When it comes to cars, the best way to purchase them is with cash.
However, many opt to finance their car with debt. And some of them are signing long-term (beyond 60 months or 5 years) loan agreements to get that car. According to Experian, around 25% of those who financed their car did so with a loan between 73 and 84 months.
Why? Because it reduces the monthly payment. A long-term loan makes it appear that they can “afford” a more expensive car.
But the appearance of affordability is deceiving. These longer term loans are quite simply bad deals.
Here is why:
- You get underwater. This means that you owe more than your car is worth. Remember, cars are depreciating assets. They do not increase in value. A new car will experience a significant drop in value as soon as you drive the car off the lot. The smaller payments in longer-term loans do not allow you to keep up with the car’s depreciation. If you decide to sell the car before the loan is complete, you may have to bring money to the table just to get rid of it.
- You pay a lot of interest. This will happen two ways. First, your longer-term loan ensures that you will be paying interest over a longer period of time. Consider the difference between a 30-year mortgage and a 15-year mortgage. Because the principle does not decrease as fast with a 30-year mortgage, you end up paying around two times more interest than the 15-year term. The same is true for car loans. Second, longer term car loans tend to have higher interest rates than shorter term loans, usually after the 60-month (5-year) mark.
- You simultaneously have repair and loan costs. Even with a new, reliable brand, you will probably have some type of repair need in year five, six, or seven. All cars eventually wear down. This is especially true when you purchase used cars. Year five, six, or seven for you may be year ten, eleven, or twelve for the car. And so while you are spending money to repair the car, you still owe money on your car loan. The double hit can have significant consequences on your finances.
- You hurt your financial future. Longer-term car loans may allow you to drive a more expensive car, but you will pay for it. The decision can leave many in a financial bind that they didn’t anticipate.
So what do you do?
Consider the cost of the car. If possible, look for cars where you can pay cash (no debt). This means that you possibly will not be able to purchase your dream car right now. And that’s okay.
Cars are almost always bad investments, outside of their function to get you to and from where you need to go. Don’t make a bad investment even worse by signing a long-term loan.