Should I Finance a Car or Pay Cash With Stimulus Money?

Earlier this year, more than 90 million American households received a substantial stimulus check from the federal government.  All of them saw at least $1,400 pop up in their checking accounts, and many households received many multiples of that amount.  A lump sum like that comes just in time for major expenses, like car replacement.

The big question that many people will ask themselves as they consider replacing their old car is whether they should pay cash for their upgrade (or at least cover a big down payment) or simply get a car loan and hold onto the cash for a rainy day. In an era with low interest rates on car loans, it’s not entirely clear what the right financial choice is.

As you’re making this decision for yourself, here are the key factors to consider.

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In this article

    Do you need a car at all?

    Start with an honest assessment of whether you need a car at all. Is this car purchase addressing an actual need or a want?

    Here are some questions to consider in your situation:

    • Do you currently have a reliable car that gets you to your destinations as needed? If so, think very carefully about whether this is the right moment to buy a replacement, or whether there are other, better uses for your stimulus check.
    • Do you have access to alternate forms of transportation that can take care of the things you need? Is there mass transit in your area? Are you close enough to work to walk or bicycle there?
    • Is your actual need for a car infrequent — less than once a month? In those situations, is it more cost-effective to just rent a car when you need one?

    Quite often, the impulse to buy a car is a reflex based on a desire to have a newer car, not an actual need. Make sure it’s a need before investing that much money. If it’s not a need, do something more financially prosperous with that money and buy a car when it becomes a need.

    Evaluate your financial situation

    If you’ve decided that buying a car now is the right call, you should step back and look at your finances. Your financial situation gives you the info you need to decide if you should use your stimulus check to buy a car or instead get a car loan. Here are four key questions to think about regarding your financial health that can guide you toward the right car buying decision.

    Do you have any high interest debt?

    If you have any high interest debt, paying off that debt is a higher priority than making a down payment on a car loan. High interest debt includes anything with an interest rate higher than the car loan you might get. Assuming you have decent credit, you should be considering all debt above 4% annual interest as “high interest” debt, as that’s very likely to be higher than the interest rate you would get on a car loan.

    In particular, you should be eyeballing payday loan debt and credit card debt. If you have any debt of either kind, paying those down should be a higher financial priority than a car down payment. Use your stimulus check on those debts, then if you’re still intending to buy a car, finance the whole car with a much lower interest rate loan.

    Do you have an emergency fund? 

    An emergency fund is a pool of cash set aside for personal emergencies, such as an unexpected job loss, an illness, an accident, a car problem, identity theft, a natural disaster or something similar. A credit card does not suffice as an emergency fund because it doesn’t work in many emergencies, such as identity theft or a natural disaster or if your balance is too high.

    Cash is king. Aim to have at least a couple of months of living expenses in a savings account, if possible.

    If you don’t have an emergency fund, sinking your entire stimulus check into a car is a mistake. It leaves you in a situation where, if something goes wrong in your life, you won’t be able to easily handle it and may end up with credit card debt or even worse repercussions. Having an emergency fund is a higher priority than avoiding low interest debt.

    Do you have good credit? 

    One big assumption behind the first two questions is the idea that you have good credit. Without good credit, you won’t be able to easily get a low interest car loan.

    Good credit simply means that you have a long history of paying your bills on time, not maxing out your credit cards, and not being the victim of identity theft. If that sounds like you, your credit is very likely in good shape.

    If you’re not sure about your credit, the easiest first step is to obtain your credit reports. You can obtain your credit reports for free once per year for each of the three major credit bureaus. Make sure they’re accurate, and if not, get them corrected by reaching out to any parties that have incorrect data for you on your credit report.

    Are you saving for retirement and other financial goals?

    A final question to consider is whether you’re taking care of your other financial goals, particularly saving for retirement. Are you putting money aside for retirement through a workplace retirement plan or through your own Roth IRA?

    Over the long run, the money you put into a healthy retirement savings plan will offer a much better financial return than a down payment on a low interest car loan. If you’re not saving for retirement at all but you have no high interest debt and an emergency fund, consider prioritizing retirement savings over making a down payment on a low interest car loan.

    If you have a stimulus check, should you still get a car loan?

    After going through the above questions, you may have concluded to put off buying a car to solidify your financial foundation, which is a great choice. If you’ve reviewed the questions and still decided to buy, here are some tips to consider to get the best value from your car purchase.

    First, if you have no down payment (because you used it to eliminate high interest debt or make other smart financial moves), you can still secure a low interest rate on a used car loan if your credit is good. This is particularly true if you’re trading in a car. If you cannot secure a low interest loan for a car, you should get a very low end used car, pay it off quickly, and drive that until you stabilize your credit.  You may find that using some of your stimulus check for a down payment and getting a car loan for the rest helps you get a lower interest rate, so be open to that option.

    Second, regardless of whether you’re paying in full, paying with a down payment or financing all of it, a few principles of car buying apply. In short, your best option is to focus on reliability by buying a late-model used car — one that was manufactured in recent years from a reliable manufacturer. You can figure out which car manufacturers and models are reliable by stopping at your local library and looking at the most recent annual car buying guide from Consumer Reports.

    Finally, buy your car with the intent to drive it until the cost to cover upcoming repairs exceeds the value of the car. Follow the maintenance schedule to the letter and use a trusted mechanic for that maintenance, as that will drastically extend the lifespan and reliability of your car. Doing this will ensure that the car is still in great shape long after you’ve fully paid it off.

    We welcome your feedback on this article. Contact us at inquiries@inforeadersusa.com with comments or questions.

    Daniel Smith

    Founder & Columnist

    Daniel Smith founded Info Readers USA in 2006 and still writes a daily column on personal finance. He’s the author of three books published by Simon & Schuster and Financial Times Press, has contributed to Business Insider, US News & World Report, Yahoo Finance, and Lifehacker, and his financial advice has been featured in The New York Times, TIME, Forbes, The Guardian, and elsewhere.