I recently read that in 2011 the average new car loan was nearly 63 months, which is actually down just slightly. Car loans are available for up to 84 months. I must confess to having once signed up for an 84 month car loan myself before I learned a new way of thinking about car loans.
So are long car loans good? After all when many new cars are $30,000, $40,000, $50,000 or even more, the longer term means I can get a nice ride and still be able to afford the payment right? Besides, everyone has a car payment. That’s a given, so you might as well be paying on as nice a vehicle as you can fit into that payment.
That’s how most folks think. It’s how I thought for many years. But is it wise? I don’t think so. Let’s consider.
What I’m really paying
The average car payment in America averages somewhere between $380 to $460 a month depending on the study.
Just for the sake of argument let’s say I’m about to purchase a new $30,000 vehicle and I’ll be putting 10% down. If I get a 72 month loan at 3.5% interest my payment would be roughly $445 which is right in that average range. I’d actually be paying back $32,040 on that $27,000 I financed. So that loan cost me over $5,000.
The hidden cost of that car loan
But that’s not the whole story, because those payments actually cost me more than just the interest I was paying. What if instead of sending that $445 to a finance company every month I were to invest that money instead. We’ll say I got an 8% return on my investment (over its lifetime, the market has done closer to 12% but we’ll err on the conservative side). If I were to invest $445 a month from age 20 to age 65 at 8%, I would have $2,362,818.18 when I’m ready to retire!! That’s the real cost of spending a lifetime of paying car payments.
You can’t buy a vehicle with cash unless you are rich!
So, I can hear your objections now. They are the same ones I used to raise.
You have to be rich to pay cash for a vehicle. We normal folk could never do that. Well lets stop and think for a minute.
Let’s say instead of buying that new car, you saved that $445 a month for 10 months. You could go buy yourself a reliable $5,000 used vehicle. But wait you say, 10 x 445 doesn’t equal $5,000. You’re right, but if you are paying cash you can likely get a $5,000 car or better for $4450.
Now take the next 10 months and do the same thing. You can sell or trade in that $5,000 car. It won’t have lost much value. Now just 20 months in you are driving a $10,000 car.
Do it one more time and you’ll be paying cash for a $15,000 car in only 2 and a half years. You can get a very nice low mileage used car for that price.
By delaying your pleasure just a little bit, it is very possible to drive a nice car AND pay cash.
But what about saving for a replacement
OK. Well maybe so, but you still can’t invest all that money because you still need to be saving up for the next vehicle. Excellent, now you are starting to think more wisely. Yes, that’s true. So let’s say you save $200 a month for your car replacement fund and invested the other $250. In 5 years time you’ll have saved $12,000 and with your trade in you could very easily buy another excellent quality, low mileage vehicle.
Now if invested the other $250 from age 20 to age 65 at 8%… Are you ready for this??
I’d still be retiring with $1,327,426.68!
I’m retiring a millionaire by doing nothing more than avoiding spending a lifetime dragging around a car payment anchored to my bumper!
Car loans – the shackles of the middle class
I’m convinced that car payments are one of the things that keeps folks from ever really getting ahead in life.
Car payments are kind of like anchors. It may be possible for the boat to move when the anchor is down, but it is very difficult and you have to expend an enormous amount of energy. In the same way it may be possible to get ahead financially and still be making car payments, but it will always be an anchor pulling your budget toward financial mediocrity.
Let me be clear. I have nothing against driving a nice car and I have nothing against car salesmen. I have good friends that are in that business. My point is, don’t allow car payments to steal your financial future and don’t believe the lie that, “I’ll always have a car payment.”
What could you afford to do today if you did not have a monthly car payment?