Book to find what price you should be looking for. Call as many car dealerships within your reach as you can and pit them against each other (haggling really works). Utilize online quotes for dealerships if you’re confused how much they’re “really” charging. Typically, the internet quotes they give are very close to their actual bottom-line no-haggle price.

Now, with all that said, once you’ve figured out the kind of car to buy, there is the issue of how to buy it. For the most part, if you can pay for your car in cash, I encourage you to do it, or find a cheaper car which you can afford to pay for in cash. However, for many just starting out in their careers, they don’t have a stockpile of cash even though they’ll soon be making plenty of money to support a basic, practical vehicle. Here are two situations where I think getting a car loan is not such a bad idea:

1. You can get a 0% (or otherwise very low) APR loan

Even if you were planning on paying for the car in cash, if you can get a 0% (or near-zero, like 0.9%), you’re probably better off getting a car loan. This will free up your money for investing. Make sure you can trust yourself to invest that money in things like your 401k and IRA, not spend it on frivolities. If you can’t, don’t get a loan, because it defeats the advantage. Also, don’t use this as an excuse to buy more car than you can really afford. Do not inflate your budget just because you can get a good loan rate, but instead use low-APR loans as a way to make your money work even harder for you. The money you have liquid because of the car loan can be invested in index funds for a much higher return, making you more money in the long run.

2. You Can Pay It Back Soon (Really)

If you’re getting a signing bonus or relocation bonus, a reliable vehicle is a good thing to spend it on. While you could get lucky with an old car, once you get into the sub-$5k range in used cars you’re taking on a lot of risk of the thing just completely kicking the bucket. Then you’ll have to buy another $5k car in a year or two, or spend ridiculous amounts on repairs. You will have spent the same amount of money by buying a reasonable, reliable $10k used compact car, and saved yourself a lot of hassle. If you happen to have these kinds of bonuses coming in, it’s my opinion that you should use them. Again, don’t let this inflate your budget (if you’re one of those lucky schmucks that gets a $30k signing bonus, but you know a $10k used car will serve you just fine, don’t go out and get a flashy new Audi instead). However, if you need a loan so you have a car to get to work in before that bonus comes in, that’s probably ok. Just make sure that if you have a non-zero APR loan, you pay off the whole loan balance the minute that money is in your hands. No sense in paying extra money in interest needlessly.

What have been your experiences in car-buying? How did you afford your first car? Any used car buying tips?

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