I had my first reader Q&A here a few weeks ago. A reader wrote in about building their credit score through using a credit card. I answered the question to the best of my ability. Once I did answer the question, another Studenomic’s member responded with a twist to the credit question:
I’m planning on selling my current car and trading it up for a much better and more reliable vehicle. My problem is that I’m still undecided as to how I’ll be paying for the new automobile purchase. I was debating putting some money down and then financing the rest. I figure that if I finance the remainder of the balance, I will be able to build my credit rating. I’ve been told that responsible payment results in an increase to your credit score. Is this true? What should I do?
(The question was edited to protect the privacy of your fellow Financial Stud.)
First I just wanted to say that yes, making your payments on time is always a good sign and a positive on your credit score. However, in this scenario there are a few other questions that you need to consider before you decide if financing the car is the ideal option for you.
How much are you spending on interest?
The interest rate that you get charged will determine how much this purchase will cost through the whole product payment process. A difference of 1% on an interest rate can make a huge difference. Are you willing to take a realistic look at the amount of money that you’ll spend on interest?
Since no numbers were shared, it’s unfair to try to dictate how much the interest costs would be. For the sake of this article, I plugged in the number of $10,000 into this car financing calculator.
- Car cost= $20,000
- You put down =$10,000
- You finance= $10,000
- Let’s assume the interest rate is 5.5% & you want to be off the car in monthly payments over 5 years. Also assuming no trade-in value.
After plugging in the numbers, your monthly payment will be $191.01, at a grand total of $11,460.60! That’s $1460.60 of interest that you’ll pay in 5 years.
Do you have the money?
If you have the full amount needed for the purchase, already saved up, then your decision becomes even more interesting. Of course the argument here exists for leverage. The couple of thousand dollars that you finance on the car could be leveraged to other areas of your life if you have the money. You could put the money into a savings account or you can try something a little more riskier (invest in securities).
On the other hand, if you don’t have the money you must determine if you really need to make this purchase. If you truly feel that you need a reliable vehicle, to get to work or school, then by all means financing the car could be the best decision for you.
Could you invest the money wisely?
If you could find an interest rate on an investment (not a scam) that’s higher than the interest rate on the car financing, then you would be better off financially. Well, um that’s not exactly how it works. Unfortunately, this process is really easy to screw up. I mean really easy. You must be 100% strict with your finances. This requires strong self-discipline and accountability. Therefore, unless you’re a 100% certain that you know what you’re doing by financing the car purchase/investing the balance, I wouldn’t recommend this option.
At the end of the day, I do understand the benefits of improving your credit score. I just don’t see the need to force yourself to make purchases.
As always please send any questions you want to have answered to md at studenomics.com! I look forward to helping you guys out. And remember I learn just as much from you as you do from me.