Car Loans: Useful or Wasteful Consumer Spending?
I’ve written before about how I’m paying extra payments on my car loan because of the higher than average interest rate. Well, as of July 7th of 2016, I officially own my car outright with no lien. I still had just under $1,000 left to pay on it; however, with lack of faith in the stock market upcoming, I decided to deploy my capital and pay off a loan that was costing me 5.65% a year. At the end of it all, I was expected to pay $534 in interest on the loan and I only paid $215. I saved $319 by paying early!
While I did finance my car, I don’t actually recommend it. You buy a new car for $15,000 and you’re feeling good. Then, when you arrive home, you realize your new car has a $15,000 loan on a $12,000 asset. That’s depressing. Yet a car is a necessity in many areas. I could not function properly in Florida because our public transportation isn’t adequate for daily living. As the King or Queen to your own financial empire, how do you protect yourself from such a dastardly good? Read on financial conquerors, read on.
Why I Got a Car Loan
I get it, not all of us make $60,000 a year. As the sole income earner in my family, our household income doesn’t even hit $60,000 a year. On top of that, I was new in my career and thus had not earned a lot. I saved very aggressively for a few months and put down a sizeable down payment; however, it would have been a year and a half to two years before I could have afforded my car outright. A car loan is simply the way it had to be. My story is probably very similar to many of you. That said, hopefully I never finance another vehicle.
For those who are in my past situation, here are some things to consider when going for the car loan. First, find a car who has hit the point in their life cycle where depreciation curve begins to flatten out and become fairly constant. Edmunds has a great “cost to own” tool for this. Inherently, by buying a car that has a flat depreciation curve, you’re buying a used vehicle. It may take some shopping around and footwork, but it’s worth it. You should only be buying a vehicle once a decade, so the initial footwork is a very small investment cost.
Try to find a car that is dependable and has low maintenance costs. When I initially went shopping I was looking for older Volkswagens and Chevrolets. I chose not to look at Hondas and Toyotas because I’m a large fellow and I didn’t want to feel claustrophobic every time I got in the car. I purchased a 2005 Chevrolet Impala and it has been every bit of dependable as I believed it should be. With basic maintenance of tire rotations and oil changes, as well as some cleaning, I spend around $150 a year. While that is only $12.50 a month, I actually budget $25 because eventually I’ll need tires or some other large expense.
Those two tips, along with paying as much down as possible, should save you the hassle and long-term costs associated with car buying. Don’t spend good money on bad costs. Minimize the cost and move on.
Don’t Overextend Your Money
The biggest problem I see with people and cars is that they simply spend too much. You see people financing 40% of their gross income in a car. Think about that for a second. Someone making $50,000 a year has a $20,000 loan for a vehicle that is only worth $17,000. It just doesn’t make sense. When you consider the monthly cash flow on it, they’re giving up experiences, retirement savings, home improvements, and a host of other worthwhile things, to have a vehicle that they spend around two hours a day in. Is fourteen hours a week worth a $300 car payment? I don’t think so.
So what is an adequate range to spend when shopping for a car? I would argue around 15% of your gross income. It may not seem like a lot, but all a car really needs to do is get from Point A to Point B whenever you need it. You don’t spend that much time in it anyway. In fact, most people will drive 15,000 miles or less a year. For those who rely on their cars for their business – people like REALTORS, salesman, or regional coordinators – it may make more sense to spend up to 20% of their gross income so they can get a newer vehicle, as well as a more fuel efficient one.
For those who aren’t as wealthy and need to receive a car loan, I would try and keep your financing around 10% of your gross income. That way you know you can handle the monthly payments with ease. Had I not paid extra each month, my monthly payments would have been roughly 5% of my net income and incredibly manageable.
A car loan is a bad buy because you’re financing an asset that loses value quicker than your loan gets paid off. So if you can avoid a car loan, you should. To do so, you should seek to spend just 15% of your gross income on a vehicle – or 20% if half of your miles are earned through business expenses. You probably only spend 14 hours a week in your car anyway, the other time it just sits in the driveway or in a parking lot of a job. Spend the money elsewhere: like upping your retirement contributions, improving your home, or creating memorable experiences with friends and family.
Readers, how do you feel about buying used cars that are only 15% of your income? Do you agree that it’s more important to “buy” memories over a fancy car? Discuss in the comments below. And don’t forget to like Cash Flow Celt on Facebook so you get the latest updates! Want more help budgeting? Check out my article on not blowing the bank on Christmas by starting to save now!