Why Car Loans Are Making You Poor

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There are basically three options when it comes to “buying a car”. You could lease it, purchase it with a few thousand down (perhaps by taking out a loan from a place like samedayloans.org.uk) and make payments for a few years, or you could buy the car outright with cash. How do you typically purchase your cars?

Leasing a Car

People that lease a car often think of themselves as sophisticated. Not only is their payment less than those that actually purchased a car (through the bank), but they get to write off more of their payments when tax time rolls around. Here’s the major problem though – after the lease runs out, they have absolutely no property to show for all of those payments.

They probably paid $5,000+ in one year, and have nothing to show for it. Oh, but don’t forget about that $1,000 tax write-off…. Now they’re only in the hole $4,000 each year. If you think this is sophisticated, you’re definitely going to be broke for life.

Purchasing a New Car on Credit

There are quite a few people that believe strongly in using other people’s money (OPM) for the majority of the purchases in their life. Since inflation increases by about 3% per year and a new car loan has an interest rate of 1.9%, many people believe that it’s wise use OPM when they’re in the market for a new car. This sounds all well and good until you factor in depreciation.

It’s a well-known fact that the average car will lose 60-70% of its value in the first 4 years of its life. That means that if you purchased your car for $25,000, it will only be worth $8,750 in only four short years. You may have gained a few hundred dollars because of the rise in inflation, but you lost over $16,000 on the value of your car!

Purchasing a Used Car On Credit

Based on the loan interest details above, you may think that it’s wise to buy a used car with OPM! After all, the interest rates are at 1.9% and inflation is rising by 3%. It just makes sense! Well hold on there. The rates for new cars are at 1.9%. Used cars typically carry notes of 6% or more. Suddenly, you aren’t earning any money against inflation. In fact, you’re losing money pretty quickly!

Also, purchasing a car on credit (used or new) is risky. If you found yourself without a job, thereby unable to make your car payments, what would happen to your wheels? That’s right, they’d be gone — taken away by those lovely repo men.

Buying a Car With Cash

If you hadn’t guessed it by now, cash is my preferred way to buy vehicles. Since cars depreciate in value severely within the first four years of their lives, I often look to purchase vehicles that are between 4-6 years old. They are often still running strong and have a great visual appeal. Plus, rather than lose $16,000 to depreciation, the value of my slightly used car would only go down about $2,000 within the same time frame.

The Reason Car Payments Will Make You Broke For Life

If you’re making payments on a car each month, you’re reducing your cash flow by an average of $350 per month, which equates to $4,200 each year! If your first car was purchased this way, chances are that you aren’t able to save up the money to pay for the next one with cash, so you get stuck on this cycle of car payments for life! That’s $350 every month for 55 years (from age 20 to 75)!!

Total up those payments and you’re looking at a loss of $231,000 over the course of 55 years. This though, is still not truly the loss of your purchase on credit. Instead of making those regular car payments, you could have been investing your money into the market and earned 10%. With those consistent deposits each month, your investment would be worth $9,500,000!! I don’t know about you, but I’d rather not have a car payment….

Do you typically purchase your cars with cash? Has this article impacted the way you think?

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Money

Derek

AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

28 Comments

    • How much did you have to put down in order to get it at $210 per month? I bet you came close to $4,000 per year in costs, and now you have nothing to show for it. If you would have bought something used, it wouldn’t have cost nearly as much over the course of the year.

    • This is basically a case of, how to lose less since cars all depreciate in value. Buying used cars for cash allows you to lose less. Thanks for the comment!

    • I like the 1/10th rule. I haven’t heard of that before, but it definitely makes sense (and I’m living by it without even knowing it!). 🙂

  1. One of my friends just bought a car with cash. I had never heard of that before, but once she explained it like you just did, I realized its brilliant!!
    Deanna recently posted..I Have Asked for Help

    • It’s amazing how few people purchase a car with cash these days! I’m glad you have a friend that cares enough about you to explain why it’s a good idea. Pay for a car with cash and you’ll feel amazing inside!

  2. We bought our first car new and our second car used, financing both of them. When we had to move out of country for a job, the finance companies wouldn’t let us take “their” cars with us, so we sold one and paid off the other with a line of credit and then paid that off as quickly as we could. When we returned to the US, we bought our next car sorta-new: a dealership loaner car that was never titled and that was a few months old. We got the new car warranty and slightly used (and heavily negotiated!) price, but still had to finance even with a healthy down-payment. We refinanced that car within a year and then paid it off within another year.

    Having done the math on how much money we lost in interest and how much value was lost immediately on buying a new car, we vowed to never buy new again. (Okay, so *I* vowed never to buy new again and then convinced my husband to agree, ha!) Currently, we’re putting away $75/week into a car fund. The plan is to trade in husband’s car while it still has good value (hooray for Wranglers retaining value!) and supplement the rest of the purchase price with the car fund.

    • I’m glad you’re sold on buying used cars with cash! Let me know when you make your purchase. I would love to celebrate in your accomplishment!

  3. You can actually get a really good car for under $5,000 if you are patient, do your research, and have an open mind. If a shiny new car is your goal, then there’s not much you can do other than finance it (unless money is no object). But if just having a reliable car with no payments works for you, then you will have some choices.

    • That’s true! As long as you’re not too picky about the model or the color, you could easily find a solid car for under $5,000. Thanks for the comment!

  4. The total cost numbers are astounding over a lifetime, real attention-getters. Like Busy Executive, I’m an advocate of carsharing. Unless you drive a lot, carsharing can save a ton of money (and hassle).

    What’ the rule: Don’t borrow money to pay for a (rapidly) depreciating asset? You’ll never ‘catch up’ to market value and have any equity in the asset.
    Kurt @ Money Counselor recently posted..Tax Deadline Panic Cure

    • They really are astounding aren’t they? You’re right – you should never finance a depreciating asset. The numbers hardly ever work out in your favor.

  5. I never buy cars for cash. I have all my money working for me and I generally get a better return than the cost of financing. I also keep my cars forever. My current cars are 17 and 15 years old. They were paid off a long time ago.
    Krantcents recently posted..The 3 N’s of Success

    • As long as you’ve got it figured out, I guess I’ll let you roll with it. I still believe in buying cars for cash though.

  6. I’ve now had two great months of no car payments. Having just paid off my car (that took way too long to pay off!) I’m glad to be car-payment free! I have no plans right now to buy another car, so I’m enjoying this period right now. 🙂
    Little House recently posted..Have You Changed Banks Recently?

    • Well congrats for that! I bet you’ll never go back to those payments! 🙂

    • I can’t wait to get rid of those mortgage payments. It’s going to take a few years, but we’ll hopefully enjoy that feeling soon too!

  7. I’ve only bought one car with a loan from the bank and I made a point to pay it off as quickly as possible. Other than that, I’ve either paid cash or used my credit card. I only buy used to save myself from the initial depreciation hit when you drive it off of the lot. When I do use my credit card, I have a special 0% interest rate, so I buy the car using that and then just pay it off over time. I have the cash invested, so in the worst case, I can pay off the car.
    MoneySmartGuides recently posted..New Debit Card To Help Pay Down Student Loan Debt

    • Sounds like you’ve got it pretty well figured out MSG! Thanks for the comment!

  8. I have always been discouraged in loaning just for a car. I admit right now I don’t have the income to purchase the car I desire or fantasize about so just for convenience buying a used car for cash is the best choice. This car would just be temporary though.
    Laura recently posted..DTS Home

    • When you save up and save up for that car, it’ll mean so much more to you than one that you just go get with a loan. When you get there, you’ll be thrilled to pay for your car with cash. Good luck!

  9. It will really be easy if we have enough cash to buy a car, I agree. But how about others who couldn’t afford that much, but in desperate need of a car, what would you recommend?

    • There are always ways to get around buying a car. Carpool, get a bike, move closer to work, etc. Honestly, anything is better than going into debt that you’ll never escape from.

  10. What if you have money and are looking for a good deal but a $5k car just doesn’t cut it. I like nicer stuff. But i also don’t wanna throw money away and buy a brand new car and take a hit on depreciation. I make well over $300k a year. What is the best way to buy? I like the idea of buying a car 1-2 years old when it has taken the first depreciation hit. With good credit i can hop into someone thing 1-2 years old at 2.9% – 3.4% interest. I use that car for the next 2-3 years and then sell it. For example. In Sept 2017 I bought my 2016 Nissan GTR for $74k with 16k miles on it(still smells new). The year before, the car brand new sold for $105k. I am not 1 year into using my car, i will use it for another year and then i will sell it for around $55k. and then in my eyes, i spent $20k-$25k for a $105k super car that i still had when it had low mileage. That is the best way to get the value out of a car without sacraficing being in an older car that may start giving you problems. Id rather have a car 1-2 years old and still under warranty, than to buy a car that is somewhat new but out of warranty. Warranty is good to spend money on sometimes.

    • If you make $300k a year, why are you buying a car with a loan? Why not just buy a nice car (2-3 years old) with cash and hold onto it for 4-5 years? It would make more sense for you financially.


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