Last week when I was driving into work with Mrs. ROB we listened to report on NPR (yes, we listen to NPR every morning and evening) about how the average car loan had ballooned to 74 months. My first reaction to this news in my head was what are people thinking? Why in god’s name would we put ourselves in debt on something that goes DOWN in value?
Truth is I know why many people opt for those long-car loans. First, the long-term loan keeps their payments down. They want a certain kind of car, probably a more expensive car than they can afford and this allows them to afford the payments. Second, people want a new car. There is something about a new car that just makes you feel RICH. I mean if you have a brand spanking new car you must be doing well financially RIGHT? Wrong, most people who buy new cars are hocking themselves up to their eyeballs. I have never bought a brand new car and doubt I ever will. I just don’t like to put myself at that much risk.
Don’t get me wrong I have had a car loan. In fact, I have had four of them and been fortunate to pay them off within about two years is my average. In the future, I would just assume buy a much older used vehicle and pay cash for it.
The Dangers of Long-Term Car Loans
The first danger is that cars depreciate quickly in value. The average car depreciates 30-40% within the first two years of buying it. Let’s say you take out a $20,000 loan, which is below $27000 average for a car loan nowadays, and you have good credit which makes your interest rate at 3% or so. Your car payment on that loan will be $300 a month. In two years, you will have the loan down to about $13500. The car will most likely be worth less than the loan. If you have an accident and total your car you will be stuck for the balance. In other words, you bought a car that potentially put you into more debt.
The second danger is that those loans allow us to buy more car than we can afford. Yes, longer-loans will result in smaller payments. But the truth is you probably can’t afford that car in the first place. If you have to take out such a long loan you might be stretching yourself. Car loans should be no more than 36 to 48 months (and even I think that is too long). But paying on something for over six years that goes down in value seems like a losing battle to me.
The third danger is you tie up all of that money into a depreciating asset that could be appreciating. By buying a car for cash or buying a car that is a bit more on the used side. If you were to only have a loan of 36 months. Paid off the car in that time and then used the rest of that money and put it into a retirement account or investment account. Doing that consistently over a 40 year period (assuming you will drive each car for 10-12 years, which is the average). If I use that $300 payment I would have over $3 million. So what would you rather have a car that depreciates and a long loan or millions of dollars? I will take the millions any day of the week.
The final danger that I see is that we get too attached to status symbols. I mean a new car signals that you have bucks right? Most people who are millionaires prefer to drive a Ford than a BMW or Mercedes. If people who have all of that money don’t care about driving a fancy new car why should you?
The Bottom Line
Look, I like a nice car don’t get me wrong. But I am not going to put myself in hock for over six years to drive something that depreciates in value quickly. I am just not going to do it. If you do want a new car…great. But buy something you can afford, pay off within 36-48 months, and that can fit what you need.
Not everyone needs a new SUV. You DON’T DESERVE A NEW CAR! I don’t deserve a new car. Buying a used car that has depreciated in value is just fine (e.g. two years old).
And leasing is also not the answer. I will write a post about my car buying philosophy later, but leasing can be just as costly if not more so than having a long loan.
A car is just a car. It gets us from place to place. It doesn’t give us love, have a conversation with us, cheer us up when we are feeling blue. I would much rather give my wife extravagant gifts, take a vacation or whatever than take a loan out for over half of a decade.