Is car finance a good idea or just reckless money management for something you can’t afford? People love to hate on car finance and argue that cash is king and that financing a car to pay for it is irresponsible and bad for your finances.
Many would argue that if you can afford a car in cash then it’s obviously the best and cheapest thing to do. This is because you will likely pay interest on the loan, finance or credit that you use to finance your brand new car.
This leads to the most common response to the “is car finance a good idea”. Many would suggest that it’s not because you will pay more in the long run. The extension of this is that ‘if you can afford to buy the car outright then you should do so, if you can’t then you should budget and save until you can’.
Car finance is seen as bad debt and that you are simply overpaying vs buying it outright. Those against car finance argue you should set aside a proportion of income and the the car. This includes calculating your disposable income and minus the car ownership costs ofinsurance, maintenance, running costs). Once you have done this you choose a car you like based on this budget.
However, there are some very crucial reasons that I think car finance is a good idea. Some are financial, some safety based and the rest are just plain old lifestyle choices. For example, a car on finance often reduces the cost of maintenance, insurance and repairs.
Disclaimer: This article should not be considered as financial advice. You are responsible for your own financial research and decisions. Please note this article also contains affiliate links.
Andrew | Mr Money Side Up
What Are The Two Main Forms Of Car Finance?
There are two main types of finance options which include hire purchases (HP) or personal contract plan (PC). Which are both ‘secured debt’ similar to how mortgage payments are seen and therefore they won’t negatively affect your credit score.
Is Car Finance With ‘Hire Purchase’ A Good Idea?
Hire purchase is a way to finance buying a new or used car. You (usually) pay a deposit and pay off the value of the car in monthly instalments, with the loan secured against the car. This means you don’t own the vehicle until the last payment is made.
This works in a similar way to a personal loan. As you’re borrowing and paying off the full cost of the car – though here you won’t own it until you’ve made the final payment. Instead the car is owned by the finance company – it pays the dealer on your behalf, then you pay it back.
Ultimately, this is probably a great way to manage cash flow when buying a car. However, I would personally find that this isn’t as good a way to finance a car as it doesn’t have the many benefits of PCP.
Is Car Finance With ‘PCP’ A Good Idea?
Personal Contract Purchase is basically a loan to help you get a car. However, you won’t be paying off the full value of the car until the end of the finance period when you can pay the optional ‘balloon payment’.
At this stage you can either return the car, pay off a lump sum or trade in your car. Although you can actually trade in your car as a part exchange around 2-3 years into the finance agreement. This is what many people do, as it allows them to always have a brand new car.
This is personally the type of car finance that works for me. This is for a number of reasons, which are similar to the usual rent vs own argument.
- New car every 2-3 years: which allows me to easily adapt my car to income and lifestyle.
- Upgrading every few years allows you to buy into the latest energy efficiency technology. My new car is a mild hybrid and hopefully the next one will be full hybrid or electric.
- Safety related features are captured with every upgrade. For example, my latest car has lane assist.
- Generally new cars are safer as there is less wear and tear.
There are also a number of cost effective reasons:
- Service or MOT are covered for a number of years
- Repairs are covered within a 3 year warranty
- Roadside assistance is often thrown in.
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Is Car Finance A Good Idea – Financially Speaking
You will pay more if the interest rate on your car is high. However if you can find a good promotional offer or negotiate then you are not going to be paying a significant amount more than the car is worth. Currently there are many 0% interest promotional offers, which then bump up only 2% which means you’re not going to pay significantly more than the car is worth.
When you combine this with the fact that PCP deals often mean you pay less than the car is worth anyway, it adds up to some serious savings. For example, I pay around £200 a month for a car that’s worth over £18,000.
Over 3 years that would work out to £7,200, so nowhere close to the total valuation of the car. Therefore I paid £18,000 upfront for a depreciating asset, I would be damaging my cash flow rather than paying a reduced amount to start. Therefore it can actually work out to be more cost-effective to finance a car rather than buy it out-right. However, this does depend on the specific circumstances of the finance offer and the car you are buying.
Is Car Finance A Good Idea For You?
At the end of the day, you might feel less anxious and more comfortable with buying a smaller budget used car. Finance agreements are not to be taken lightly. All those monthly instalments add up to some serious amounts, so you have to be comfortable with budgeting that out.
As I’ve indicated I like the freshness of driving a new car and not worrying about repairs that tend to creep in after a few years on the road. My lifestyle is always evolving and as my career and income has grown I’ve allowed a degree of lifestyle inflation. It’s nice to treat yourself to improved drivability, features and comfort.
Not buying a car upfront allows me to manage my cashflow and keep saving and investing my money more aggressively. If I didn’t save and invest a high proportion of my income maybe I would buy a car upfront?However, as I mentioned there are a bunch of good reasons (e.g. car repairs) that I mentioned earlier that give me peace of mind.
So it really depends how you feel about certain questions:
- Are you comfortable with finance agreements?
- Do you mind saving in preparation for repairs and unexpected costs?
- Are you happy to keep the same car for a long period of time?
In Conclusion…
I try to run my finances in a similar way to a business. When you look at a business’s balance sheet you will see revenue, cost of revenue and then a profit margin. I’ll admit this is a pretty simplified explanation! With many successful businesses you will also likely see a healthy cash flow.
Following this principle, it would make me uncomfortable to pay a large sum of money up front for a car. Although I am taking on finance, I always know that I can comfortably pay off the future monthly instalments. This is actually a rule that has helped me to over triple my net worth in just a few short years.
Budgeting For Your Next Car
Whether or not you choose to save up and buy a car or take out a finance deal, budgeting is absolutely crucial. Especially when taking on a financial commitment such as a PCP deal. Knowing how much you are likely to earn, spend and save at the end of each month is an essential first step to managing your finances. So make sure you download my monthly budgeting spreadsheet.
Secondly, tracking your finances is ever more important. Luckily this has been made much easier due to the innovation of Fintech companies such as Wise and Revolut. These companies are revolutionising the way we manage our finances and as a result you can automate the tracking and analysis of your finances.
There are some great Fintech apps and Digital Banks with awseome money saving features. These include the likes of Monese that allow you to really easily track and visualise your spending. The Monese app is available on either Google PlayandApple Store. Monese also have a bunch of incredibly useful features such as their ‘spend like a local feature’ which allows you to easilyopen up accounts in multiple currencies to spend abroad like a local.
So regardless of if you are trying to save for a car to buy in cash or using a finance deal, these are effective tools for managing your finances along the way.
