Should you save for a new car or finance it over time?

Buying a car is a long-term commitment. You either need to save up for it or pay it off over time, and the option you choose will depend on your personal circumstances and preferences.

So, what should you consider when deciding which payment method to make use of? JustMoney got in touch with experts in the field to answer this for you.

Tip: Regardless of the option you choose, you’ll need car insurance. Click here to get a quote today.

It all depends on the interest rate and price

According to Marius du Toit, founder of Beat the Price and 4Wheels, the crux of whether you should buy a car upfront or pay it off over time depends on the interest rate.

“This is because someone, usually a bank, lends you money, and the amount of interest you have to pay back then becomes the biggest deciding factor,” says Du Toit.

He believes that if the interest rate is lower than what you can make with your cash in way of profit generated, it would be wise to finance.

“Where a business makes a profit of 12% on its own cash and will get finance money at 11% it would be beneficial to finance. However, if someone gets an interest rate of 7% on a savings account and must pay 11% it would be better to pay cash as you would save 4%,” says Du Toit.

When considering how much more you would pay if you decide to finance your vehicle over time versus how long it will take you to save up for it, Du Toit explains that this will depend on both the interest rate and the price of the vehicle.

“The amount of money that can be saved would be divided into the future selling price to determine how long you need to save. If we expect higher inflationary pricing with many price increases and low-interest rates it could be wise to finance,” says Du Toit.

Pros and cons of each option

According to Kriben Reddy, head of Auto Information Solutions for TransUnion, you should make sure you compare the pros and cons of each method of financing, bearing in mind your own specific needs and circumstances.

“If you are looking at paying cash, work out what the cash amount would be worth as a five-year investment with a reasonable return, against what you would end up paying for the vehicle if it was financed over the same period,” says Reddy.

He points out the following characteristics of each option:

• Financed: The upside is that at the end of the term, the vehicle is a paid-off asset which can be sold. The downside is that you would have incurred interest charges through financing the vehicle.
• Cash: The upside is that the vehicle is yours right away and you don’t have to pay the bank any interest from financing. You also have the flexibility of changing vehicles at any time. The downside is that the vehicle is a depreciating asset, and it will be worth less than what you paid for it upfront.

Reddy explains that there’s no one-size-fits-all. It all depends on your personal circumstances and affordability. However, he suggests that when you’re doing your sums, you shouldn’t just work on the purchase price.

“Be sure you’re taking into account the day-to-day costs of actually running the car. The instalment by itself looks affordable, but you also have to cover insurance, petrol and maintenance,” he says.

“As a rule of thumb, double your instalment cost, and ask yourself whether you can afford this and still honour your other monthly financial commitments,” says Reddy.

He adds that you should remember that the bank approves vehicle financing applications based on affordability and a good credit standing. He recommends you work on improving your credit record to increase your chances of being approved for financing and negotiating for a better interest rate.

Lastly, he says you should be careful with balloon payments. He explains that they make the car seem a lot more affordable now, but you don’t want to come to the end of the term and find yourself saddled with a lump sum that you may have to refinance.