Should I Finance or Pay Cash for a Car?

You've gone to the car dealership and you’re looking to buy a car. The car salesperson has given you the smooth talk about how great the car you've just test driven is. They’ve told you the price after giving you the "I wish I could give you a discount, but this is the lowest price I can do" line. It's above your price range but you really want it. You are then given a suggestion of financing the purchase…..Car Finance.

Car finance? What’s that? Don’t worry we’ll get to that shortly.

Back to the scenario...

The repayments are only £275 per month, you’ve worked out that you can afford that. You think "you’ve twisted my arm, let's go for it". They've even thrown in some free floor mats..... deal breaker.

You get approved for the car finance, of course you do, you have a great credit rating, you've always been good with money. Anyway, back to that question again. What is car finance?...

Car finance in simple terms, is the borrowing of money to purchase a vehicle.

However, the important part is the borrowing is attached to the vehicle. Meaning that the car does not belong to the purchaser until all the finance has been completely cleared.

When people take out car finance and acquire a new ride, they naturally tell other people that they've just bought themselves a new car. Some might even post it on social media with a caption "just splashed out on this new toy". They receive congratulations from their friends about how they deserve this, all their hard work has paid off!

What they miss is, well...the car does not belong to them! The car is owned by the finance company and will remain that way until every penny owed to the finance company has been paid. This means that if the person does not make all the payments, the finance company has the right to repossess the vehicle.

Strangely these facts don't appear on that same Instagram post. “Yeah guys, I forgot to mention I will be making payments every month to a finance company for the next 5 years for this new ride as I can’t afford it. One more thing, the car doesn’t currently belong to me until I’ve completely cleared the finance." Doesn’t have the same impact when you read that.

That’s why it’s very important to understand the difference between an asset and a liability. In a nutshell, if something makes you money it’s an asset. If it costs you money, it’s a liability. When someone is being congratulated for buying a car on finance, they are being congratulated about taking on a liability. Something to remember before pulling the party poppers.

A lot of people do not fully understand that they are essentially borrowing the car until the last payment reaches the lender.

This is very important to know, as any serious change in your financial circumstances that results in you not being able to make payments could result in you no longer having a vehicle and in many cases, an outstanding debt to top it off due to a shortfall!

What are we talking about? Let's break this down:

Dean takes out finance on a £20,000 car. He makes each monthly payment as per his agreement for a while. Unfortunately, his financial situation takes a turn for the worse. Dean can't make the monthly payments for his finance agreement. The finance company continually contacts Dean asking him to clear the arrears otherwise they will repossess their vehicle.

Dean isn’t able to pay the arrears and the finance company moves towards repossession. After exhausting options to recover the money (as per the Financial Conduct Authority guidance) the decision is taken to repossess the car. Within days recovery agents are at Dean’s home. He’s asked to remove his belongings and hand over the keys. The car is taken away. That's the end of the matter for Dean right?

No, it’s not!

The finance company want their money, not the car, so they send it to an auction to get a quick sale. The car sells for £12,000 and Dean’s remaining finance is £17,000. So, what happens to the remaining £5,000 from his car finance agreement? They pursue Dean for it, somewhat aggressively, which ends up with finance company instigating court action to recover the debt.

Dean ends up with no car, a £5,000 debt and a County Court Judgment (CCJ) which also affects his credit score. This really isn’t how Dean imagined things would end when he splashed out on that new car.

We never recommend you take out car finance, as there could be better alternatives for you. These are:

1. Buy what you can afford: This is obvious and not what most people want to hear but it works like a charm. You simply save up and buy a car that you can afford.. This might feel like a buzz kill but remember, it’s not a popularity contest. A car’s role is to take you from point a to point b, not about how flashy it looks. With this approach, you know the car is yours. If there is any downturn in your finances, your car will not be at immediate risk. One less thing to worry about!
2. A Personal Loan: If you insist on buying a car out of your budget (i.e., you are determined to obtain some sort of finance which we suggest you avoid). You may be better off obtaining an unsecured personal loan to buy the car. That way if you do run into financial difficulty the vehicle is not at immediate risk because the loan is not attached to the vehicle. You can manage the payment difficulties you have without the immediate threat of your car being repossessed as well.

The information in this article is considered to be true and correct at the date of publication.