Is it better to pay cash for a car or finance it?
It comes down to one comparison: what your cash would earn against what the loan really costs. Here is how to make it properly, and the two offers that can flip it.
Updated · Figures calculated with the car loan vs cash calculator
The short answer
Pay cash unless your money reliably earns more, after tax, than the loan really costs. On a typical 7% car loan that means more than 7.23% a year. Few safe places pay that, so for most people with the cash available, paying cash is cheaper. The main exceptions are genuinely cheap finance and the value of keeping an emergency fund.
Why it comes down to one rate
Financing a car means keeping some of your cash and paying the lender for the privilege. Paying cash means giving up whatever that cash would have earned. So the question is simply which is bigger: the interest you pay, or the return you keep.
The car loan vs cash calculator works this out over the life of the loan, with the kept cash invested and each repayment taken out of it as it falls due. It finds that the two options cost exactly the same when your cash earns the loan's own true annual rate. That holds whatever the deposit, the term or the period you compare over, which is what makes it a useful rule of thumb.
The loan costs more than its quoted rate
Car loans quote a yearly rate but charge interest monthly. Interest then earns interest, so the true yearly cost is a little higher than the number on the paperwork. Savings returns, by contrast, are usually quoted as what you actually earn over a year. The true yearly cost is the return your cash has to beat:
| Quoted loan rate | True yearly cost | Interest on $35,000 over 60 months |
|---|---|---|
| 3% | 3.04% | $2,734 |
| 5% | 5.12% | $4,630 |
| 7% | 7.23% | $6,583 |
| 9% | 9.38% | $8,593 |
| 12% | 12.68% | $11,713 |
| 15% | 16.08% | $14,959 |
Compare against your return after tax
Interest on savings is usually taxed. Interest on a loan for a car you use privately is usually not deductible. So the fair comparison is your after-tax return against the loan's full cost. Here is a 5% savings rate at a range of marginal tax rates, on the calculator's $40,000 car with a 7% loan over 5 years:
| Tax on interest | Return after tax | Result |
|---|---|---|
| 0% | 5% | Cash ahead by $2,328 |
| 20% | 4% | Cash ahead by $3,282 |
| 30% | 3.5% | Cash ahead by $3,739 |
| 40% | 3% | Cash ahead by $4,183 |
Tax pushes the answer further towards paying cash. Before tax, at 5%, cash is already $2,328 ahead; the higher your tax rate, the wider the gap.
Riskier investments can expect more than a savings account over the long run, but the loan's cost is certain and the investment return is not. Borrowing at 7.23% to stay invested is a bet that the market beats that rate, after tax, over the life of the loan.
When 0% finance changes the answer
A true 0% loan has a break-even of zero: any return at all on the cash you keep makes financing cheaper. On the $40,000 example, keeping the cash invested at 5% while repaying an interest-free loan leaves you $5,112 better off after 5 years.
The catch is that 0% offers are often paid for elsewhere: a higher price than a cash buyer could negotiate, fees, or compulsory extras. A cash discount is worth having on day one, so to compare it fairly it has to be worth more than that advantage brought back to today. Here that is about $4,005, or 10.0% of the price. A bigger cash discount than that beats the 0% offer.
Fees count more than they look
The calculator assumes no loan fees. An establishment fee is paid up front, out of the cash you would otherwise have invested, so a $500 fee costs about $638 by the end of 5 years at 5%. Monthly account fees add up the same way. Both make financing worse than the headline rate suggests, so ask for the APR or comparison rate, which includes them.
Reasons to finance anyway
- An emergency fund. Emptying your savings for a car can leave you exposed to a job loss or a large bill. The extra interest can be a reasonable price for keeping a buffer.
- Dearer debt elsewhere. If your cash could pay off a credit card or another loan at a higher rate, that is a better use of it than the car.
- A genuinely cheap offer. Low-rate or 0% finance with no fees and no price penalty.
A checklist before you decide
- Get the loan's APR or comparison rate, which includes fees, and convert it to a yearly cost.
- Ask the dealer for the cash price as well as the finance price.
- Work out what your cash really earns after tax, in the account it would actually sit in.
- Put the figures in the calculator and compare the break-even with that return.
- Decide how much of a cash buffer you want to keep, whatever the arithmetic says.
More guides
- How much does a house need to appreciate to beat renting? Less than most people assume when rents are high, and far more when they are not. Here is the break-even growth across a range of rents and mortgage rates, and how to work out your own.
- Does a rental property beat a savings account? Only if it grows fast enough to cover the gap between its rent and its interest. Here is how fast that is, across yields and loan rates, before tax.
- Should you pay off your mortgage early or invest? Overpaying earns your mortgage rate for certain; investing has to beat it after tax and risk. Here is where the line falls, and what moves it.