Financial Freedom and New Car Loans Don’t Mix Well

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Apparently, my rule of thumb about affording cars isn’t exactly going viral. If you are serious about financial freedom, you shouldn’t be taking out loans for luxury items. A new car is a luxury item! Basic transportation will cost you under $10,000 and you can usually get a loan with the best interest rate from a credit union. Here are some surprising statistics from the WSJ article The Seven-Year Auto Loan: America’s Middle Class Can’t Afford Its Cars (paywall?).

The average new car auto loan is now $32,000 over 69 months. 1 out of 3 people are rolling over debt from their previous car. 90% of new car loans are for longer than 4 years. 70% of new car loans are for longer than 5 years. This is crazy. Soon we’ll have a 15-year mortgage for cars.

Dealerships now make more money from car loans (and add-on insurance junk) than the purchase price. They are getting a cut of all the interest you’re paying.

So far this year, dealerships made an average of $982 per new vehicle on finance and insurance versus $381 on the actual sale, according to J.D. Power, a data and analytics company. A decade earlier, financing brought in $516 per car and the sale made dealers $837.

This is why I support the FIRE movement. It may not be perfect, but it can inspire a change in mentality where you would never consider going into debt for heated leather seats. Instead of a $32,000 car loan, you could spend $8,000 on a used 2012 Toyota Corolla and put $24,000 towards owning a $120,000 investment rental property with positive cashflow. Or you could put that $24,000 into maxing our your 401(k) or IRA. Or you could start building a compounding stream of dividend payments from owning high quality businesses. Or seed your own new small business. The idea of owning income-producing assets is what should get you excited!!

I’m not saying you should never buy a new car. If you have your financial ducks in a row, then sure buy whatever car you want… with cash! The debt industry wants you to have your dessert NOW, and pay for it later. They want a direct cut of every future paycheck. If it’s a luxury, you should have to save up for it first, and then buy it. I know, such a quaint idea.

Getting far enough ahead to pay cash for your next car can seem impossible. Consider taking out a loan for minimalist basic transportation from all the major credit unions (NavyFed, PenFed, Alliant CU) as well as your local credit union. It’ll work at used car dealerships and even on a car off Craigslist. $10,000 financed at 3.5% APR for 3 years is under $300 a month. After 3 years, instead of starting another new lease or facing another 4 years of car payments, you can now use that $300/month to buy your next income-producing asset.

Here is a chart tracking non-housing debt from the New York Fed. The slight decrease from 2009 to 2013 made me optimistic about the future. Since then, the debt has shot back up and my optimism has gone down:

Have you noticed that half of all TV commercials are about new cars? It takes a lot of effort to convince you to buy something you don’t really need.

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  1. Plenty of new, reliable cars and compact SUVs in the $20K-$24K range. The only thing less transparent then used car pricing, vehicle history and potential problems is the Feds phony interest rate setting metrics.

  2. What is the “FIRE movement”?

    • FiRE is Financial Independence Retire Early.

    • FIRE is hard to exactly define as there is no official brand, but basically it’s the concept of saving very aggressively in order to to achieve “Financial Independence and/or Retire Early” at a very young age (the trendy examples are in their 30s, 40s). There are criticisms that this is an unreasonable and/or unrealistic goal for the vast majority of people.

      However, I think the important part is to get people to wake up and realize there is an option in life other than the default work 9-6 for 40 years, buy a new car every 5 years or lease every 3 years, buy the biggest house your mortgage broker will approve you for, and so on. You don’t need to retire at 30. Just question the default.

  3. I saved up and bought a new hatchback earlier this year. Could have paid cash but the dealer knocked about $1k off the price because I financed it (and immediately paid it off, the bank made a whopping $20 in interest). Using metrics from this blog, I figured that the hard pull on my credit report was worth $1k since no typical credit cards offer that much of a bonus promotion. It really is bizarre how the whole thing works nowadays. In my case the dealer and I essentially colluded to screw the bank.

    Another side note is I was originally looking at a small SUV, but opted for the hatchback that had similar engine and interior, only rode lower to the ground, and was $7k less. I hear lots of people getting bigger cars and trucks so that they can “haul stuff on the weekends” or “occasionally shuttle friends around”. I just can’t see how they justify the extra cost in the long run. Renting a truck for a couple hours for the one or two projects a year where you need it is way more cost effective. Renting a larger car with more cargo room for a long family trip is also more cost effective in the long run. But it’s all about convenience in today’s world – no one wants to spend the time to save the money.

  4. Steve Kohn says

    In 1963, I bought my first car, a 1950 Chevy, for $75. Paid cash, of course. Liked the feeling of not being in debt, enough that all my life I’ve never made a car payment. My only regret is that I didn’t start buying Toyotas sooner. 🙂

    Your advice, Mr Ping, is always on target. This especially.

  5. In general, people should be averse to taking on debt.

  6. Good article. When I saw the WSJ article I had a similar reaction.

    Your save up the money first then buy it comment reminds me of this timeless SNL video:

  7. I couldn’t agree more with purchasing your car with cash. I have automatic savings set up with Ally Bank for my next car fund. Ally pays 1.8% while I’m saving up. When I have enough for the car I want, I withdraw the money and purchase the car. Dave Ramsey points out that people will spend more when they finance a car than they do when they pay in cash.

    On a side note, I work in a profession where I drive by many apartment complexes and am always surprised to see the number of new cars in the parking lot.

  8. I have never had a car loan. For that matter, I have never paid a penny in interest except for my mortgage. I would suggest if you need a loan to buy a car, you keep the car long past the loan pay off but keep making your car payment except now you put it into a savings account or mutual fund. That way you will have the money saved up to buy your next car. Create a budget and stick to it!! Live within your means.

  9. Some car manufacturers often offer 0% financing. Wouldn’t it make more sense to finance with 0% over 5 years, than pay the whole sum upfront?

    • If you actually have that sum upfront and have the discipline to not spend the money elsewhere, sure take the 0% financing if you want. Usually at 0% financing, you can exchange that for more money off the car (i.e. the deal might be $500 or $1000 additional savings OR 0% financing).

  10. what if you buy new and keep for >12 years?

    • As long as its not a $60k SUV with bad gas mileage, it’ll probably work out fine. But it’s still not cheaper than buying something 3-years-old and keeping for 9 years (or 12).

  11. From a purely economic perspective, buying used does come out cheaper. Though that advantage diminishes (but still remains) if you amortize it over many years, assuming you hold the car long enough. I’ve only bought new, for cash, and held onto my cars for 15+ years. And let’s not forget the aesthetic value of that new car smell 🙂

    Sometimes it may indeed seem that most of the commercials are for new cars. You’re never going to see a TV ad for an individual used car, that’s just not practical. But just as manufacturers advertise a single model to drive the sale of many units, used car services also advertise extensively to push the sale of many units.

    Meanwhile, impressions aside, the top three TV advertising categories are tech (notably wireless carriers), media (streaming content companies), and pharma. Do you really need any of this either, including drugs for a condition you never heard of until a drug maker advertised its sure fire cure? Now that’s manufacturing demand.

  12. Vlad Gurovich says

    The math of new vs used does break down a bit when you are buying electric — there are not that many good used electric vehicles that are 3 years old and have a reasonable range. Plus if you pick the right manufacturer — you may get nearly $10k in tax rebates from federal+state depending where you live.
    I recently ran some numbers on leasing a new electric and and a cost of ownership of the 10 year volvo station wagon that i have and leasing a smaller electric won out while leasing a somewhat larger vehicle came dangerously close.
    Of course i could arbitrage the desire for all things electric and buy a cheaper used hybrid/plugin-hybrid instead….

  13. I’ve only had two cars in my life, both used. That being said, used cars are more expensive now than ever. People are driving cars longer and the financial crisis pinched production so it has turned to the classic supply vs demand argument. Yes used cars are still cheaper but it is harder to justify it. If I were to buy a car now I would look to used rentals – there is a stigma against them, which makes them cheaper, but they are always kept up on (maintenance-wise). Transportation is never cheap but I just can’t fathom some of the loans and such out there now.

  14. At 18, I bought a brand new car for $17,000. The next year, it was worth maybe $11k – $12k. Dumbest financial move I ever made but I was 18…no guidance or not listening…whichever one lol. But it cost me. A new car loan will eat, delay, stop and hold up your financial freedom.

    SCREAMING – don’t do it lol

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