Don’t Waste Money Financing a Car for More Than 3-5 Years

As if financing the purchase of a rapidly depreciating asset isn’t bad enough, financing it for an extended period of time is even worse. Financing the purchase of a car or truck for more than 5 years just so you can afford the payments is not a wise financial move, regardless of how bad you want that vehicle. If you need additional time to make the payments affordable you are only lying to yourself and likely purchasing more vehicle than you really need. Don’t let your car make you poor.

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 how long do you really expect to be driving it? Will the vehicle even last that long before it becomes more expensive to repair it than it is worth? Even with a standard 36-60 month loan it will generally take you at least three years before the car you are driving will be worth more than you owe unless you put a significant down payment on it.

Depreciation

It all comes down to depreciation. Typically, a new vehicle will depreciate 15-20% during the first year. 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 you 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. The more interest you end up paying over the life of the loan, the greater your overall loss will be when it comes time to sell.

Think About Total Price, Not Payments

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, entertainment systems, to even new clothes,Ā  it’s no surprise people are often more concerned about what type of payment they can afford instead of what the item actually costs.

When buying a vehicle, the first thing you should do is to start thinking about how much total car you can afford and what a reasonable payment would be for that car. Dealers and car salesmen are notorious for shying away from the price and talking about how they can lower your monthly payment in order to up-sell you into something more than you need. The number one way they can make your payment lower is by stretching out the term of the loan, which in the end just has you shelling out more money towards interest.

Also, don’t forget about the total car ownership costs. Your monthly payment for the car itself is just a small fraction of what it will really cost you. You also have to consider car insurance, gas, and maintenance costs. In some cases the gas and insurance alone might amount to as much as the car payment itself.

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Filed Under: Personal Finance

About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning CounselorĀ® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.

18 comments
john
john

i think its better just to pay a car for in cash. a used reliable car. why make paments on a car, regardless of how much interest you will pay. a car depreciates and is not considered an asset. making car payments on a used car is just plain insane and stupid. Look, if a person does not have the cash to pay for a car, then they should not drive, but take the bus instead. this is my opinion. i bought a used honda civic, and paid cash, 6,000.00 dollars. i have had the vehicle for 9 months now, and the car has given me no problems. the only thing i pay for is my insurance, but NO CAR PAYMENTS. its an awesome feeling. Just buy a good reliable used car, and try to pay it off in cash. You will be a much happier person.

Title Insurance Florida
Title Insurance Florida

You are absolutely right, most of people not think about their depreciation on cars, depreciation + Maintenance + Time Wasting all need to be count in all this than you can easily get understand.

Terry Sands
Terry Sands

Evolution - Leased Cars are not dealer maintaned unless the person leasing it pays extra for that. And in most cases, people that lease cars dont pay anything additional for maintenace because they wont have the car long enough for it to make a difference!
In my opinion, buying an "off lease" car is not a "plus" as I beleive it has been maintained worse than a normal 2 yr old car...

Goran Web | Net Age
Goran Web | Net Age

The car is such an accessory, that we tend to really overlook the true costs associated with our gleaming new purchase, and rather look at how much we can afford to spend on vehicle on a monthly basis. What a waste! I've been driving the same car for nine years now, and really love the idea that there are no monthly interest ridden payments to be made to any financial institutions.

Evolution of Wealth
Evolution of Wealth

How about buying a car that is 2-3 years old that just came off a lease? That way it is dealer serviced and maintained, the worst depreciation is out of the way and it is probably still under warranty.
To Midg, wouldn't paying cash for a depreciating asset be the worst investment you could make with your money? Factor in opportunity cost and it's nothing but losing. If you had the free cash you might then have the opportunity to offset some depreciating, obviously depending on the interest rate. It could be a leverage opportunity.
Of course having the cash might look like a best case scenario to some. So what do I think the best case scenario is? Loaning yourself the money. Leverage your own assets and don't be reliant on a bank. Imagine that?

Planea Tus Finanzas.com
Planea Tus Finanzas.com

I believe that a new car should always be purchased in cash, saving our own money instead of financing it. This way we will always keep in mind how much we can pay, the kind of effort that we need to make and how much it really costs to get.

This kind of thinking may lead us to buy a used car instead, or a cheaper new car.

pays to live green
pays to live green

I hate it when car salesman try to sell you a car by the monthly payment and not the actual cost for a car. When I was searching for a car, many would quote the lowest monthly payment instead of the actual price of the car. Whenever shopping for a car, always ask for the full price and not monthly payments and try to avoid financing through them if you can get just as good of a rate through a local credit union or bank.

Jerry
Jerry

These are valid points, assuming the purchase is of a new vehicle. However, buying a late model new car can also lead to great savings and even less in some ancillary costs (for insurance, etc.).
Jerry

Tips to save money
Tips to save money

That's a great point of view you've given there Jeremy. I'll be reading more articles on your blog to get some more serious advice from you.

trevorblack
trevorblack

I think it is really important whenever you buy anything on finance to understand exactly what your monthly payments are any charges, repayment early fees and settlement fees to work out exactly how much you will end up paying.

I think when you work hard to make money from home it is important to know where it is going when you spend it.

Savings Accounts Girl
Savings Accounts Girl

I just bought a new 2009 Nissan Altima 2.5S this past weekend. I financed the entire amount with the credit union I bank with. I have 5 years to pay off the loan but I'm aiming to pay the entire amount in 3 years. I basically had a choice between a 0% interest car loan for 3 years through the dealer and not get the $1,500 rebate or go with my credit union that gave me 4.5% interest and I would get the $1,500 rebate. If I pay off in 3 years with my loan it would be equivalent to the 0% since the interest I would pay is under the $1,500 rebate amount.

The reason why I didn't pay any cash down for my car is because I think it's important that should anything happen I have cash at hand to take care of unforeseen problems that might come up. Also since I consider my $1,500 rebate as an amount already going towards the interest payment (so long as I pay up in the next 3 years) there is no need to pay in cash.

So depending on the situation, Mido, paying all in cash may not be the best thing.

Bottom line, if dealers are willing to give you rebate and you're also able to get a good deal on a low interest rate you should take it, since you're basically paying almost zero in interest so it's okay to finance.

However, if you're afraid of depreciation on your car - there is really no way of getting out of this because most cars depreciate in value over time. So it's up to you if you want to get a new car that works well and doesn't give you too much problems since you know its history - plus most cars have up to 3 years of warranty by the maker company, or get a used car and maybe even possible have to pay out of pocket for maintenance when it brakes down on you - which is a waste of time. :)

Moneymonk
Moneymonk

Not just the car loan, you need to look at the overall price- maintenance, gas, tires, registration fees, insurance, car repair, etc.

I paid my car off in 3 yrs on purpose!

Beth
Beth

I'm sorry if I put you on the defensive, Jeremy. I do agree that anything more than five years is ridiculous. In fact, until I saw your post I didn't know six or seven year loans existed.

What I didn't agree with you on was that five year old cars were worthless. The reason -- I could have sold mine 2/3 of it's original value when the loan was up (though obviously the black book value would have been a bit lower lower). That's because I did some very careful research when I bought my car to look at things like total cost of ownership and which models depreciated the least. (There was quite a difference at the time I was buying).

And yes... it's the black book in Canada. I do know what I'm talking about even if I'm not citing the KBB. ;)

John Forman
John Forman

Generally speaking, I agree with what's being said here. If, however, you can get an extremely low interest rate then it makes sense to go out as far as you can because you can invest the money you don't put into car payments into something that will pay more. For example, my last car loan was at 0.9%. I would have been foolish to have paid it off earlier than the 5 year term.

Jeremy
Jeremy

The word "worthless" is a bit of an exaggeration, but the numbers are fairly accurate. Go ahead and pull up some numbers from KBB.

For example, a new 2009 Honda Civic LX is listed at around $19,000 MSRP. If you pull up a three year old 2007 Honda Civic LX with 50,000 miles, even in excellent condition they list the trade-in value at about $9,500. Private party value a little more at $11,500.

Either way, that is about a 40-50% drop in value in just 3 years. Sure, that might be still a little better than some other makes and models, but it's still a 50% loss in value after just a few years.

Granted, it won't keep dropping significantly in value and be "worthless" after about 5 years, but you lose most of the value in just the first few years and if you're stretching your payments out much beyond that, you're just tacking on a few thousand in added interest on something that's ultimately only worth a fraction of what your total outlay was.

Beth
Beth

Hm. I think you're numbers are way off -- unless you're only looking at American makes. I went with a five year loan, but I bought a Japanese car which was better quality (i.e. not as much maintenance), held it's value longer and got better gas mileage. When I paid off the loan, my car was still worth a fair chunk of money (according to the black book value). It certainly wasn't worthless.

The total cost of ownership for a comparable American brand sedan turned out to be much higher in the long run, even if the purchase price was a little lower.

Midg
Midg

Why finance at all? You are better off putting the car payment into the bank each month until you have enough to pay cash for the car. You won't have to pay the interest finance charges and you will have some extra cash each month.

Here's a few numbers: you want $20,000. Set aside $303.16 a month at 3% interest gives you $20,000.33 ($18,492.76 in savings and 1507.57 in interest) in 60 months. Finance $20,000 for 5 years at 6% you pay $23,199.36 ($386.66 a month for 60 months). Paying in cash would save you $4,706.60 or $83.50 per month. For $30,000 set aside $474.74 a month and you will save $7059.90 over 5 years or $125.24 per month. If you can get a higher interest rate you will save even more.

Stephanie
Stephanie

My Husband leased a car before we were married, and he ended up with huge debt and didn't keep the car in the end. A very bad exprience, I wouldnt recommend leasing a car at all. Thanks for the post!

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