An excerpt from Life After Bankruptcy by Seth Hanson
My clients probably get into more financial problems with car loans than with anything else. Most of my clients have car loans with monthly payments of at least $400. Sometimes I even see families with two cars loans totaling almost $1,000 per month. That’s $12,000 per year!
Sure, there’s a sense of pride in driving around a newer car. However, there’s even greater satisfaction in driving a car that’s completely paid for.
I have clients all the time who say they need a car loan because they need something “reliable.” While having “reliable” transportation is nice, I might disagree with my clients about whether the cost of that “reliable” car will be best for their long-term financial health.
The vast majority of my clients are making payments on a new car. Let’s examine how expensive it really is to borrow money to buy a brand new car.
First, a vehicle is a depreciating asset. New vehicles depreciate several thousand dollars per year. In fact, new cars on average depreciate 60% in the first 5 years. For example, if you buy a car for $30,000, in five years it will be worth around $12,000.
Second, when you borrow money to purchase a car, you increase the purchase price by the amount of interest you pay. For example, let’s say you buy that $30,000 car on credit and are paying 7% interest over 5 years. The total you will pay over the 5 year period will be $35,642.40. So you will pay a $5,642.40 premium because you borrowed the money. When you factor in depreciation, it gets even worse. The vehicle you just bought for $35,642.40 will be worth $12,000 by the time you pay it off.
During the 5 years you will have owned that brand new car, you will have paid $23,642.40 more than the car will be worth. So the premium you will pay to have the “reliability” of a new car will be almost $5,000 per year.
A better approach, in my view, is to buy a used car for cash. For example, the last car I purchased was a 2002 Toyota Sequoia for $4,000 cash. I am anticipating mechanical problems, of course. However, the transmission was recently replaced and the engine is in great shape. Based on my conversations with mechanics and other people who own the same vehicle, I believe I can get another 150,000 to 200,000 miles on the vehicle. Even if I have to pay an extra $1,000 per year in maintenance, that will be much cheaper than the $5,000 per year it would cost me to buy a new car on credit. Insurance expenses are also much higher for a new car, particularly since a lender will require full-coverage.
If you have a car with a loan against it, you should seriously consider selling it. A possible exception would be if the car is almost paid off. If you do plan to keep your car, pay off the loan as soon as possible.
A used car with no payment will probably get you to the office, to school, or to the grocery store just as well as an expensive car with a hefty payment. If your car happens to break down (as has happened to my wife and me on several occasions with new cars and old cars), it is not the end of the world. You can always use Uber, Lyft, or call a taxi. If your car will need to be in the shop for a couple of days, you can rent a car fairly inexpensively, usually for about $25 to $30 per day. Even accounting for the cost of repairs and alternate transportation from time to time, buying a used car for cash is almost always cheaper than borrowing money to buy a new car.
Sometimes it’s hard to drive an old car when we see our neighbors driving brand new cars, or colleagues with shiny new trucks and SUVs, or fellow parents at the school with their brand new minivans. A well-known financial author and radio personality, Dave Ramsey, said it best,” Don’t be jealous of the Joneses. The Joneses are broke.” Those shiny new cars come with shiny new car payments.
Find a car that you can drive around without a car payment. There are many fine, good-looking, older vehicles that can be acquired for under $4,000 and even less. Make sure it has good safety features, good tires, and is as reliable as an older vehicle can be. Do your research on which cars age the best. Get yourself out of the car payment trap.
THE DANGERS OF CO-SIGNING
At some time in your life, you may be asked to co-sign on a loan. It is usually one of your children or a close friend. If you are considering doing this, I have a simple bit of advice for you – don’t do it! If you ever do co-sign for someone, you should be prepared to write a check for the entire loan amount.
When a lender asks someone to co-sign, it means the lender thinks the person can’t pay back the loan. The lender requires a co-signer who will be liable when the loan defaults. Notice that I used the term, “when,” not “if.”
When your children or someone you care about asks you to co-sign for them, it is tough to say “no.” But, it is what you should do. This is not a personal decision. It is purely a financial decision.
When you are asked, you can lovingly tell the person, “no.” You might consider telling them something like:
“Thank you for trusting me to help you, but I’m not in a financial position to take on any additional debt.”
If they say, “Don’t worry, it’s my loan and my debt – you’ll just be co-signing,” you might answer:
“In the eyes of the courts, it would be my debt just as much as yours. I think we should listen to the experts who are saying you cannot afford to repay this loan.”
Help them brainstorm ways they can accomplish what they need in life without additional debt. Have them read this book. Help them understand your choice in life is to live without debt. No matter how much you love and care about them, you can’t take on their debt.
If they turn around and walk away from you in anger, count yourself especially lucky. You’ve just dodged a major bullet.
For more information contact your Yuba City bankruptcy attorney.
Categorized in: Loans