Fear the Car Payment!
Yes, I said it… You should be afraid of a car payment! One of my first blog posts was about how car payments prevent wealth building. I decided to write this post after having car problems and riding a sweet 2016 Chrysler 300. It had Bluetooth U-connect, push to start, a large touchscreen, and of course new car smell. If I was not passionate about the principles I live by, this rental could have easily given me “New-Car fever”. It did exactly the opposite, it reinforced my views on why car payments are the primary reason most Americans are broke. Watch this video and see if you have same feelings about car payments (FREE CARS FOR LIFE).
Here are some horrible stats if you think that salary is the indicator of living well and justifies your 20k+ purchase.
1. The average car note is just about $500 per month, for 68 months (5 1/2 years), with a loan amount average of $30,000
2. A whopping 86% of car purchases involve financing, leaving borrowers with car payments.
3. $500 invested for the same term of the average auto loan would become $36,000.
4. The average American can’t cover a $800 emergency and lives paycheck to paycheck.
5.The savings rate for the average American is 4% of disposable income. So, with an average U.S. worker with a salary of $50,000. That reveals a modest $120 per month average savings. Good luck on that next large purchase!
As many more people are getting enticed into more expensive vehicles for extremely long terms, the outlook on their personal finances becomes bleak. Americans are investing more into shiny devices of transportation at the expense of other values, they may not be aware they are trading out. The opportunity cost of purchasing expensive depreciating assets results in lack of cash flow for investing, kids college, home payoff, living well, vacationing, investing, and saving for large purchases. Not to mention, generally having money to make choices with! Car payments suck!
The problem with auto financing is that people are making decisions based on how much of a monthly car payment they can afford, rather than determining how much car they can afford. As long as the car payment is in the monthly affordability range, the buyer ends up satisfied and doesn’t look at the long-term contractual obligation to the bank that will strangle their cash flow like the Incredible Hulk opening a jar of pickles.
Over the course of your loan, the deprecation of your car is criminal. Your car will lose 10% of its value the moment you drive it home and an additional 70% over the course of your loan. That means your $30,000 car investment will be worth $6,000 when you pay it off 6 years later. Chances are, you won’t be comfortable driving a $6,000 car when you have $30,000 car taste. So its back to the dealer for newer, more expensive car payments.
So How do I get a car without a car payment?
The answer is to save that car payment that you claim you can afford; inside of a low turnover, no-load index fund. (Click here if you are not knowledgeable about investing.)You can deposit the minimum required to start the fund and set up an automatic payment to the fund in the amount of what that car payment would have been. This creates an automated system and allows your money to make money as you save. I recommend several mutual funds on my recommendations page, but even if you saved it in your savings account chances are you will easily eclipse the most savings you have ever had. The beauty of this method is that you have stability and security as you work towards your goal. You also will make wiser decisions when you save for $500 for 10 months to purchase a $5,000 car. I currently save $500 inside of an index fund monthly for a $25,000 car purchase 2 years from now.
What if I already have an car payment?
If you have a car payment and you don’t meet the affordability ratio (less than 40% of your annual salary) you should get rid of your car for something more affordable. If you meet the ratio, you should attempt to pay off your note early using the baby steps. If you don’t have the cash flow to pay off your car in two years, your expenses are too great for you to drive the vehicle you have chosen. You should downgrade and drive a car that matches your income situation. If your cash flow is fine, you can pay it off in two years, and the ratio matches; then you should keep your car and continue to work the baby steps.
Cars are purchased so that we can own our transportation, this article was written because so many borrowers are being owned by their transportation. It makes sense to want to drive something nice, but if that is your only motivation for purchasing your vehicle, be prepared to work for the next 5 years paying for that decision. Cars are awful investments and absorb your cash flow, borrower beware!