Reader Q & A: Building Credit With Car Purchase

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.

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Comments

  1. says

    hmm this is a question I love to talk about and hear others opinions. I am in favor of buying a Car with CASH. I have never had a car payment, and don’t intend to in the near future. How do I do it? Public Auto auctions. I get cheap good cars there for between $1-$5000. My Father has bought 5 cars from them, all of which our family ended up using for 2+ years each. I’m driving one now, debt free and I love it!

    Not only do you have to consider the extra money that you will be paying on a car due to interest and the monthly payments if you finance, but it is also costing you in that the money you are paying every month for this car, is money you could be putting towards other debt. The quicker you knock out the other debt, the more money you save in interest! Now if you have to first pay off your car loan, that’s over $1,000 of extra interest paid on the loan, before you can even start tackling your additional debt.

    Call me weird, but I just hate to take on additional debt if I have not already eliminated the majority of my debt:) Of course, the reader did not say he/she had any other debt, so my whole point could be useless haha:)

  2. says

    Hubby and I just paid off our hopefully-last-ever car payment…I will say that if you have to finance, then pay it off as quickly as possible.

    If I could go back and do things over, I would have bought a used car and paid it off in my first year at work since I literally only had $1000 to spare for a downpayment right out of college. Instead I bought a new Chevy Aveo (crap car) for $12,000 and paid it off in 2 1/2 years, which cost me about $800 in interest. 5 years later, I hate my car but will continue driving it until it dies because I hate a car payment more and we’re just rebuilding our car fund…

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