You’ve likely heard of interest-free car loans, a relatively new trend where car manufacturers are offering five-year, interest-free loans as an incentive to purchase a new car.
But is purchasing a new car with an interest-free loan a better choice than purchasing a used car with a loan with interest? You may think that the interest-free option is undoubtedly the better choice. After all, you don’t have to pay interest on the car. But this doesn’t take into account other factors to consider when purchasing a car, such as depreciation of the car.
How Much Will You Lose When You Purchase a New Car?
First and foremost, it’s important to keep in mind that a car is a depreciating asset. Many people consider cars an investment, simply because of the large purchase price, but a true investment should bring you a rate of return for the money you spend, and a car will not.
According to CARFAX, a new car depreciates an average of 15-20% each year and will depreciate about 60% during its first five years of ownership. If you are trying to build net worth or reduce debt, it doesn’t make sense to spend a lot on a depreciating asset.
How Much Will I Pay in Interest for a Used Car?
If you are considering buying a used car instead, it will likely be at a much lower purchase price. Be sure to calculate how much you will save in interest over the life of your loan to see if you will come out ahead by buying a used car at a lower purchase price, rather than a new car at zero interest.
Let's say you purchase a used car for $12,000, with an interest rate of 6% for a 5-year loan. Over the life of the loan, you will pay approximately $1,919.62 in interest. You may be able to find an even better interest rate by shopping for a loan. Compare this to the 15-20% average depreciation of a new car to determine the best value for you. (Hint: buying a used car will likely be the cheaper option.)
Other Used Car Tips
Still not sure what to do? Check out this list of the best used cars to buy to get the most value for your money. But, when buying a used car, take your time in making a decision, and be sure to check the vehicle's VIN and history. This will prevent you from making a costly mistake.
Also, take into account that the value of a car depreciates much more rapidly during the first three years of the life of the car and begins to slow down by the time it is five years old. So, although the car will continue to depreciate in value it will do so at a much lower rate. So, if you are looking for the best value, consider a used car that is about five years old, which means that a bulk of its depreciation has already occurred. There are plenty of cars in that age range that are affordable, safe, and of good value.
Is it Better to Buy a Used Car with a Loan or a New Car With an Interest-Free Loan?
Although buying a new car with an interest-free loan may seem like a good idea on the surface, you may lose more money than if you were to buy a used car with a loan that has interest. The loss will be even more if you roll your old car loan into a new one. Additionally, many used cars come with warranties and are still very reliable.
It can be tempting to buy a new car, especially if it is your first car or if you had a lot of repairs for your old car. But you should do your research and crunch the numbers to ensure that it’s really the best deal.
- Be sure to do your research to make sure that you buy a car with a good consumer report and that has a good history with few required repairs.
- Consider setting up a sinking fund to cover car repairs.
- Begin saving now so that you can purchase your next car with cash instead of worrying about getting a loan.
Updated by Rachel Morgan Cautero.