Why Financing a Car is Probably a Bad Idea
You may not have the cash laying around to purchase a car outright, so you're considering financing a car. I get it, it's a status symbol and part of your image so you really want a new one (or a very good used one).
This problem arises when people feel like they are earning a lot of money and have nothing to spend it on. It usually starts right after college when people get a good first job, but the habits continue throughout life.
You want the car and you want it NOW. You don't want to wait.
Financing a Car can be a Bad Idea
For most people, their largest purchase is buying a home. I am a huge advocate of turning your debts into assets that pay you. I often write things like this article about that explains why you should buy a duplex instead of a single family home.
Second to buying a house, is the purchase of a car or truck and people are spending more than ever to finance cars. My opinions don't change and I still think it's really important to focus on investing instead of buying debt. Basically, a car is only worth what it can give you.
WHY AM I TALKING ABOUT CAR FINANCING?
There is a record $886 billion in financed vehicles right now. It's crazy! Between huge student loans and car payments, how does anybody actually start investing? Anything related to real estate is the focus of my website. Debt holds you back from investing, so it's what I'm talking about today. Most people get into a ton of car debt, which makes it so much harder to really invest.
When you increase your debts, you spend more of your monthly income paying those debts, and save less money each money for investments. On top of it, every loan you have puts you further away from buying a home or investment property. Since investments pay you and a car doesn't, let's learn how to reduce our debts and focus on investing.
You should opt for a lifestyle of investing instead of debt. Check out my article on debt and real estate.
Reasons Why Most People Buy a Car
There are a lot of good reasons to buy a car:
- You need to get to work and back.
- You live in an area where you can't walk anywhere.
- There is very little public transportation in your area.
- Your family doesn't live nearby and you need to visit occasionally.
So, for most people, a car is about getting around to do things. The most important reason to own a car is to get to work and back. Obviously, buying groceries and necessities are another reason to buy a car.
So you should buy a cheap car that serves it's purpose. Buying an expensive car is a bad idea because a cheap car can get you to the grocery store just as easily as a shiny new Lexus LS. Every dollar you spend over the minimum is just a complete waste of money.
Reasons Why Some People Buy an expensive Car
Here are some less common reasons:
- You work out of your car (traveling salesman).
- Your clients see your car so it's a symbol.
- You are trying to sell something and need to show status.
OK, these are also valid reasons. Consider a contractor that is going to build an addition on your house. If he shows up in a car you may think differently about him than if he shows up in a truck. Then consider, what if he shows up in a crappy small truck or a huge truck. This may be a good reason to spend more on a nice truck.
A person selling you on something might drive a nice car too. "Hey, buy my book on getting wealthy. It really works!" If the person is driving a beater, you won't take him seriously. Show up in a shiny BMW 7 series and suddenly people are listening.
The fact is that people are judgmental. People believe what they want to believe based upon what they see. So, when your status is part of the sale pitch, it's important to fit the description people expect to see. These are good reasons to buy an expensive car... but only if the income justifies the expense.
Why Financing a Car Can be a Mistake
When something burns you, you pull your hand away. Similarly, when people accumulate some money, it "burns a hole in their pocket." They just can't get it out of their pocket fast enough. Sometimes it's OK to spend a little money, but it's more of a problem to spend money you don't have. The availability of credit is no reason to go on a spending spree.
Why Financing a Car is a Bad Idea
- Cars Depreciate
- All cars depreciate. New cars depreciate the most. When you finance a car or truck, it is guaranteed that you will owe more than the car is worth the second you drive off the lot. If you ever have to sell the car, or get in a wreck, you owe more than what you can get for it. You will need to find even more money laying around to pay the difference before you can even consider getting another one. Every step is even more money, more debt.
- You can afford the payments, but did you consider the repairs? You need oil changes, filters, tires, brakes, transmission fluid etc. If you avoid maintenance because you can't afford it, you simply reduce the life of the product you just spent a ton of money on. You never save money by avoiding maintenance. It's simply called deferred maintenance and we all know that deferred maintenance is more expensive than just maintaining it properly!
- If you buy a used car, you may be stuck with major repairs long before the loan is paid off. If you own a truck that needs its engine or transmission replaced it can cost half as much as the truck or car is worth. You might just trade it in for something new, but if you have a loan to pay off, you may get no net trade in value, or very little. You just get deeper into deb.
- Interest Payments
- Another reason it is a mistake to finance a car is that you end up paying interest. Obviously, if you get a 0% rate then go for it, but most people are paying at least something. Car dealers may give you a lower price on your car because they know you will finance the car, and they get a piece of that.
- You Simply Don't Need It
- The reality is, you don't need that car, so you don't need to finance it. If you do need a car, buy something cheaper than what you want to buy. You should spend what you need to spend, not what you want.
- Car Salesmen are Good at Their Job
- Trust me, I was in sales. Car salesmen are great at their job and they know how to get you to spend more money. You might think you are good and will buy only what you need to buy, but the majority of people spend more than they need to and buy more 'car' than they need. You may have planned to pay cash, but instead you buy something bigger and finance the difference. After all, It's only a few bucks a month for that fancy widget.
- By knowing exactly what you want and how much you will spend, you won't be convinced to spend more and finance the rest.
- Instead, opt for a car that is 2 or 3 model years old. They have depreciated the most but still have a long life left. Cars depreciate the most in the first 2 to 3 years so you will lose the most money if you buy new. Financing a new car means you are wasting more money than financing an older car.
Why Financing a Car is a Good Idea
There is really only one reason you would finance a vehicle instead of buy the the vehicle outright. If you are disciplined and actually have the cash saved and have it invested in an interest bearing account at a much higher rate than the financed amount. Then, withdraw the payments directly from that account.
Essentially, you would be acting like a bank. You are borrowing from one person and investing at a higher interest rate somewhere else. Again, this only works if you actually invest the money. Compound interest is really powerful, and I even wrote a tongue-in-cheek article about how baby diapers can save you $109,000 over a lifetime. Small savings really add up!
Unfortunately, most people take half the advice. They borrow the money for a car and simply spend their savings on a new TV, computer, or entertainment. Now they have no savings, no interest, and plenty of debt.
Honestly, I'd say spend all that money on a nice cash-flowing property. Find something that pays more than your car payment. Now, you can buy whatever you want!
An Alternative to Financing a Car
An easy way to avoid taking out a loan for your car is to save for your next vehicle now, before you need one. Make extra payments toward the car to pay it off faster, then once it's paid off, keep applying that payment toward an interest bearing account that will go toward your next car.
You could use the money to buy the next car, or simply finance the new car if you can earn more interest in the account.
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