Skip to main content
Blog Banner

Plan Well, Retire Well

Saving and investing your money

Are Car loans the next mortgage crisis?

I was reading the money section of a national newspaper today when I saw that car loans are being written now for 7 years or 84 months. That's a long time. I remember when the latest and greatest thing was the 48 month car loan. It opened up a wide range of car buying opportunities especially for the young adult. It meant that I could buy a little better car than the old "beater" that I could afford with my very limited cash. It meant that I could have a more reliable car and fewer repair costs to keep me on my way to work on time and reliably.

Today it means that people can purchase cars that are probably out of their budget. The payments are spread out over a longer length of time making the monthly payment smaller and easier to fit in a budget. How does this compare to the value of the car? Like the recent mortgage crisis where so many people owned a home that was worth less than they owed on it, the new 84 month loan means that for most of the life of the loan, you will owe more than the value of the car.

Here is an example:

Let's "purchase" a new vehicle for $29,837 and take out a loan for the entire amount at a really good interest rate of 5% for 7 years or 84 months. Our monthly payment is $422-an amount that is not unusual for a car loan. How long will it be before the car has a value that is more than what we owe?

Car Value Loan Balance

After 1 year (12 Months)

$24,168

$25,903

After 2 years (24 months)

$20,579

$22,044

After 3 years (36 months)

$17,406

$17,988

After 4 years (48 Months)

$14,593

$13,724

After 5 years (60 months)

$12,069

$9,241

After 6 years (72 Months)

$4,530

After 7 years (84 months)

$0

A new car depreciates about 11% the moment you drive it off the lot. It loses value at the rate of 15%-25% per year for the next 4 years. After 5 years- a car is only worth about 37% of what you paid for it according to the car site Edmunds.com

Let's look at the cost of this loan. At a modest 5% interest-you would have paid $5,124 in interest through year 5-the point at which your car has more value than liability. However, for the entire life of the loan you'd pay only $5,593 in interest. Furthermore, if you put a lot of miles on a car annually, live in an area where weather conditions cause a car to age rapidly, or have any kind of damage, your car will lose even more value and you will be "upside down" longer.

Here are a couple more problems with this kind of payment structure. Not only does it cost you more money in interest on the loan but if you total the car in an accident, you insurance will only pay for the value of the car at the time of the accident, leaving you to pay the balance. Another reason to not be "upside down" on car value is that if in an emergency you need to sell the car to raise cash, chances are you won't get what you need to pay off the loan-let along extra to help with your emergency needs.

Here is your car buying strategy- if you currently not making payments on a car or if they are about to end, continue to make payments to a savings account. That will give you a healthy down payment that will lower the amount you have to borrow making those monthly payments easier on your budget. Look at vehicles that fit your needs not just your wants. A less expensive car is easier on the budget as well. Finally, take the loan out for as short a term as possible and when you have paid off the car- keep paying the monthly payment towards repairs and a new down payment. Drive the car as long as financially possible-get every dollar of value out of the car. Then it will be worth all the money you have spent on it.


Please share this article with your friends!
Share on Facebook Tweet on Twitter

Read more posts from this blog

COMMENTS



Email will not display publicly, it is used only for validating comment


I do believe car loans will be the next crisis. One reason why is because of how many people were placed in deceptive car loans or "leases". Another reason is we are losing our mom and pop mechanics because the cost of tools needed due to the technological advances are far too much for the working man/woman to afford. Let us not forget, eack make of car may require a different tool to do the same job. This my friends, makes it difficult for our neighbors with car troubles, to be able to aford their less than new vehicles... Dealerships are not cheap. Just some thoughts.
by Danielle Skrzypckzak on Tuesday 11/26/2013


Posted by Pam Atkinson at 7:59PM on 11/1/2013
Categories: Pam Atkinson Budgeting Credit and Debt How to Choose/Purchase a ...