Have you ever financed a car purchase?
What was your payment? How did it feel to have that debt?
I personally have never financed a car. I believe it is one of the worst financial mistakes you can make. Here are four reasons NOT to finance your next car:
1. You are paying unnecessary interest
When you finance a car, you are borrowing money from a bank to pay for the car. Obviously, the bank wants to be paid for the loan, just like with a mortgage or credit card. So they charge you interest on the amount you borrowed.
Let’s see how quickly that interest adds up.
Per Kelley Blue Book, the fair purchase price for a 2017 Honda Civic is $18,702. After adding tax, title, and license fees, the cost bumps up to $20,562.
Let’s say you want to pay a 10% down payment, which we’ll round to $2,056. If you get a 60 month loan with an interest rate of 2.49%, your payment will be $328 a month.
|Initial cost of car||$18,702|
|Cost inlcuding tax, title, etc.||$20,562|
|- 10% down payment||$2,056|
|Total to be financed||$18,506|
So let’s do the simple math here. You borrowed $18,506. At the end of that 5 years, you have paid the bank $19,680. That’s $1,174 that you gave to the bank! This is an unnecessary cost. Read more to find out why.
2. Cars lose value quickly
It is commonly said that cars are one of the worst investments. And for good reason. The moment you drive a car off the lot, it becomes “used”. You instantly devalue your car.
But what if you keep your cute new Civic for 5 years while you’re paying it off? It was worth $18,702 new. By the end of the 5 years, you have paid $19,680 to the bank + your $2,056 down payment. So you paid $21,736 all in. Now that you’re no longer a slave to the bank, you want to sell the car. What is it worth now?
Per Kelley Blue Book, most cars lose about 60% of their value in 5 years. If that was true of this car, your car would now be worth $7,480.80. That’s about 1/3 of what you paid for it.
Is it worth it? I think not.
3. You could be saving your monthly car payment
Let’s pretend like you opted out of the financing game and decided to put the same amount into a low-cost index fund instead.
In May 2017, you open a Roth IRA (a tax-advantaged investment account) with what would have been your down payment for your car, your $2,056. Every year, you decide to contribute the amount of your would-be payments into the account, or $328 a month X 12 = $3,936. Let’s see how that plays out:
After 5 years, you could have a balance of $27,103 (assuming a 7% rate of return) in your Roth IRA, rather than having SPENT $21,736 on a car that you can only sell for around $8,000.
Plus, even if you stop contributing to your Roth after those 5 years, your account will continue to grow. Even if you don’t add another penny to that account, in another 30 years, you could have $206,315 in your account, after only putting in $21,736 [$2056 + ($328 X 60)] of your own money!!!
*Like this Roth IRA calculator? You can find this calculator and many others like it at Bankrate.com.*
4. Peace of mind
If you have a monthly income of $4,000 and a car payment of $328, you are spending 8% of your income on your car loan. If you are already living paycheck to paycheck, that may push you over the edge. Debt is so stressful, especially when you are already struggling financially.
But imagine if you could spend that 8% on something else, anything else! Wouldn’t it be so nice to have an extra 8% that you were planning on putting toward a terrible investment?
The less debt you have, the more peace of mind you will have.
I hope it doesn’t come across that I don’t want you to buy a car ever. I have no problems with owning a car…as long as you haven’t financed it.
So what’s the alternative? Do I think you should save up the $18,702 in cash to buy your new Civic? No.
But…I do want you to pay for your cars with cash. If you are really into new cars, then by all means, save up the $18,000+. I personally think $18,000 could be spent (read: saved) in better ways, so I buy cars that are considerably less expensive.
What kind of cars am I talking about? Good quality cars that are years old and have higher mileage.
Um…isn’t that kind of the opposite of what you are told to buy? Yes. But here’s why it works.
If I buy a 10-year-old Honda Civic in “very good” condition, with 115,000 miles on it, I only have to spend $5,219 (per Kelley Blue Book). Isn’t $5,219 a much easier savings goal than $18,702?
Sure, my car may be the oldest in the parking garage at work. I guess you have to decide if status is worth $1,174 in interest costs. If you didn’t catch my ‘tude, I think this is a really stupid thing to care about.
A legitimate concern, however, is the age and high mileage of the car. I know people don’t like to buy old cars because they are worried that they will break down and/or fall apart.
The good thing is, great quality cars like Hondas or Toyotas will often run perfectly fine past the 200,000-mile mark, as long as you take care of them. Listen, you’re going to have to spend money on maintenance and repairs for your brand new Honda…so what’s the difference if you are spending it on your older Honda instead?
If you are really worried about spending money on car maintenance and repairs, you should forego a car altogether. Because every car is going to cost you extra money at some point. But just because a car is older, does not mean it will cost more to run, as long as you get a good quality car.
If you have concerns about the condition of a car while shopping, walk away. Or, if you know someone who is good with cars (an absolutely invaluable friend to have), have them take a look at the car before you buy it. Even if you are not good with cars, you can find a lot of basic checkslists online.
I ranted about depreciation on your new car earlier, so it’s only fair that I mention it here as well. Will your old, used car depreciate? Absolutely. Luckily, most of the value is lost in the first few years of a car’s ownership. Because you are going to buy the car well past that period, it will lose its value much more slowly (per this article). And, because it lost so much value before you purchased it, you are buying it for thousands less than you would have if it was new.
I know $5,000 can be a lot for some people to save. And usually, when you need a new car, you need it ASAP. So what should you do if you can’t even afford an older car?
I suggest you get creative. I would literally do anything else before I would finance a new car. Why not take the bus for a few months until you have enough saved? Or ask around your office and see if there is someone you can carpool with. You have options!
So basically it comes down to this: would you rather pay $21,000 for a car you can only sell for $8,000, or would you rather buy a $5,000 car and have an investment account balance of over $200,000? The choice is clear for me, which is why I will NEVER finance a car.