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.
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, 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.
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.