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A common question car buyers ask themselves is whether they should pay in cash or get a car loan. Find out about the pros and cons of financing a car compared to paying cash upfront.

Car loans vs. buying outright

The reality is that paying cash may not be feasible when buying a car for a variety of reasons, and it could even make less financial sense. Below are some of the benefits and drawbacks of getting a car under finance compared to paying with cash.

Financing a car: pros and cons

In this low interest rate environment, there are quite a few pros to financing a car, mostly coming down to ‘opportunity cost’, explained further below.

Pros of car finance

Get a safer or more reliable vehicle sooner:

Most quality cars these days set you back at least $15000-$20,000, with some utes and bigger cars at least $50,000. While you get a lot of cars for your money, saving this amount is not feasible for a lot of people.

Opportunity cost:

This term refers to the money you could spend on a car being used in more useful ways. For example, paying down your home loan could be more useful than paying cash for a car, investing that cash into shares, or keep it in the bank as an emergency fund.

Low interest rates:

Interest rates are generally very low these days, making car payments more accessible for a lot of people. This means ‘the cost of money’ is generally much lower than in years prior. What this means is you can potentially get a better car for cheaper, and one that works in your budget.

Build up your credit history:

Having a manageable weekly, fortnightly, or monthly car payment can be a budget-friendly way to build up your credit history and demonstrate to a lender that you can pay off debt, which could be useful in securing a home loan later on.

Cons of financing a car

Interest paid:

Interest paid over the life of the loan ultimately means that you’ll be paying more than the drive-away price for the vehicle in the long run.

A car loan could limit vehicle choices:

Many of the most competitive car loans limit vehicles to new ones or ones only a few years old. Further, to get the most competitive ‘green car loan’ rates, your car needs to be an electric vehicle or a hybrid.

A few things to know:

There’s a bit of jargon to familiarise yourself with. Do you go fixed or variable? Secured or unsecured? What loan term do you choose?

Paying for a car with cash: pros and cons

Paying for a car with cash is a big decision, and there are a few pros and cons associated with this method.

Pros of buying a car outright

  • It’s done and dusted: Once you pay cash, that’s it-you don’t have to worry about car repayments, staying on top of your loan, or worrying about things like ‘negative equity’ and so on.
  • Flexibility: Paying cash means it’s yours right away. This means you can sell it without telling your lender while also choosing whatever car you want.
  • No interest paid: Paying with cash obviously means there’s no interest paid on the money borrowed, as with a car loan. However, interest rates are at record-lows these days, making this less of a burden than in the past.

Cons of buying a car with cash

  • Saving takes time: It can be tough saving your hard-earned money only to watch it all go away when you hand the check over to the dealership for a new car. Saving the tens of thousands required for a new car could take years. Can you wait that long for a car?
  • Cash could be better spent on other things: It’s a big hit to the bank account, parting with $30, $40, $50,000, or more right away. Your cash could be better put to use saving for a deposit on a home loan, in which homes generally appreciate in value, or put towards other investments that could yield more than the interest paid on a car loan-called ‘opportunity cost, as mentioned earlier.
  • Potential car limitations: It could take forever to save, say, $50,000, and it’s tempting to just get any old car if you’ve saved, say $10,000. But the reality is, a $50,000 car is probably going to be newer, better, and much safer than a $10,000 car.

Acquiring a Car

There are various ways that the acquisition of a car can be financed:

  • Novated lease
  • Hire-purchase agreement
  • Chattel mortgage
  • Lease

Novated lease

In this arrangement, the employee enters into a lease for a vehicle with a finance company. Then a deed of novation is entered between three parties: the finance company (the lessor), the employee (the lessee), and the employer, whereby they agree to change or transfer all or some of the rights and obligations in the motor vehicle lease entered into between the lessor and lessee to the employer. The deed of novation usually contains a clause that transfers the lease obligations back to the lessee on termination of the lease or when the employee ceases employment.

Generally, a fully novated lease is entered, which provides for the employer to take over all the rights and responsibilities contained in the original lease between the lessor and the employee. There are no income tax or GST consequences for the employee during the period when the employer makes the lease payments. It should be ensured that a partial novation is not entered, as this may result in adverse tax consequences for the employee.

Hire purchase agreement

A hire purchase agreement is a contract for the hire of goods. Instalment payments are made. The hire purchaser has the use of the goods while paying for them, but the title to the goods remains with the financier. The title does not transfer to the hire purchaser until the final installment has been paid or an option to purchase is exercised. The total amount charged to a recipient under a hire-purchase agreement is typically made up of a principal component (i.e., the amount financed) and a credit component (i.e., the terms and charges). The principal component represents the price of the goods financed, and the credit component represents the interest and associated fees and charges payable by the recipient. For income tax purposes, hire purchase agreements are treated as a sale of goods and a separate supply of finance.

Income tax treatment

The hire purchaser is treated as the nominal owner of the vehicle. Where the vehicle is used for income-producing purposes, he or she can claim depreciation and can also claim a deduction for the interest component paid each year but not the principal payments.

Note that the amount of depreciation that can be claimed is limited to the car depreciation limit (i.e., $68108.00).

Chattel Mortgage (one of the popular)

A chattel mortgage involves a taxpayer borrowing to acquire a vehicle. The taxpayer takes title to the vehicle at the time of purchase. The purchase price (or part thereof) is paid for out of the borrowed money. The purchaser has title to the vehicle and holds a tax invoice for the purchase. However, the effect is that the purchase of the vehicle is fully financed by a finance company. The borrower (purchaser) assumes ownership of the goods but transfers to the lender an equitable interest in the goods, enabling the lender to seize and sell the goods in the event of default. By providing a mortgage over the goods as security, the borrower is able to obtain funds from the lender.

Income tax treatment

For income tax purposes, when acquiring a motor vehicle, the taxpayer has acquired a depreciable asset on which depreciation can be claimed up to the luxury car limit (discussed below), where it is used for income producing purposes. Interest on the mortgage will also be deductible in these circumstances.

Car lease

Under a lease agreement, a person, the lessee, has the use of property for a specified period in return for a series of payments. The person who grants the lease, the lessor, remains the owner of the property.

Income tax treatment

The lessor pays income tax on the lease payments each year, less the GST component. The lessor can claim depreciation on the asset.

The lessee, who using the asset for income-producing purposes, can claim deductions for the lease payments each year, less any input tax credit entitlements.

A deduction may be claimed for expenditure incurred in preparing, registering, or stamping a lease of property or an assignment or surrender of a lease of property to the extent it is used for the purpose of producing assessable income. On disposal of the car to the lessee, the lessor will have a balancing adjustment for depreciation purposes. Special rules apply for leases of luxury cars.

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