Do you currently have a car payment? If you do, you are part of the whopping 43% of adult Americans who have a car loan (according to CNN Money). We live in a world where everything is advertised as affordable monthly payments to fit any budget (instead of advertisers thinking about what kind of car can you can actually afford). It seems too good to be true that even someone like me with over $250,000 of debt could afford a $30,000 vehicle. But guess what? I’ve done it!
Buying a car is exciting, terrifying and sometimes confusing. But who doesn’t love that new car smell? Am I right? You test drive a few vehicles, you hold your breath praying your credit check comes back excellent for approval of a loan, and then the salesperson does the “magical” number crunching to give you the very best monthly payment. Buying a car becomes an emotional process and you end up leaving with this amazing feeling even though you have just saddled yourself with a $25,000 loan.
That’s where the mistake is. We all fall into this trap of thinking “what payment can I afford per month?” instead of thinking about “what kind of car can I actually afford?” To stop yourself from falling into the trap of a car loan (or if you already have one, to kick you in the butt to get out of it ASAP!), you need to understand why a car loan is such a waste of your money.
Let’s crunch some numbers so you can see why a car payment is a terrible use of your money.
You purchase a $25,000 car on a 6-year plan. Based on average interest rates, your car payment will likely be ~$500/month. Within the first year of driving your car off the lot, its value will decrease by 25%. After 6 years (at the end of your loan), its value will have decreased by 60-70%.
Where will you be in 6 years (at the end of the loan)? Your $25,000 car might be worth $7,500 (pending condition). After 6 years of paying $500/month, you will have paid $36,000 for your vehicle.
Do you see why this sucks? You are paying $36,000 for a vehicle only valued at $25,000 when it was brand new, and by the time you pay all of that off, it is only worth a measly $7,500. That’s crazy!
Why do we do this?
Answer: because we don’t look beyond the monthly payment we can “afford.”
What’s the solution?
Start thinking about what kind of car you can afford to buy completely instead of what kind of monthly payment you can afford.
We had a six-year loan on my husband’s vehicle that had a pretty reasonable monthly payment of $300. This was one of the first debts we chipped away at when we started our debt snowball, and we were able to pay it off 2 years early. Even with taking two years off, we paid over $20,000 for a vehicle that was only worth $7,500 at the time of payoff. Not worth it. After realizing the truth in the math on vehicle payments, we swore we would never have a car payment again.
Now, let’s crunch some numbers in this new way of thinking to see how paying cash for a vehicle is the smartest thing to do.
For this example, let’s say you have $2,000 available to purchase a car (no it isn’t the cutest car you have ever owned), but you pay cash and it is all yours.
Now, instead of spending $500/month on a car payment, you bank that $500 every month for 1 year. In 12 months, you have now saved $6,000. Take the $6,000 + you sell your $2,000 car (for $2,000 because at this point it has not lost any of its value) = $8,000 to pay cash for another car.
Over the next 12 months, you keep banking $500/month. At the end of the year, you have another $6,000 + $8,000 (your current car you sell) = $14,000 vehicle. In three years of doing this, you will be able to pay for a $20,000 vehicle with cash.
