Today’s post is an article by Josh from FamilyFaithFinance, a newer blogger on the personal finance scene. In it, he talks about why a new car is a bad investment and the importance of paying off your car loan sooner rather than later.
It’s undeniable. There’s nothing quite like the feeling you get when you drive off the lot in your brand new car. There’s the new car smell, the pristine interior, the feel of those new tires and the looks you get from your neighbors as you pull into your driveway.
The thought never even occurs to you that you just made a really bad investment. Why? Well, why spoil the moment and why should you care? You have the car you wanted and it will pay for itself, right? Wrong. In fact, aside from the emotional currency, you will never get back what you put into that new car. Ever.
Pssst – I’ve Got a Stock I want to Sell You
Consider another scenario in which your investment adviser recommends a stock. He makes it sound so good that you buy $25,000 worth of shares. However, the minute you buy it, the stock’s price drops 10%. No big deal, you say, because you are holding it for the long-term. But, after 12 months the stock price falls by another 10%. You believe in the stock, so you hold it only to have it lose another 40% of its value over the next four years. When you finally want to unload it, it takes another 20% hit because it’s no longer a very attractive stock.
That is exactly what happens when you buy a new car. Just as sure as the sun will come up tomorrow, your new car will depreciate in value – as much as 11% the minute your drive it off the lot. By the end of 5 years, it will have already lost more than half of its value. Then when you do try to sell it, you find out the market is not so enamored with it and it sells for just 30% of its original value. That’s a lousy feeling.
Is it Really the Best Use of Your Money?
But wait! A car is a necessity, not an investment, so you shouldn’t expect to get a return on it. That is an excellent rationalization. However, did you consider the opportunity cost of buying that new car versus the same model, only three years older? Instead of paying $25,000 for the car, you could have spent $15,000 and invested the difference. If you invested the $10,000 in a mutual fund earning 6%, you would have $15,000 in a few years, about what you’d need to buy another used car. Or over the next 25 years, that $10,000 could turn into $42,000 for your retirement account.
The point is that while buying a car may not be considered an “investment,” there are much better things you can do with your money (for example, millionaires invest in appreciating assets, not expensive cars).
However, if you are like most Americans, you probably had to finance your new car, which only compounds the opportunity costs. For that $25,000, you will have to pay an additional $1,700 in interest costs over a 60-month term. Just because you make one mistake by buying your car brand new, doesn’t mean you have to make a second big mistake by continuing to make loan payments on a depreciating asset.
To redeem yourself, you should focus on paying down that loan as quickly as possible. Is it such a big deal to save that small amount in interest? I don’t know. Could you use $1,700 right now? For reference, some interest rates are a crazy high 24.99%. Ouch! Editor’s note: If your car loan interest rate is 25%, sell the car immediately and start walking everywhere. The real cost to you is the lost opportunity of investing the money that you’re paying the lender. With the average auto loan payment at $479, that can add up to serious lost investment income.
Why You Should Pay Off Your New Car Loan ASAP
The sooner you can pay off that car loan, the sooner you will have $479 per month to invest. If you invest $479 a month for 10 years in a fund earning 6%, you’ll have $78,500 saved for retirement, a down payment on a house or four more used cars. You can pay off your car loan more quickly by throwing your small windfalls at it each year, such as tax refunds, annual bonuses, garage sale proceeds or extra cash from your raises.
When it comes time to buy another car, you’ll know exactly what to do. Cut your losses by 30 to 40% by buying a three-year old car. Or cut them by as much as 60% when you buy one that’s five years old. With the money you save in cash or interest costs, you can hire a great mechanic that will keep you car running like new for many years.
Josh Wilson is a personal finance blogger at FamilyFaithFinance working to become a thought leader for Millennial finance.