Why Financing a Car Can be a Bad Idea

If you are looking to get a car and you don’t have enough money saved to purchase the car outright, you may be tempted to finance a car  so that you don’t have to wait. Most young people long to have a nice car. It is part of an image that they want to obtain. Plus, after they graduate from college and get a decent paying job, they feel like they have all this money to throw around. Yet, if they want to save up for a car, that would mean a lifetime of waiting to purchase the car of their dreams. The next best option then is to finance the car. This means there is no waiting – we do live in a “microwave” culture of wanting things now, now, now! Yet, financing a car can be a huge mistake!

finance a car

Why Financing a Car Can be a Mistake

If you are looking to take a loan out on a car, you should consider the following reasons why it can be a mistake:

  • Owe More Than You Have: It is well known that cars are a depreciating asset. Cars, especially new cars, lose value pretty fast. If you have a long enough car loan, it is possible that the car will be worth less than what you owe. This means that if you ever had to sell your car, you would lose money. Even if you don’t want to sell it and plan on keeping it, if your car gets ‘totaled’ (beyond repair), the insurance agency will only give you the current value of the car. This means that you have to find extra cash laying around to pay the difference before you can even look at buying a new car. Then, where is the deposit going to come from for the next car? You are forced to go further into debt.
  • Necessary Repairs: It was just a few months ago that my friend’s car broke down. The engine needed to be replaced. I guess I should clarify that it wasn’t a small car – it was a SUV, with a costly engine. The total repair costs were about half of what the car was worth. Usually this kind of necessary repair on vehicle that is 10 years old would suggest that you just sell the car for scrap metal and buy a different one. The only down side is that they still owed as much as the car was worth (if the engine didn’t need to be replaced). If they chose to scrap it, that means that they would have had to either pay off their entire loan (which they couldn’t afford to do) or keep paying the payments on a car that they were no longer driving. All of this while having to get a different car that was running. Long story short, they ended up fixing the car by scraping together some savings (that was supposed to go towards a down payment on a house) and cross their fingers that nothing else goes wrong with it before it’s paid off.
  • Paying Interest: Another reason why it is a mistake to finance a car is that you end up paying more for your car. Unless you are getting a 0% rate, you are paying more money for the same amount of car. If you felt good about yourself because you negotiated a lower price on the car, but then took out a loan with a 4% interest rate, you should think again!

An Alternative to Financing a Car

An “easy” way to avoid taking out a loan for a car is to save for your next car before you need one. I am currently driving a car that is 7 years old. I estimate that I can drive it at least 3-4 more years before any major repairs might come up. While I’m not sure that I would sell my car in 3-4 years (because I love it and have had very few problems with it), I know that I need to be prepared.

If I start saving now (like I suggested in my short term financial goals), I could save a $167 per month for the next 4 years and have $8,000 to put towards my next car purchase. When you consider that my car will still be worth $4,000, that means I can buy a car worth $12,000 in cash. The best part is that this means I don’t ever have to stress about how my wife will get to work or how I will pay for necessary repairs. By simply planning ahead and saving first, you can avoid the same horrible situations.

Do You Finance Your Car Purchases?

33 Responses to Why Financing a Car Can be a Bad Idea

  1. We have paid cash for our last two cars and it is the best way in our minds. Sure we have maintenance bills but that is it. I love not having a car payment. A mortgage is enough.

    • Corey says:

      I agree. I don’t have a mortgage, but I have to pay rent and I would hate to have more money committed than I already do with other expenses.

  2. I’ve actually thought about this quite a bit recently. Particularly since many new car dealers are offering like 0-0.9% APR loans. I find myself wondering – what’s the catch?

    But, I think ultimately, it just comes down to owning a depreciating asset and owing more than you can/should afford to pay back – particularly since the car goes down 30% in value after you drive off the lot.

  3. Jeffrey says:

    I financed a car before, and I don’t think I’d do it again. I just hate making those payments. I’m totally fine with driving an older car and just saving for the full payment, like you said.

  4. Juan says:

    Ya, that mortgage payment usually tends to be enough to worry about. After throwing on one or two car payments I would much rather save up beforehand than before to have such a high percentage of my income going to debt payments.

  5. Forest Parks says:

    I really don’t think people should be financing for cars either. If you save as you earn in a vehicle fund that you set up there should be no reason why you can’t pay cash…. Just my 2 cents :)

  6. I have financed every car I’ve owned and after this last round, I’ll never do it again. I hate having a car payment. I find it cumbersome and annoying. If I could, I’d give up my car completely but unfortunately, that’s not an option, especially where I plan on moving to. So I’ll settle for driving an older car. Anyone who judges me based on my car isn’t someone I want to be friends with anyway.

  7. Only financed a car once. Usually pay cash and drive them forever!

  8. Next car will be a used one and I’ll pay cash however, with interest rates as low as they are financing a car is not a bad option as long as you have a down payment of over 30%.

  9. Buck Inspire says:

    Great point about cars being depreciating assets. Never thought about a total loss and then being on the hook for the difference. Sounds like you have a great plan for your next car. Nice job!

  10. Another interesting alternative is to consider occasionally renting a car when you need one. If you don’t drive every day and only need a car once in a while this can be a lot cheaper than car payments, plus there’s no maintenance costs.

  11. [...] Corey, from 20′s Finances explains why Financing a car can be a bad idea. [...]

  12. Although I don’t recommend going into debt to buy a car, I chose this option when purchasing my current vehicle. I bought a new Honda Civic in 2007 (historically they’ve held their value well). Since I bought a new car, the financing costs were lower than they would’ve been on a used car. And I decided, before ever stepping foot in a dealership, that my car payment would not exceed $250 per month and that I wouldn’t borrow more than $12,000. I think it took me a year and a half to pay my car loan off. I was never concerned about being underwater on the loan since I borrowed much less than the car was worth.

  13. The first car I ever got financing for was a huge mistake. I was young and didn’t know anything about money, the interest rate was about 30%. Never again. The 2nd (and last) car I financed was around 4%, much better and easier to pay off. I also sent in more than the minimum payment. :-)

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  21. Matt says:

    Ha! I didn’t even know you wrote this before I wrote my car post this week. Had I known, I would have integrated your post with a link somehow. Found yours via one of the carnival submissions.

    Since you’ve already read my post, you know my take! Saving and paying cash is always the best option when buying cars.

  22. [...] you probably guessed it, a Macbook Pro. It’s this mentality that often leads people to finance a car that they can’t afford. What is unfortunate with American consumerism is that it is driven by [...]

  23. [...] and houses by taking out loans that stretch for eight to ten years (this is not how you want to finance a car) or up to forty years for a home in order to bring the payments down to “affordable” [...]

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  25. [...] While my parents did their best to provide for us kids, the one area of my life that I felt was missing at the time was a brand new power wheel car. Who doesn’t like the feeling of knowing you have the nicest vehicle of your 5 year old friends? Regrettably, this is just one of the fine examples that cars and the need to have/drive/be associated with them is part of the narrative that is corrupting us – even from childhood.The popular and perhaps subliminal message to children is clear from the beginning. Driving a nice car is important – it says something about who you are.  And you wonder why so many people think it’s okay to finance a car… [...]

  26. Ash says:

    Think like a business. Things work on cash flow. Money is fake, and should be leveraged like the big banks and big businesses do. If you have $50,000 in cash, get a car at $300 a month and use the rest of the money to invest in an APPRECIATING ASSET (like a business, company, real estate) instead of locking the big money in the car knowing that it will ONLY LOSE VALUE. Try and meet successful CEO’s that have ‘made it in life’ and they will usually tend to agree. Or ask the neighbors who are broke and they will advise against financing (conventional wisdom). Contact us for life coaching, money is fake and man’s creation, learn to manipulate it the right way. Build a business with your cash, the returns are far more. We are car lovers, we are the aspiring 1%, we are Full Stack Partners: http://www.fullstackpartners.com

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  29. Brian_87! says:

    I can understand what you want to convey! I think the biggest mistake of my life was regarding same; financing car when I had other prominent investments lined up. Thanks for sharing insight, I am pretty sure that these tips and suggestions will be a great help for many :)
    Glad reading them!

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