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Are you looking to buy a new car? Do you think it is a wise decision? I think you will feel like you are standing on top of the world when you go to a dealership and they provide you with the keys to a brand-new car. But after a few months, you will feel it like a financial weight as it will start eroding your hard-earned cash in monthly payments.
Here is why I am saying car payments are a financial trap and one of the biggest financial mistakes you can make if you buy a new car on an auto loan.
How Car Payments Make Your Car More Expensive
1. Value Depreciation
If you do not know, let me tell you, that most of the car’s values are depreciated by around 20% to 30% in the first year and 50% to 60% in five years. That means you are paying monthly for something that is losing value constantly. Do you think that is correct for your better financial future?
2. Cost of Loan Interest
If you are planning to buy a car, you probably considering an auto loan, right? But wait, have you figured out the cost of your car loan? You are going to pay thousands on loan interest over the period. Well, how much you will pay, depends on your loan term and credit score. The longer the term, the more you will pay in interest and that will make your car more expensive.
Example: Suppose you are planning to buy a new car for $20,000. You have a $5,000 down payment and planning to finance the remaining $15,000 with an auto loan at a 6% interest rate on a 60-month term. This means you will need to make monthly payments of $290. Over five years, you will pay a total of $17,400, resulting in an extra $2,400 spent on a depreciating asset.
Also, you need to pay loan processing, dealership, and extended warranty fees.
3. High Cost of Insurance
For your knowledge, a new car comes with full coverage of insurance. This coverage will cost you more than the liability-only coverage. Generally, we do not factor these additional costs before making a purchase.
4. Financial Strain
The average monthly payment for a new car is around $500 to $700. Your chances of investing and saving will be reduced once you start paying for a car since a large portion of your monthly savings will go toward the loan. That money could have been used for appreciating assets like a high-yield savings account, stocks, or real estate instead.
5. Upside-Down Loans
If you do not have a down payment amount, You will consider owing more than the car value (negative equity), right? That is a financial risk because you could lose a significant amount if you need to sell or trade your car during financial uncertainty.
6. Lifestyle Inflation
We all know inflation is rising every day. Financing options can tempt you to buy a new car instead of a more affordable used one with cash. This increases your debt burden just for the sake of a luxury lifestyle.
When Financing a Car Might Make Sense
- if you absolutely need a car and don’t have the cash upfront, financing can be a necessary option.
- If loan interest rates are extremely low i.e. 0-1%.
- If you have a large portion of money to pay 80% to 90% down payment.
- If you already achieved all other necessary goals.
Any Smart Alternatives?
Here are a few alternatives instead of buying or financing a new car.
- Save up and pay in cash: You can set aside a small portion of your monthly salary toward your planned car savings goal. Go to a dealership and buy a car once you achieve your goal. This way, you can avoid interest and high monthly payments. Here is a guide on how to save up for a car on a low income.
- Buying a used car: You can buy a well-maintained used car instead of a new one. The main benefit of buying a used car is that you will lose less to depreciation and save on loan interest.
- Lease a Car: Car leasing is an affordable and cost-effective alternative if you love driving newer models.
- Car Subscription Services: Nowadays, many companies offer monthly car subscription services including maintenance and insurance costs as well.
- Consider alternatives: You can use other options like public transport and car sharing or rental service as well instead of buying a new car.
In my view, For 80% to 90% people of world, car financing is an unnecessary burden. As you know, a car is a depreciating asset. Avoid buying a new car if possible to save your hard-earned money. It is advisable to buy a low-cost car if you really need it.