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Context

My current car, a hand-me-down from a family member, is 10+ years old with ~100k miles and starting to have enough problems that maintenance costs are quickly piling up. Over the last 2 years or so my brother and I (we share the car and split costs evenly) ended up spending ~$7,000 on various repairs and replacement parts, despite the fact that the car is only worth around that much as a trade-in according to KBB.

The car is now starting to leak oil from the engine and we're both concerned that there isn't a light at the end of the tunnel in terms of maintenance costs. And so we're thinking about cutting our losses and trading the thing in to buy a newer used hybrid or electric car. Ideally something with 4WD or AWD.

Here are some other key details:

  • I live in the United States and have no plans to move elsewhere in the immediate future.
  • I have a decent credit score (It was ~800 a few months ago, but unfortunately I missed a payment by accidentally putting lunch on the wrong credit card which I don't usually use so my score is now ~700. I have since frozen/locked that card and put it in my drawer so I never make the same mistake again.) but zero installment borrowing history as I've never taken an installment loan before.
  • At the same time, I have pretty solid savings of ~60k. Some of that is in cash, but most of it is in investments (mostly "safer" investments like index funds). I feel financially secure enough that I could drop most or all of the price of a used AWD car in cash, and I'm even lucky enough to have the option of sharing a car or getting financial help from close family.
  • I have a full time job, though it's not exactly high-paying as I work in the non-profit space, but between my income, my ability to share a car with family, and my savings, I'm not exactly worried about being able to afford the car.
  • I do have a electric bike, but I feel that I need some kind of reliable car with AWD because I live in the hills where we can have somewhat harsh winters, and public transportation is non-existent for miles.) After losing power for multiple days in sub-freezing temps in a previous winter, I can say that being able to get out of the house and go to a hotel with heating was a lifesaver. I would prefer not to buy a new car at all, but I don't think it makes sense to go with something without good winter performance.
  • I would eventually like to have a good enough credit history so that I may one day be able to buy a starter home of some kind. But just last week I was denied a loan from my local credit union (even with a joined co-signer who also has a ~750 credit score) because of my recent missed payment...

My Question

Now here's my personal finance dilemma...

  1. Based on my situation, does it make financial sense for me to get a ~$20k @ ~14% APR used car loan instead of withdrawing from my savings, if only to improve my credit history in the long term? (Obviously I would save money some money immediately by buying the car in cash, but there may be an opportunity cost to depleting my savings and I'd like to do whatever I can to improve my credit history in the long term.)
  2. If I did take the ~$20k @ ~14% APR used car loan with the goal of improving my credit history, what would happen if I ended up paying the loan off early? (For example, taking the loan and then paying off the entire thing at the first billing cycle, or maybe paying the regular installments for 6 months and then paying it off entirely?)
  3. Is there some "magic number" of on-time loan payment history that one can use to optimize their creditworthiness? In other words, how many months of on-time loan payments does a bank need to see to understand that I can be a reliable borrower? Does recency factor in at all?
  4. Assuming it's not a good idea to drain my investments (appreciating assets) to put money into a car (a depreciating asset), what is a reasonable down payment to make on a ~$30,000 car? Should I aim to put as little money down as possible while still aiming for the lowest APR possible? Looking at my currently pre-qualified offer from Capital One, I'm noticing that the best rate that I seem to be able to get is around 14.25% APR regardless of how much money I offer to put down. So would it be a good move to put the least amount down while still getting as close to 14.25% as I can? Does the amount of down payment I provide have any bearing on my goal to establish good borrowing history?
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    Are your investments guaranteed making more than 14%+tax? If so, I want to know what you're investing in.
    – littleadv
    Commented Apr 15 at 22:47
  • Obviously no investment is "guaranteed" and I didn't say that.
    – Donuts
    Commented Apr 16 at 2:57
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    Obviously no investment is "guaranteed" - you say that, yet you're describing a situation where paying cash for the car guarantees you exactly that.
    – littleadv
    Commented Apr 16 at 4:08
  • I see what you mean. Because -14% due to interest on the car is certain, while a >14% return on my other investments is only just possible. Good point.
    – Donuts
    Commented Apr 16 at 20:21

1 Answer 1

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I find it difficult to believe that you were flat denied a loan just because of one missed payment and a 700 credit score. It's also possible that either you wanted to borrow more than your income would afford or there were other extenuating circumstances. The dual owner/obligor might have also been a red flag, or it didn't fit neatly into their pre-approval model (they may have underwritten the loan using just one of your incomes).

There should be absolutely no reason to get a loan and waste money on interest (especially at 14%) just to raise your credit score. If you continue to make payments on time, your credit score will improve naturally.

To answer your specific questions:

does it make financial sense for me to get a ~$20k @ ~14% APR used car loan instead of withdrawing from my savings, if only to improve my credit history in the long term?

No. Absolutely not. 14% interest is an incredible waste of money.

what would happen if I ended up paying the loan off early?

Nothing magical - the loan would show as paid off on your credit report. There are no "bonus points" for paying a loan early. You would save money on interest, but if you can pay cash now you can save ALL of the interest.

Does recency factor in at all?

Yes, but so does a long history. Keep making payments on time and you'll be fine.

what is a reasonable down payment to make on a ~$30,000 car?

When you can only get a 14% loan, then the only sensible down payment is 100% (30k). If the thought of paying that much cash for a car disturbs you, then consider a cheaper car. 14% on a 20k loan is $2,800 per year ($233 per month) in wasted interest.

My suggestion would be to pay cash for the car and to take the car payment you would have made and put it back into your investments (assuming you have no other debts). You'll be much better off in the long run.

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    No, taking out a loan and quickly paying it off will not help your score significantly. Having dual borrowers might have been a red flag as it increases the risk that neither of you could afford the loan on your own.
    – D Stanley
    Commented Apr 16 at 3:29
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    @Donuts - How are you determining that your credit score is 700? The credit score that, say, your credit card tells you on your monthly statement isn't necessarily the same as the credit score that was used to deny the loan. If you're denied credit, you should get an adverse action letter and you'll have the right to get a free copy of the credit report that was used. Make sure there isn't something else on there that is incorrect.
    – Justin Cave
    Commented Apr 16 at 7:13
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    @Donuts - It is also likely that you could call the credit card that you paid late, explain the issue, and get them to remove the late payment from your record. They would much prefer that to having you put their card in a drawer.
    – Justin Cave
    Commented Apr 16 at 7:13
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    @Donuts - That "free credit report" isn't necessarily the same as the credit report they use for credit decisions. Even the same agency has different scoring models so you could have a dozen different Equifax credit scores in their different models. The models used for lending decisions are generally not the models that are used for the "here's your monthly credit score" feature. Ideally, they would be similar. And most often they are. But when something weird happens and someone with a 700+ score gets flat denied for a car loan, it's worth investigating the "less often".
    – Justin Cave
    Commented Apr 16 at 20:46
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    @Donuts - The credit bureau won't remove the late payment unless it was inaccurate. But you can ask the lender to do so. The lender wants you to use their card more often-- that's how they make money. If removing the one late payment you've had in x years makes you a happy customer that is more likely to use the card in the future, that's very, very cheap for them. They'll probably also waive the late fee.
    – Justin Cave
    Commented Apr 16 at 20:48

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