Q&A: "Should I take out a car loan?"

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Here's the question we'll be tackling today, from Callie in Boston:

Hey Nicole! I wanted to hear your opinion on car loans? I think that I may take one out so I can afford to get a newer car. What do you think? Thanks so much!

Now, my two cents.

The short answer, Callie? I’d really prefer it if you didn’t take out a car loan, because you are borrowing to buy a depreciating asset. A depreciating asset refers to stuff that’s worth less the older it gets. This includes most goods like furniture, appliances and . . . cars!

One exception would be a vintage designer handbag that defies my wildest dreams of appreciation, but more on that in future articles. The bottom line? A cardinal sin of finance is borrowing for a depreciating asset.

Let’s say you borrow at 10% interest (more than the average, but I am rounding for easy math) to buy a $25,000 car. That means your monthly payment is more than 500 bucks. In five years, you’ve spent more than $30,000 for a car that’s probably worth $7,500 by the time you sell it or trade it in. Can you tell me why this makes sense? Rather, can you tell yourself? Because I already know it doesn’t.

And this only gets worse if you don’t have a stellar credit rating—because your interest rate will be higher, so more of your hard-earned cash will be blowing out your, ahem, exhaust pipe.

All of that said, I know that right now is a particularly difficult time to buy a car. I recently got into a car accident— everyone is okay, but my car isn't; and so I just went through the process of buying a car myself and it was extremely difficult. I actually had to pay over sticker price for the first time in my life. So if you’re trying to buy a car right now, I feel for you, and I do understand that with the current prices, taking out a loan may be absolutely necessary.

If that’s your situation and you must take out a car loan, please have at least 20% to put down in cash to shorten the length of your loan term to at least three years, which can save you from some of the rapid depreciation after that. Plus, you want to pay your car off as quickly as possible to avoid what could happen in the event of a bad accident: how much would it suck to keep making loan payments for a totaled car that you don’t actually own?

However, even if you do have that down payment, let me offer you a suggestion: take that $5,000, or whatever the amount is, and buy a used car. Save the $500 you would be spending on payments for ten months, and presto: that’s $5,000 more. At that point, you could upgrade to an even better used car (or have more cash to put down on a new car so the loan will be a lot smaller).

xo,

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