In this series I am covering the 24 tell-tale signs that you could be in financial trouble. Over the next few weeks I will be presenting these signs, how to identify them and tips on how to address the issue.
Financing the purchase of a car or truck for more than 5 years just so you can afford the payments is not smart money management. If you need additional time to make payments affordable you are only lying to yourself and likely purchasing more vehicle than you really need.
How long do you actually intend on owning the vehicle? Many people own their car or truck less than the term of the loan as it is so do you think you will own it for six years or more? Will the vehicle even last that long before it becomes more expensive to repair it than it is worth? Even with a standard four or five year loan it will generally take you at least three years before the car you are driving will be worth more than you owe on it.
Typically a new vehicle will depreciate 20% once the first owner pulls out of the lot. After that your car will generally see between a 10-20% depreciation per year depending on make and model as well as wear and tear. This is a significant loss each year, so stretching your financing out for five years or more not only costs more in interest, but you are continuing to pay for an asset that is constantly dropping in value to the point it is almost worthless once the loan is paid off.
Thinking Payment vs. Price
One of the biggest traps consumers fall into today is thinking of purchases as payments instead of the actual price. With people financing everything from homes to new clothes it is no surprise people think about what type of payment they can afford instead of what the item actually costs.
If you find yourself shopping for a vehicle and realize that you need to stretch out payments with a longer loan, stop right there. You are shopping on payment alone and are not taking into consideration what the true cost of ownership will be. It might be nice to finally afford that SUV with the navigation system but if it means you need to stretch payments out to 6 or 7 years you are making a foolish mistake.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
That's true and there are always exceptions. Clearly people who are savvy enough with their finances aren't the type of people who get a new vehicle every 3 years and are likely to continue driving it after the payments are done.
The problem is that the majority of consumers are driven by always having something new and can't settle to hold on to an old vehicle. These are the same people who don't make extra payments either.
So yes, done properly there is nothing inherently wrong with a 7 year car loan over a 4 year loan for the right people who can make it work for them. The problem is just people getting into these loans just to lower their payment so they can afford it.
"but you are continuing to pay for an asset that is constantly dropping in value to the point it is almost worthless once the loan is paid off."
I agree with the rest of the post, but want to be nit-picky about this one point. Even if you buy a car for $20K, and finance it for 6 years, and you can't sell it at the end of 6 years for a reasonable amount (ie, almost worthless), it STILL presumably is worth 1 car. That is to say, it still probably performs reasonably well in its chief duty of moving you from point A to point B.
This is a subtle but important distinction. A person might get to the end of their outrageously long 6 year loan and look at their paint-falling-off, ugly, ripped-seat, can't-get-$500-for-it car and make the mistake of thinking it's "worthless" and therefore they need a new car, when in reality they might be able to squeeze 2 more years out of it. 2 years of no car payment even at a low payment of $200 a month is still $4800, a pretty nice chunk of change.
I've paid off my new car from 2001 in 2 years. Now it's 6 years old and knocking on a forest, it hasn't needed much repair yet. It has 52,000 miles on it and still retains quite a bit of resale value (probably over 10K).
I think living in a home might be inheritly different than driving the same car. I've moved about 3-4 times since I bought that car (mostly renting), but each time the car has come with me. That's the nice thing about cars, they are portable and can move with you.
The other thing to note is that usually it's not bad thing to get a long loan as you can make extra payments and pay it off quicker. I figure you can always make extra payments on a $200 loan, but the bank really frowns on you paying $200 on a $900 loan. By choosing that short loan, you are making quite a commitment that simply a lot of people aren't in the position to make.
You're right, and I see a lot of this going on. Most people don't even live in their homes for 7 years let alone drive the same car that long. The bank tried to talk us into a 5+ term loan when we bought one of our new cars last year. And for what, to save $50 a month? Get real!
I put around 22k miles on my car a year and if I were to keep that car for the length of a 7 year loan it would have over 150,000 miles and be worth about $1,000 bucks. Not to mention the potential reliability issues, having the warranty expire, etc.
The worst is when people get into these long-term loans and trade in their cars every few years. Even after two years you have paid a ton in interest, very little principal and the actual value of the car is 25-40% less than what you paid, and probably even less than the remaining balance on the loan. So these people are in a perpetual cycle of losing money every few years.
But hey, at least they can impress their friends with their new car so they feel better about themselves.
You know, this is a good one. Especially for your younger (20s) readers. I was speaking with someone with whom I am close about the car her husband recently purchased. Worried that they could not afford it, I asked if he bought or leased it. She told me they bought it. Happy to hear that, I asked how long the loan was. "The longest. It's the only way we could afford it."
"The longest? I hope that means five years."
"No, I think seven. That's how long we did the other car."
They're going to be paying for cars forever.