What’s Better – Taking a Loan or Saving to Buy a Car?

When it comes to buying a car, some do it as a necessity due to work demands, while to others buying a car is aspirational – a sort-of success metric.

So then, what is the best way to go about funding such an undertaking? Bearing in mind that cars cost a considerable amount of money, is there an ideal financing model?

This article examines two common car purchasing options. Which is better, saving up and buying it or taking up a loan?

Save, Buy in Cash

First of all, make sure to leave enough money in the regular savings account if you plan to pay cash for a car. Financial experts actually advise people to have at least three months' worth of emergency savings before making any major money moves whether it is buying a car or investing in shares. 

Building this financial cushion will come in handy when emergencies such as loss of income, a business deal goes wrong, a medical bill needs to be settled urgently or when that beautiful car you purchased needs some major repair that your insurance doesn’t cover. 

Read Also: 7 Financial Emergencies Everyone Must Be Prepared For

The most obvious benefit of saving up and buying a car straight up using cash is that one isn’t burdened with monthly payments as is the case in other financing modes.

If sending in that monthly car payment makes you shiver, the psychological benefits of paying with cash may make this the best financing mode for you. This option also means you don’t have to spend sleepless nights wondering if that cheque you’re waiting on doesn’t come through and your new car will get repossessed.

Read Also: More Kenyans Unable to Repay Loans - Money Weekly

Another benefit of going the savings and cash payment route is that interest charges are avoided. By avoiding interest – the cost of borrowing money, paying extra money for the car is out of the equation which could then translate to significant savings.

Shortfalls of Using Savings

Before splashing all of your money on a new car, you should think about a few drawbacks:

Paying cash for a new car will feel nice because there are no payments to make, but it could also drain your savings and cause financial problems down the road.

For example, if the car develops significant mechanical issues a few months after the purchase, do you have more cash on hand to fix it or would that be the end of the road for you? This is an important question to ask before spending your entire savings on one item. 

This could easily apply to other big purchases such as land, a home or even big household items that cost significant amounts. Is it wise to lock all or a significantly high portion of the cash you have in one illiquid place? 

Another thing to consider when opting for the savings and cash upfront option is the fact that you are going to lose money due to depreciation. 

New cars quickly lose their value. It is estimated that after five years, a brand-new car may only be worth 60% of its original value. Therefore, by paying for a new one in cash, you could be paying for a lot of depreciation out of pocket. 

The cash upfront approach could also mean that you lose any investment opportunity for the cash, plus this also generally means you are decreasing your savings for unforeseen events down the line

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

When Does a Car Loan Make Sense?

While getting a loan could mean driving off the lot in your dream car, it also means that you will be making payments for some time.

This is why it is important to examine the advantages and disadvantages of this financing option.

For one, car loans generally come with fairly long tenures. Each payment made on time will improve your payment history, and consequently boost your creditworthiness in the long term.

Secondly, if you choose to pay in cash, depleting your savings is never a good idea, as it leaves you exposed when an emergency strikes. This makes small monthly payments the better options as it offers a cushion against uncertainty.

It also frees up cash that can then be diverted into worthwhile investments that could grow it even further, which can then be used to ease the burden of monthly payments.

Another major benefit of taking up a car loan is the availability of options that could fit your specific financial situation. There is no shortage of places to get a car loan. They are readily available through traditional banks, Saccos, microfinance institutions and even at car dealerships.

On the other hand, taking up a car loan may not be the best option for you if:

• Your monthly income is unstable. 
• You can comfortably afford to pay cash without making a major dent on your emergency funds and savings.
• You can’t afford to keep the car – always consider the cost of owning the vehicle, including fuel, insurance, registration renewals, maintenance and repairs. This could also mean that getting a car in general could be the wrong financial move for you at the moment

WRAPPING UP

Ultimately, the preferred financial option when it comes to buying a car is unique to each individual’s financial situation, needs and preferences.

For example someone who is just starting a family has a different set of financial priorities compared to someone on the tail or mid end of family life. 

Maybe the one who is just starting out isn’t willing to spend their entire savings on a car, making a  loan and periodic payments could be the prefered mode of payment.

Getting a car loan is worth it if you know what you're getting into and you can pay off with some good degree of comfort.

Interested in car financing? Learn more here>>FULL GUIDE: The Process of Car Financing in Kenya