Is Taking a Loan to Buy a Car Worth it? The Pros and Cons of Auto Loans

Buy a car in cash, and you're free from the potential hassles that come with car financing.

It's a relief to not have to deal with car financing costs like processing and disbursement fees, monthly interest payments that can stretch for years, or the discomfort of co-owning your car with a lender that tracks your every movement. 

Yet, if you're an average earner, buying a car in cash (especially if you are eyeing a newer, more expensive car) could mean years of saving. If you're not willing to wait for years to own a car, taking an auto loan may be your next best option.  

‍Auto loans are usually frowned upon because a car is a highly depreciating asset and many people would rather take a loan to buy an appreciating asset like land or a house. But taking a loan, in some instances, can be a wise financial move and sometimes even beat the idea of buying a car for cash. 

Should you take a loan to buy a car? Let these pros and cons of taking a car loan help you decide the best way to go.

Advantages of Buying a Car on Loan

1. You can get a car as soon as possible to solve your urgent needs

When you urgently need a car for convenient traveling with your family, to facilitate your side business, or to help you get to work earlier but you're low on cash, taking a loan gives you the chance to get your car now. 

Before you take a loan, you'll first need to create a budget to determine how much in monthly loan and insurance installment payments you can comfortably afford to make so that you don't find yourself struggling to make payments. 

Once your budget is ready, find an auto lender whose overall terms of payment such as interest rates and structure and other associated costs meet your financial needs.

2. Saving for a car could be a tall order if you don't have other buffer savings 

Saving for a big purchase could mean years of saving and a high saving discipline if your income is on the lower side.

Your savings will be more successful if you already have a separate emergency savings account or insurance cover to cater to emerging business or family needs. Without a savings buffer, you may find yourself digging into your car savings on rainy days, delaying your goal of becoming a car owner. 

You can consider saving for a few months to make a large down payment on a car loan, instead of struggling for years to save the entire car purchase amount. Making a large down payment may qualify you for an affordable, low-interest loan and you can drive your dream car sooner. 

3. You can get 100% financing on a new, more reliable car

Many cash buyers likely buy older and cheaper car models. But older cars are generally less reliable. For example, if you buy a car with high mileage and little record of repair and maintenance, you could find yourself overspending on repairs, maintenance, and insurance before you even have a chance to enjoy your car. The cost of repairs may also exceed the car's value at some point and you'll soon discover that you're better off without the car. 

There are cases where a dealer may also lie about the history of an old car by, say, altering its mileage to a lower one so you end up getting a raw deal. Unless you can identify a trustworthy dealer for an old car, you may prefer to opt for a new, more reliable car. New cars are much more expensive but the good news is that some lenders offer 100% financing on new cars, which can be a good deal if you are low on cash and really need a reliable car that will serve you for many years to come. 

4. You can save your cash for rainy days or make profitable investments

Buying in cash is not always a good idea even when you have the cash ready.

You could end up cash strapped in case of a business or family emergency. Instead of pouring all your savings on a car, you could take out some cash and make a huge down payment so that you're left with a smaller loan to pay and possibly qualify for a lower interest rate. 

You may also put the extra money into profitable ventures like rental property or starting or expanding a business. If the return on your investments is more than your auto loan interest, you could come out on top even if you are paying interest. 

Read Also: Buying Your First Car? 8 Things You Need to Learn Now

Disadvantages of Taking a Car Loan

1. Car value depreciates fast

Your car loses approximately 10% of its value the moment you drive off the lot. If you're financing an older car, the value goes down even faster and you could end up with negative equity, a situation where the loan you owe is much more than the value of your car.  

For instance, if you owe Ksh900,000 on a vehicle currently worth Ksh600,000, then you have Ksh300,000 in negative equity. This situation mostly happens when you make zero or a small down payment or your interest rates are too high.

While you continue to enjoy your car, this negative equity becomes a problem when you lose your income and can no longer make payments.  You'll not be able to repay the loan even if you sell your car. Lenders may also not want to refinance your loan and you'll have to find extra money to cover the negative balance before you can be open to better financing options. 

You can also do a car trade-in and take on a new loan, but that leaves you with more monthly payments to make as the new loan may include your previous outstanding negative loan balance. 

2. You end up paying more for the car overall

The process of car financing involves lots of extra costs. These costs vary from lender to lender and may include excise tax, car valuation costs, processing fees, late payment fees, disbursement fees, credit life insurance, and the cost of installing a car tracker.

You may also end up paying very high-interest rates on your car loan, for instance when you: 

• Are financing an old car
• Make zero or a small down payment
• Have a longer loan tenure of, say, more than 5 years which can also put you outside your car warranty and expose you to expensive repairs
• Have a poor credit or income history and the lender considers you to be a high-risk loaner
• Choose a lender with a fixed interest rate structure instead of a reducing balance structure 

With all these costs combined, it's easy to find yourself paying much more than the cash value of your car in the hundreds of thousands. 

3. You own the car jointly with your lender

A car on loan jointly belongs to you and the lender until you pay your car in full. You have to put up with issues like car tracking and mileage limits imposed by the lender which can limit the way you might want to use your car. 

You also risk car repossession when you default on your car payments. Repossession often comes with additional fees to you such as the cost of sending a repossession agent, towing, storage, and auction fees. All these costs can go upwards of Kshs 15,000, interfering with your budget. 

Tips to Navigate Car Financing Challenges and Get the Most Out of Your Loan

You can overcome or avoid the challenges that come with taking a car loan. Here are some tips to help you navigate auto loans:

1. Save for a large down payment to reduce your loan obligation, which may help you qualify for lower interest rates and avoid a situation where you have negative equity on your vehicle
2. If you find yourself with negative equity, find some cash to pay out your negative equity and refinance your loan to get lower rates. With a lower rate, you may be able to clear your loan obligation faster
3. You can increase your monthly loan payments to clear the loan faster if your income increases during the loan period. Find out if this will result in an early payment penalty from your lender first and weigh the options to determine if it's worth making larger payments
4. Choose the best lender that matches your financial goals. Check out these 10 things to consider when choosing a lender‍
5. You can use your car for a side hustle or other money-making opportunities to make extra money towards your installment payments
6. Refinance or renegotiate your loan for better loan terms when you get stuck

The Right Car Loan Should Match Your Financial Needs

It’s great if you can buy a new car but taking a loan is also a worthy option if you can't afford to buy a car in cash — for instance, if you urgently need a car or you prefer to buy a new car. 

At times, taking a loan is better than buying cash because you get to keep your savings buffer for a rainy day or invest the money in more profitable ventures. 

The challenge is to partner with a lender whose terms align with your financial needs and capabilities so that your loan doesn't become too much of a burden. 

Money254 matches you with an auto lender that meets your specific budget needs for a smooth car financing process. If you're planning to buy a car on loan, we can help you find a suitable auto lender today.