What are the pros and cons of financing a car?

An auto loan can help you minimize the upfront expenses associated with buying a car by allowing you to spread the cost of ownership over several years of installment payments. However, there are some drawbacks to consider when purchasing this way, including the impact of monthly car payments on your budget for years to come.

During steep interest rate environments, auto loan rates can also mean you’re paying significantly more for a vehicle than if you were to pay cash instead. With the average new car price hovering around $48,623 as of October 2024, according to data from KBB, the cost of finance charges can really add up over time. Before purchasing a new car, take some time to understand whether financing is the most cost-effective approach.

Pros and cons of financing a car: Quick look

Before moving forward, weigh the pros and cons of financing a car — for many, it can help make a large purchase affordable, although you risk damaging your credit score if you fall behind on your payments.

Pros of taking out an auto loan

• Spreads the expense over years.
• May help you afford a more reliable or safer car.
• Can help improve your credit score.
• Allows you to focus on other financial goals.

Cons of taking out an auto loan

• Monthly payments might be expensive.
• Risk of damage to finances.
• The vehicle’s value depreciates while you’re still paying.
• You’ll be stuck with the same car for longer.

Benefits of taking out an auto loan

Though there are some drawbacks, securing an auto loan also comes with perks that other ways of getting a car do not. You’ll spread out the expense, may be able to afford a better car and could have a boost to your credit with consistent on-time payments.

Spreads out the expense

Few drivers can purchase a car with cash. An auto loan reduces the amount you spend upfront, swapping a big one-time expense for a smaller ongoing one. It also leaves you with money in the bank to use for other purposes. Draining your savings leaves you without an emergency fund, which could come back to bite you in the future.

Afford a more reliable car

Financing a car might mean a higher-end option fits your budget, but it’s still essential to determine how much car you can afford to finance. Generally, a loan will give you access to more money to spend than you could reasonably save up, especially with current used and new car prices remaining high. If you’re paying in cash, you may have a hard time finding a newer vehicle with decent mileage.

May improve your credit score

Your payment history makes up 35 percent of your FICO score. If you can keep up each month, your credit score should increase over the loan’s term. Your credit mix — the different types of credit you have — also plays a small role in your credit score. Adding an auto loan can diversify your credit mix and slightly boost your score.

Allows you to build savings

By keeping your cash free, you can use that money for building your emergency fund or to invest in long-term financial goals. Even with regular loan payments, you may be able to offset the interest you pay by earning interest elsewhere — although as with anything, fluctuations in the market involve risk, and you should carefully consider how you save or invest your money before making a final decision.

The effectiveness of this strategy largely depends on current market rates. With the Fed funds rate seeing a few cuts in September and November, you may be score a lower auto loan interest rate — but also not have access to the same good rates in an investment account that you had when rates were higher.

Drawbacks of taking out an auto loan

Getting an auto loan is one of the most effective ways to afford a car, but it has downsides. High monthly payments, potential damage to your credit and your overall risk go up when you borrow money.

Monthly payments can be expensive

Even if you finance a vehicle that fits your budget, your monthly payment can be steep. On average, drivers paid $737 per month for new vehicles in the third quarter of 2024, according to Experian. And this high cost is on top of insurance, which averages $2,458 annually, according to Bankrate data.

Risk of damaging your finances

Falling behind on your auto loan payments will lead to trouble. Even one missed payment will affect your credit score, and multiple missed payments can lead to your vehicle being repossessed.

This is because, for most auto loans, your vehicle secures the loan. If you cannot make payments, the lender technically owns it — and will repossess it to recoup its losses. But even if you chose an unsecured auto loan, you could be taken to court for missed payments.

Your vehicle’s value depreciates

Your vehicle’s value will depreciate the moment you drive off the lot. Cars can lose as much as 20 percent of their value in the first year alone, and there will likely be a steady decline in value over time.

If you have a high interest rate, you could owe more than your car is worth and end up being upside-down on your loan. This means that you can’t sell the car unless you have enough savings to make up the difference. It could also cause problems if you get into an accident and total the car. If you don’t have a policy that pays off the full amount of your loan, your insurance payment likely won’t be enough.

Stuck with the same car for longer

Unlike with leasing, the vehicle you sign off on is the vehicle you will be operating for the foreseeable future. These days, long loans are the norm, with the average auto loan for a new car lasting 68.17 months, according to Experian.

If you opt for a long loan term, you could be stuck with the same car for longer than you might want. This is especially true if you imagine yourself changing your mind, as selling a car with a lien can be complicated.

Should you finance a car or pay cash?

Financing a car can be a good move if you don’t have the cash to cover the cost of a vehicle or if you want to use your savings for other financial goals. However, the trade-off is that you will pay more in interest and be locked into a loan for an extended amount of time.

To best compare the pros and cons of auto loans, answer some questions about your finances and your needs for the vehicle.

• What can I afford? Unless you can afford your dream car upfront, an auto loan is the most effective way to get a vehicle. Use an auto loan calculator to estimate your expected monthly cost and ensure you can afford it.
• Do I need to build my credit? Signing off on a loan you know you can pay off can be a great way to build your credit score and diversify your credit mix.
• How long do I want this vehicle? The average monthly car payment tends to last between 36 and 84 months, and at the end of your loan term, the vehicle is yours. If you intend to swap cars frequently, leasing may be a better option.

Alternatives to auto loans

An auto loan is not your only option. There are other ways to finance a vehicle, though the most common will be through a personal loan or by taking out a lease.

• Personal loan: You can use a personal loan to buy a car, though you may face higher interest rates. The upside is that you won’t have a lien on your vehicle, so you won’t risk having your car repossessed if you are unable to make payments.
• Leasing: Many consider leasing versus buying when looking into newer vehicles. While leasing can put you behind the wheel at a lower monthly cost, unless you choose to buy out your lease, you will not own your vehicle at the end of the lease term.

Bottom line

Deciding whether an auto loan is right for you depends on your financial state and how long you want the vehicle. Crunch the numbers to determine how much you will be spending out of pocket over the life of an auto loan versus paying cash to purchase a car.

If you find that vehicle financing is the best approach, take the time to research auto loan offers from several different lenders. Do your homework by learning how to get the best auto loan rate.