Car loans have become so common that most of us seldom think of buying a car without one. But you should think about doing just that, and there are a number of strong reasons you should.
Other Big Debts are only getting bigger
A house is an expensive proposition these days; so is a college education. Most people today are using debt to pay for the majority of these purchases, and that ’s forcing overall debt levels to get steadily higher.
As the bigger debts get even bigger, one of the best ways to manage debt overall is to be debt free on everything else. That means no credit card debt, no secured debt (furniture loans, etc) and no car loans!
We may not be able to completely eliminate mortgages and student loans from our lives, but that makes getting rid of the rest even more important.
Cash flow drain
All loans are not created equal, not when it comes to monthly payments. A typical monthly credit card payment will be about two percent of the outstanding loan balance. A student loan payment will be in the ballpark of one percent of the loan balance. Monthly mortgage payments (on a 30 year loan) will be substantially less than one percent of the balance.
Car loans are a different story entirely. The monthly payment on a $15,000 car loan at five percent interest for a four year term will be $345 a month, or more than two percent of the loan balance. That ’s not bad, but it gets worse as time goes on.
When you’ ’ve paid your loan balance down to $10,000, your payment will still be $345 a month, or nearly 3.5% of the remaining balance. At $5,000 your payment will be equal to nearly seven percent of the balance.
That ’s good for paying the loan off quickly, but it ’s an outsized payment for a small loan balance, and a big cash flow drain on a relatively small debt. And it figures significantly in the next issue ……
You can lose your car for a very small loan balance
Let ’s stay with that $345 monthly payment for a bit. You’ ’ve paid the balance down to $5,000-which is good- —but you just lost your job and now you have no income. Even though you ’’ve paid the loan down by two-thirds, the monthly payment isn’ ’t doable any more and the lender won’ ’t give you any credit for your good work to date if you can’ ’t make the payments going forward.
You know what happens when you can’ ’t make a car payment- —the lender takes back the car. A car repossession doesn’ ’t take nearly as long as losing a house in foreclosure. You can lose a car in a matter of weeks and there aren’ ’t many legal defenses for non-payment.
If the car is worth, say $12,000 at the time of repossession, you will have lost 100% of that value for inability to pay a $5,000 debt that you were well on your way to paying off while you were working. It ’s a lot to lose for a small loan balance.
Pay it off, and you don’t have to worry about any of that.
A car is too important to risk with a loan
Staying with the repossession idea, this is complicated by the fact that it ’s very difficult for most people to earn a living without a car. Some areas are well served by public transportation, but let ’s face it, most aren’ ’t. In the areas where most people live, no car equals no job.
For that reason you want to keep your car free of debt risk. You already have the break down/repair risk that ’s inherent in cars to begin with so you don’ ’t need to increase that risk with a loan.
Keep the car free and clear so that come what may, you ’’ll always be able to earn a living.
More people are working from home than ever
Few things in life are as absurd as the concept of making payments on a car that seldom leaves your driveway. If you work from home, this could be your situation.
Whether by telecommuting or running some sort of online business, more people are working from home now than ever and more are joining the ranks all the time. You may still need a car for other purposes, but if you don’ ’t have to worry about commuting to work you almost certainly don’ ’t need too much of a car, and certainly not one that ’s expensive enough to rate having a loan on.
Take advantage of your work status by getting rid of that expense.
Considering all of the above, if you ’’re planning to buy a new car, try to buy one that doesn’ ’t require a loan. That might mean buying a less expensive vehicle, or delaying the purchase until you can save up enough to pay cash for it.
If the car you own now has a loan on it, do what ever it takes to pay it off as soon as possible. The sooner you do, the faster you’ ’ll eliminate a big monthly payment, and guarantee that, come what may, you’ ’ll always have a car to get to work in.
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Written by Kevin
With backgrounds in both accounting and the mortgage industry, Kevin Mercadante is professional personal finance blogger, and the owner of OutOfYourRut.com, a website about careers, business ideas, money and more. A committed Christian, he lives in Atlanta with his wife and two teenage kids.
Yep, car loans are just excellent to pay off. We work from home now but still drive for errands and trips. We are just so happy not to have had a car loan since 2010…and we plan to keep it that way from here on out.
I totally agree. I like to buy all of my cars with cash for a few reasons. First, if you are paying cash you won’t spend as much. Plus, I don’t think you should get a loan for a deteriorating asset. In other words, the value of a new car falls much faster than the rate at which the car is paid off, at least for the first two years.
If you only buy a car with cash, then you will be more likely to buy a used and more affordable car, which over a lifetime can save you tens of thousands of dollars.
Funny that I just saw that my neighbor bought a Maserati. I looked it up and it’s a $150,000 car. His house is assessed at $350,000. Does that make any sense?
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It is always better to have a clear title to your car than not!
I agree with you on this Kevin.
In fact, I would take it a step further and say that the same logic applies to every debt including mortgages!
We all want to be debt free, at least I know I do. I can’t be sure of other people.
Thanks for this reminder, Kevin, that we should all strive to be debt free!
All great points. Anytime you’re paying interest on any item you’re losing money, and that’s one of the reasons why so many people are struggling. When you pay for a car over time you end up paying a few thousand dollars extra for an item that’s dropping in value like a stone.
That’s a double whammy that never works in your favor.
I wrote an applicable post a while back about how anyone can get rid of car payments forever and pay cash for their cars. You can find it here: http://www.cfinancialfreedom.com/CFFwordpress/?p=556