Are car loans really that bad?

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kafshar1
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Are car loans really that bad?

Post by kafshar1 » Sun Feb 01, 2015 12:43 am

I have noticed that a substantial number of BH have commented that car loans are unwise and instead cars should be purchased with cash. I was wondering if someone can elaborate to exactly why this is.

The reason I ask is that my last two car loans were for 1.99%. That doesn't seem too bad to me. I know that a car is a depreciating asset but, unfortunately, I am going to need to own this depreciating asset no matter what.... so what is the big deal about 1.99% interest vs cash. The only thing I can see that makes getting a car loan not great is that the insurance coverage required by the bank for your car (until you pay it off) may be more insurance that you would otherwise purchase.

Are there other reasons that car loans are considered a bad idea? Am I missing something?

Thank you in advance.

BeneIRA
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Re: Are car loans really that bad?

Post by BeneIRA » Sun Feb 01, 2015 12:53 am

Most Bogleheads believe, as you said, that a car is a depreciating asset so it makes no sense to get a loan on it. That's why so many Bogleheads get decent used cars with cash. I am with you that I think they are probably demonized too much. I come from the "drive it 'til it does" mentality where you buy a new car, but drive it until it makes absolutely no sense to repair it anymore. If that is 18 years and over 300,000 miles, then so be it. And if that car is a base model Civic, then I am much more than overcoming the loan. Back to your point: most here would prefer a decent used car they can pay for in cash that the previous owner has already eaten the depreciation on and with no loan. I understand that most of the time, you can make a better after-tax return than 1.99%, but how many of us when we finance a new car put the excess money into a taxable account to grow? I'll admit that I don't.

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Ketawa
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Re: Are car loans really that bad?

Post by Ketawa » Sun Feb 01, 2015 1:11 am

kafshar1 wrote:The reason I ask is that my last two car loans were for 1.99%. That doesn't seem too bad to me. I know that a car is a depreciating asset but, unfortunately, I am going to need to own this depreciating asset no matter what.... so what is the big deal about 1.99% interest vs cash. The only thing I can see that makes getting a car loan not great is that the insurance coverage required by the bank for your car (until you pay it off) may be more insurance that you would otherwise purchase.
The fact that a car is a depreciating asset doesn't matter. An auto loan is just debt. The car is merely collateral to secure the debt. As soon as it is purchased, its value has nothing to do with the amount of debt.

The insurance issue has not been an issue for me since I have the highest liability, collision, and comprehensive limits with high deductibles plus an umbrella policy. If you don't have this amount of insurance, maybe it would be a consideration.

My car is financed even though it is seven years old since 3.24% is less than I can get investing in a Mango or UnionPlus account and the additional liquidity is valuable. Another possibility is prepaying a mortgage, depending on the rate and personal situation with cash flow.

My car was fully paid off when I found out that PenFed would let me take out a loan against if for 1.99%. I refinanced less than a year later to 2.74% since NFCU gave me $300 (a win), and refinanced again less than a year later to 3.24% with USAA to set me up with another refinance opportunity with NFCU for 2.99% and $250. USAA offered me $21k even though the loan balance was only $15k and my truck was purchased for $23k! I would have taken them up on the larger balance had I realized that I could potentially open up another UnionPlus account and arbitrage interest rates further. You might not want to deal with all this complexity.
Last edited by Ketawa on Sun Feb 01, 2015 1:23 am, edited 2 times in total.

Spirit Rider
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Re: Are car loans really that bad?

Post by Spirit Rider » Sun Feb 01, 2015 1:16 am

Also, the dynamics of car loans have changed. It used to be that car loan APRs were always higher than mortgage APRs. Now it is relatively easy to get a car loan for 1/2 of typical mortgage rates.

Part of living below your means is not spending a significant percentage of your income on car loans an insurance. If you are buying a car with a six or seven year payment term to get the monthly payment reasonable then you are buying too much car for your income.

I have always bought a new car an kept it about 10 years/150,000 miles. They have always been moderately priced vehicles, when I could have easily afforded one twice as much (which many of my friends did and continue to do). The first three were cash, then one 50% down, then the last 25% down. Like you it is pretty hard to disagree with a 1.75% auto loan.

As long as you live below your means which allows you to have an adequate savings rate, I see nothing wrong with financing a new car.

BeneIRA
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Re: Are car loans really that bad?

Post by BeneIRA » Sun Feb 01, 2015 1:23 am

Spirit Rider wrote:Also, the dynamics of car loans have changed. It used to be that car loan APRs were always higher than mortgage APRs. Now it is relatively easy to get a car loan for 1/2 of typical mortgage rates.

Part of living below your means is not spending a significant percentage of your income on car loans an insurance. If you are buying a car with a six or seven year payment term to get the monthly payment reasonable then you are buying too much car for your income.

I have always bought a new car an kept it about 10 years/150,000 miles. They have always been moderately priced vehicles, when I could have easily afforded one twice as much (which many of my friends did and continue to do). The first three were cash, then one 50% down, then the last 25% down. Like you it is pretty hard to disagree with a 1.75% auto loan.

As long as you live below your means which allows you to have an adequate savings rate, I see nothing wrong with financing a new car.
I think Suze Orman's rule on this is a good one: If you can finance the car over 36 months or less, you can afford it, if you can't, then you truly can't afford the car. The real world application seems to hold on that one. It makes sense, too. Because by financing over three years, you are effectively paying a third a year, plus fees. If you can't afford 1/3+fees for the car, then it costs too much. I got a Honda Fit Base and I was universally panned for my choice because I "should" have spent more on a car because I had the funds and I was "being cheap." The car gets the job done. Funny when those people later come to you for a loan.

basspond
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Re: Are car loans really that bad?

Post by basspond » Sun Feb 01, 2015 1:32 am

Because in the end the price of the car is being inflated and by paying cash the person is showing discipline to save for a huge purchase and not getting into a mentality of financing their lifestyle.

Trader Joe
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Re: Are car loans really that bad?

Post by Trader Joe » Sun Feb 01, 2015 2:18 am

Yes, they are bad and I would never go into debt for a car.

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mlebuf
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Re: Are car loans really that bad?

Post by mlebuf » Sun Feb 01, 2015 2:26 am

The last new car I purchased was in 2002. I could have paid cash but financed the purchase because the dealer offered me a zero percent loan with no money down and 5 years to pay it off. With an offer like that I would have been a fool to pay cash. When I bought the car, I planned to keep it for 10 years. I still have it, it has almost 80,000 miles on it, stays in a garage about 22 hours a day, looks like new and I plan to keep it until it falls apart.
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Alchemist
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Re: Are car loans really that bad?

Post by Alchemist » Sun Feb 01, 2015 6:06 am

Car loans aren't the worst thing in the world, but by and large they aren't a good thing either. First of all, I consider cars to be consumption items. Adding debt interest to the cost of a consumption item is just silly to me. Additionally people who finance a car are more likely to pay more for the car overall than someone paying cash. It is easier to spend tomorrow's dollar than today's fist full of cash so you are likely to buy a more expensive car if you finance. Further more dealers don't offer loans to be nice, they do it because it profits them more either through financial charges/interest or again the very well known psychological fact that people spend more when paying with credit.

Lastly I just like to keep things simple. The only monthly outlays I want are the ones I have to have. Rent/Mortgage, utilities, and that's it. Keeping your financial life simple can pay huge dividends because it helps you, or it helps me at least, to keep focused on my long term goals. Payments=complexity.

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stemikger
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Re: Are car loans really that bad?

Post by stemikger » Sun Feb 01, 2015 7:18 am

kafshar1 wrote:I have noticed that a substantial number of BH have commented that car loans are unwise and instead cars should be purchased with cash. I was wondering if someone can elaborate to exactly why this is.

The reason I ask is that my last two car loans were for 1.99%. That doesn't seem too bad to me. I know that a car is a depreciating asset but, unfortunately, I am going to need to own this depreciating asset no matter what.... so what is the big deal about 1.99% interest vs cash. The only thing I can see that makes getting a car loan not great is that the insurance coverage required by the bank for your car (until you pay it off) may be more insurance that you would otherwise purchase.

Are there other reasons that car loans are considered a bad idea? Am I missing something?

Thank you in advance.
I don't think it is an all or nothing when it comes to this but that only depends on your situation. If you are very wealthy and it will not make a dent in your financial life one way or the other then it really does not matter which way you go. If you are like the average Joe who does have to live within his means then having a large car note can be a sure way to stay average. I personally have used the approach of not getting car fever and buy a brand new compact or subcompact every decade. I had to take out car loans, but never more then 4 years. The last car note I had, I paid off in a year. The main thing is not spending $800 a month on a lexus or high-end car. My average car note was $288 to $311 being the highest.

I was in a car accident the other day so I am currently renting a car. The 23 year old Kid from Enterprise picked me up and was a very nice kid and he was saying how he can't wait to get a car now that he has a job. I asked what kind of car he wants and he said a Lexus which will cost him $800 a month. He said he will go in with his girlfriend so it will only cost them $400 each. I laughed at how naive he was and I said, I'm 50 and drive a Nissan Versa because I rather put the extra money in investments. During the same conversation he said he wanted a Mercedes but he didn't have good credit. LOL. I said, I'm not sure you are going to get the Lexus either.

Having said all that, live below your means when buying a car and if you have to take out a loan make it a small one.
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Louis Winthorpe III
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Re: Are car loans really that bad?

Post by Louis Winthorpe III » Sun Feb 01, 2015 7:42 am

mlebuf wrote:The last new car I purchased was in 2002. I could have paid cash but financed the purchase because the dealer offered me a zero percent loan with no money down and 5 years to pay it off. With an offer like that I would have been a fool to pay cash.
Anytime someone offers to give a zero interest loan, ask if they'll give you a better price if you pay cash. Since a zero interest loan costs the seller something, they can come out ahead by agreeing to the lower price paid today in cash.

bberris
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Re: Are car loans really that bad?

Post by bberris » Sun Feb 01, 2015 8:09 am

A loan is a loan. Whether you borrow money to buy a car, or a house you still owe the same amount of money. The only difference is the collateral for the loan, and that would only matter if you are in such severe default that they take the collateral. So the argument that borrowing against a car is worse than borrowing against your house is a little weird. You could always take the bus if you lose your car, but losing your house is something else.

I think what's happening here is that its easier to spend too much on a car than on a house. That is a separate issue from which asset serves as collateral.

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Toons
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Re: Are car loans really that bad?

Post by Toons » Sun Feb 01, 2015 8:12 am

Some individuals ,me being one of them ,just do Not like any form of Debt. :happy
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crg11
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Re: Are car loans really that bad?

Post by crg11 » Sun Feb 01, 2015 8:31 am

Just paid off my last car loan last week. What an amazing feeling to not be staring at that big payment in my budget every month.

Since both of my cars are about 5 years old apiece, they will hopefully last another 5+ years. It's my intention that the next car I buy will be in cash.

therivler1
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Re: Are car loans really that bad?

Post by therivler1 » Sun Feb 01, 2015 9:05 am

money is fungible. If you can make more than 2%, don't pay it off and use that money elsewhere.

That is what I do. At 2% I am in no hurry to pay off the note.

I think a lot of people here equate getting a car loan with an inflated purchase. Those are separate issues.

If you are evaluating paying cash or 2% for the same exact car, go forth and conquer. If you are going to use the financing option to buy a more expensive car than you otherwise would - that is bad.

p.s. there may be benefits to your credit score for some people by getting a car loan. but that is a different thread.

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knpstr
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Re: Are car loans really that bad?

Post by knpstr » Sun Feb 01, 2015 9:15 am

Was going to pay for my wife's new car (couldn't convince her to buy used) in cash... but they gave me 0% interest for 5 years with extra money off on top of that, plus her dad is a Ford employee so even more money off. Couldn't resist, she was coming from a lease so we arranged the auto payment to be roughly the same as her old lease payment so I could just swap them in the budget.
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Dru
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Re: Are car loans really that bad?

Post by Dru » Sun Feb 01, 2015 10:50 am

We have significant student loan debt, and have been saving to replace a 12 year old 190k mile car with one with upgraded safety features for our expanding family. We've been saving to pay cash for the new car, but auto rates are several % below student loan rates, so I think instead I'm going to bolus our loans with the cash. So yes we take out a new loan now, but will basically be swapping a portion of a 5.5% loan for something in the 1-2.5% range (how happy I'd be if I could do that with all of my student debt). And the monthly "save for a new car" budget item turns into the "car payment" item.

Grt2bOutdoors
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Re: Are car loans really that bad?

Post by Grt2bOutdoors » Sun Feb 01, 2015 10:59 am

Stop making payments on the loan, then you'll see how bad they can be when the tow truck repossesses your car - now you have no money and you have no car and there you are! :twisted:
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keelerjr12
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Re: Are car loans really that bad?

Post by keelerjr12 » Sun Feb 01, 2015 11:18 am

I think it depends on how risk-averse you are. In my mind (I'm going to catch flack for this), Bogleheads are extremely risk-averse (maybe too risk-averse). My first vehicle was paid for with cash ($1,400) and driven for 7 years which allowed me to pay off student loan debt. My next vehicle was a 2007 Silverado($16,200) that I purchased from an older couple with only 46,XXX miles on it. For this vehicle I took out a loan because the interest rate was so low (~2%). I have been completely comfortable having a loan for it because it allowed me to put that money into other investment vehicles that brought about higher returns. I am about 5 months out from having my truck paid off, and although it will be amazing to be completely debt free, it would've been much smarter to use the loan to my advantage and not pay down the truck so fast while putting even more money into my IRA/TSP.

Evaluate how risky you are willing to be with your money. To make money you're going to have to accept higher risk.

cherijoh
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Re: Are car loans really that bad?

Post by cherijoh » Sun Feb 01, 2015 11:38 am

therivler1 wrote:money is fungible. If you can make more than 2%, don't pay it off and use that money elsewhere.

That is what I do. At 2% I am in no hurry to pay off the note.

I think a lot of people here equate getting a car loan with an inflated purchase. Those are separate issues.

If you are evaluating paying cash or 2% for the same exact car, go forth and conquer. If you are going to use the financing option to buy a more expensive car than you otherwise would - that is bad.
I agree, if you are basing your decision on which car to buy based on being able to afford the payments for a 72-month loan :shock: then this is an issue. But taking a car loan because you want to concentrate on paying off higher-rate student loans or because you don't want to sell investments is not that big a deal. Just make sure the decision is made rationally before you hit the dealership and get entranced by some gorgeous new model.

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ClevrChico
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Re: Are car loans really that bad?

Post by ClevrChico » Sun Feb 01, 2015 11:47 am

If you watch Youtube videos for training car salesmen, it's always about the payment. That's proof you don't want a car loan. :-)

jerryk68
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Re: Are car loans really that bad?

Post by jerryk68 » Sun Feb 01, 2015 12:11 pm

Got 1.49% $16k loan from USAA in Sept and it was from their new car buying service. The car was cheaper than I could have negotiate on my own. Why take the money out of a mutual fund investment at that rate? Car salesman tried their smoke/mirrors show but I understand money. The salesman even commented that he rarely deals with people that do research and understand car financing. Most people it's all about the payment and the style.

mhalley
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Re: Are car loans really that bad?

Post by mhalley » Sun Feb 01, 2015 12:48 pm

I don't think bogleheads are against car loans per se, more against spending your life in debt, IE, trading in the car every 2-3 years, having a car loan constantly. Using an inexpensive car loan infrequently to help with cash flow is fine, specially when buying a car every 7-10 years. I don't think we are even against new cars if you can afford it, it is knowing whether you can afford it or not.
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randomguy
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Re: Are car loans really that bad?

Post by randomguy » Sun Feb 01, 2015 1:05 pm

Louis Winthorpe III wrote:
mlebuf wrote:The last new car I purchased was in 2002. I could have paid cash but financed the purchase because the dealer offered me a zero percent loan with no money down and 5 years to pay it off. With an offer like that I would have been a fool to pay cash.
Anytime someone offers to give a zero interest loan, ask if they'll give you a better price if you pay cash. Since a zero interest loan costs the seller something, they can come out ahead by agreeing to the lower price paid today in cash.
You can ask but often times these deals are at a higher level than the dealership.

People are against loans as a knee jerk reaction to people using them to buy cars they can't afford. You can the math on spending 30k (and paying capital gains) versus borrowing 30k (and paying interest). Odds favor borrowing at today's rates.

Johno
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Re: Are car loans really that bad?

Post by Johno » Sun Feb 01, 2015 1:09 pm

The core problem with car loans, like mortgages for that matter, or any other debt, is if it induces you to consume more than you should. 'More than you should' is subjective, but most people in the US (not necessarily this forum) aren't where they should be in terms of retirement or other (future education etc) savings. If they use car loans to buy more car than they need, they are making that problem worse.

But I agree it's oversimplifying to just say 'cars loans are bad'. I've never had a car loan, but I've never commuted to work by car either (except when working overseas, and a car was provided). If you need a car to get to work and basic errands, and you'd have to increase your housing cost significantly not to, then IMO there's nothing wrong with starting out with a basic new car bought with a loan, as long as you make every effort to use cash by the time you buy the next one. It might be cheaper to buy a used car for cash, or not if it turns out to need more repairs than you expected. It partly hinges on being a car-oriented person or not, but also there's simply more uncertainty (risk v return) about used car repair costs and reliability than new cars with warranty. And new car pricing nowadays is almost completely transparent, easier to see if you're paying what you should than 'certified pre-owned' (which it seems people often use to get upscale brands they don't need) or regular used. The Suze Orman 3 yr test sounds reasonable to me. If you can't afford afford a basic new car with a 3 yr loan, there's probably nothing special about your job that you couldn't get an approximately equivalent one along a bus route, etc. And if you're stretching the loan term to buy more car than basic, you probably should wait till you can do that with cash instead.

But this is pretty out of touch with what most people actually do. A higher % of (new) car sales in the US are financed than home sales.
Last edited by Johno on Sun Feb 01, 2015 1:21 pm, edited 1 time in total.

Grt2bOutdoors
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Re: Are car loans really that bad?

Post by Grt2bOutdoors » Sun Feb 01, 2015 1:15 pm

Not if you can get a loan as low as 1.99% and you don't purchase more car then you were willing to if using cash only. https://www.lightstream.com/rates-loan-calculator
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midareff
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Re: Are car loans really that bad?

Post by midareff » Sun Feb 01, 2015 1:20 pm

LOL, 5 year at 1.49% ... I will take the risk that the market will not give me in excess of 1.49% for 5 years.

cherijoh
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Re: Are car loans really that bad?

Post by cherijoh » Sun Feb 01, 2015 1:42 pm

Johno wrote:The core problem with car loans, like mortgages for that matter, or any other debt, is if it induces you to consume more than you should. 'More than you should' is subjective, but most people in the US (not necessarily this forum) aren't where they should be in terms of retirement or other (future education etc) savings. If they use car loans to buy more car than they need, they are making that problem worse.

But I agree it's oversimplifying to just say 'cars loans are bad'. I've never had a car loan, but I've never commuted to work by car either (except when working overseas, and a car was provided). If you need a car to get to work and basic errands, and you'd have to increase your housing cost significantly not to, then IMO there's nothing wrong with starting out with a basic new car bought with a loan, as long as you make every effort to use cash by the time you buy the next one. It might be cheaper to buy a used car for cash, or not if it turns out to need more repairs than you expected. It partly hinges on being a car-oriented person or not, but also there's simply more uncertainty (risk v return) about used car repair costs and reliability than new cars with warranty. And new car pricing nowadays is almost completely transparent, easier to see if you're paying what you should than 'certified pre-owned' (which it seems people often use to get upscale brands they don't need) or regular used. The Suze Orman 3 yr test sounds reasonable to me. If you can't afford afford a basic new car with a 3 yr loan, there's probably nothing special about your job that you couldn't get an approximately equivalent one along a bus route, etc. And if you're stretching the loan term to buy more car than basic, you probably should wait till you can do that with cash instead.

But this is pretty out of touch with what most people actually do. A higher % of (new) car sales in the US are financed than home sales.
Many of us don't live in a city where commuting to work is feasible for much of the population. For my current job, it could be done by taking either a combination of 2 or more buses or a bus and light-rail. As a woman, I don't care for the idea of standing around at bus stops on the side of the road - much of the year in the dark. Buses run frequently during rush hour but frequency drops off dramatically outside of those hours. Therefore, I consider that I "need" a car.

I'm not a car person and have always purchased new cars due to the fear of getting an unreliable used car as some of my friends have done.

MathWizard
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Re: Are car loans really that bad?

Post by MathWizard » Sun Feb 01, 2015 1:49 pm

My two car loans were for 18 and 12%
I certainly have an aversion to car loans.
They also increase cash flow req. so the
EF has to be bigger.

I also buy older cars and don't have full coverage
which is required when you have a loan,
so I save on insurance.

It also gives me more confidence in negotiations
when I know I can pay cash.

mesaverde
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Re: Are car loans really that bad?

Post by mesaverde » Sun Feb 01, 2015 1:52 pm

1. A car is something that most people can save money for and buy without going into debt to do so (as opposed to student loans/mortgages).

2. It does not make sense to go into debt on a continuously depreciating asset (regardless of how often you even use that asset).

3. Numerous studies have shown that people spend more $ when using credit as opposed to paying in cash... this is exponentially so with the high cost of buying a new car.
"Learn from the past, live in the present, plan for the future"

MrMatt2532
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Re: Are car loans really that bad?

Post by MrMatt2532 » Sun Feb 01, 2015 2:00 pm

I think the main reason I would avoid a car loan is for financial simplicity and to make sure I don't fall into the trap of buying more car than I would otherwise buy had I been forced to pay in cash.

Purely financially, I think it probably makes sense to get a loan at sub 2% rates for most investors if you would otherwise be getting the same car with cash anyways. Nonetheless, the value of a car is likely relatively small compared to the rest of the portfolio, so it shouldn't make a big difference either way.

keelerjr12
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Re: Are car loans really that bad?

Post by keelerjr12 » Sun Feb 01, 2015 2:26 pm

MrMatt2532 wrote:I think the main reason I would avoid a car loan is for financial simplicity and to make sure I don't fall into the trap of buying more car than I would otherwise buy had I been forced to pay in cash.

Purely financially, I think it probably makes sense to get a loan at sub 2% rates for most investors if you would otherwise be getting the same car with cash anyways. Nonetheless, the value of a car is likely relatively small compared to the rest of the portfolio, so it shouldn't make a big difference either way.
This. I ran the numbers to just see how much of a difference you're looking at. It's a ~$20,000 (nominal) difference after 30 years if you had paid for a car in cash vs taken out a 60 month car loan and invested the money in equities. So I guess in real terms, it's ~$8,500 or so.

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Whit
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Re: Are car loans really that bad?

Post by Whit » Sun Feb 01, 2015 3:00 pm

"Are car loans really that bad?"

Compared to credit card debt at 19% a car loan at 2% seems insignificant. But option A being better than option B doesn't necessarily make option A good. We try to rationalize our choices by saying there is "good" debt and "bad" debt. If we can deduct it on our taxes, then its not so bad. If our rate is not to high then its ok. But the reality is that debt is not good. Debt restricts your life, it does not free you. When possible debt should be avoided. There is not good and bad debt, just bad and worse.

Now give me a minute to step off my soapbox. :wink:

KlangFool
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Re: Are car loans really that bad?

Post by KlangFool » Sun Feb 01, 2015 3:15 pm

TS,

I could had paid for my new 2014 Nissan Altima with cash. But, I took a minimal 3 years car loan instead because it is CHEAPER. I got about $750 back that pay for the car loan interest and $300 to $350 more. So, if you get this kind of deal, it is worthwhile to take the car loan. BTW, I bought this through Costco deal and I received another $200 dealer voucher. All this is after tough negotiation on the cash price.

KlangFool

keelerjr12
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Re: Are car loans really that bad?

Post by keelerjr12 » Sun Feb 01, 2015 3:18 pm

Whit wrote:"Are car loans really that bad?"

Compared to credit card debt at 19% a car loan at 2% seems insignificant. But option A being better than option B doesn't necessarily make option A good. We try to rationalize our choices by saying there is "good" debt and "bad" debt. If we can deduct it on our taxes, then its not so bad. If our rate is not to high then its ok. But the reality is that debt is not good. Debt restricts your life, it does not free you. When possible debt should be avoided. There is not good and bad debt, just bad and worse.

Now give me a minute to step off my soapbox. :wink:
I see what you're getting at with this and I can agree but only to a point. I think if you are left with more money at the end then it can be considered "good" (not sure this is the right term) debt. I'm not saying leverage is always the best way to go, but think about how companies view leverage. Almost every major company (besides Google) is financed through debt, because it allows the company to be more efficient.

In terms of personal finance, I think IT DEPENDS on a number of factors including the individual.

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Re: Are car loans really that bad?

Post by Johno » Sun Feb 01, 2015 4:53 pm

keelerjr12 wrote:
Whit wrote:"Are car loans really that bad?"
There is not good and bad debt, just bad and worse.
I see what you're getting at with this and I can agree but only to a point. I think if you are left with more money at the end then it can be considered "good" (not sure this is the right term) debt. I'm not saying leverage is always the best way to go, but think about how companies view leverage. Almost every major company (besides Google) is financed through debt, because it allows the company to be more efficient.

In terms of personal finance, I think IT DEPENDS on a number of factors including the individual.
I agree the absolute version 'there is no good debt' can't be sustained as an argument. It might be if you modified it to 'there is no good debt to finance consumption' as opposed to financing investment, but then two of the typical real cases, homes and cars, are combinations of consumption and investment. To stay on point with cars, as mentioned before if you need a car to get to work, without otherwise increasing your housing cost (or taking significantly elevated personal risk to crime etc.), then the car is really an instrument of your work, not strictly consumption. I understand the counterpoint that that could be a 'slippery slope' toward financial sloppiness and buying more vehicle than you need, but the basic concept can't be easily refuted. For those who have to get a car and aren't car people and want to take low risk to unknowns like the history of a used car and don't have the cash for a new car at that moment, a relatively short term car loan to get a basic new car could in fact be 'good debt'.

And outside of quasi consumption items there's even less basis for an argument 'all debt is bad'. As you say, companies virtually all have debt, and making an exception just in that case because it's not 'us' taking on the debt doesn't make sense because then that would mean for example financing a rental property is a bad investment because it involves leverage. Actually some people confuse themselves to the point of almost saying that, that one should stick with 'unleveraged' assets like stocks (which are actually leveraged interests in underlying assets of companies) not 'leveraged' assets like financed real estate, nor does it make sense to go into real estate limiting oneself to always buying everything with cash (though you might wisely do that at times). So a broad statement that 'debt is bad' becomes clearly wrong if you take it far enough.

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Re: Are car loans really that bad?

Post by Whit » Sun Feb 01, 2015 7:04 pm

Johno wrote: To stay on point with cars, as mentioned before if you need a car to get to work, without otherwise increasing your housing cost (or taking significantly elevated personal risk to crime etc.), then the car is really an instrument of your work, not strictly consumption. I understand the counterpoint that that could be a 'slippery slope' toward financial sloppiness and buying more vehicle than you need, but the basic concept can't be easily refuted. For those who have to get a car and aren't car people and want to take low risk to unknowns like the history of a used car and don't have the cash for a new car at that moment, a relatively short term car loan to get a basic new car could in fact be 'good debt'.
In the example getting a loan to buy a basic new car may be their best alternative because they need a car to get to work and don't have the cash to purchase one. But just because it is their best option doesn't make it "good debt". Wouldn't it be better to plan for the future knowing that the car you currently drive will eventually need to be replaced and save accordingly? You will earn interest (not much at current rates, I know) while saving and don't have to pay interest while using the car. While using the car you are saving (and earning interest) on the next car purchase. Now can we find an example where preplanning is somehow not possible? Yes. But for many preplanning is possible. Debt restricts your life, it does not free you. When possible debt should be avoided.

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Re: Are car loans really that bad?

Post by arcticpineapplecorp. » Sun Feb 01, 2015 7:13 pm

The article in today's Wall Street Journal (link below, third column of article) seems to think it's fine...but only under today's super low rates. The reason? You're financing at the rate of inflation:

http://online.wsj.com/public/resources/ ... _-A001.pdf
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Re: Are car loans really that bad?

Post by Johno » Sun Feb 01, 2015 8:22 pm

Whit wrote:
Johno wrote: To stay on point with cars, a relatively short term car loan to get a basic new car could in fact be 'good debt'.
In the example getting a loan to buy a basic new car may be their best alternative because they need a car to get to work and don't have the cash to purchase one. But just because it is their best option doesn't make it "good debt". Wouldn't it be better to plan for the future knowing that the car you currently drive will eventually need to be replaced and save accordingly? You will earn interest (not much at current rates, I know) while saving and don't have to pay interest while using the car. While using the car you are saving (and earning interest) on the next car purchase. Now can we find an example where preplanning is somehow not possible? Yes. But for many preplanning is possible. Debt restricts your life, it does not free you. When possible debt should be avoided.
Wouldn't it be better to inherit $100mil and never have to worry about money a day in your life? :D But it's not an ideal world. And even seriously, if somebody say is just starting out in the working world, starting over after some event that put them back to square 1 financially etc. there's not necessarily any failure in 'preplanning' to need a car to get to work, and not have the cash now. And again wondering if we widen the context would you say it's a 'lack of preplanning' to conduct a real estate investing business by borrowing to buy properties, or is it better to avoid that? How about corporations having debt? Just wondering since that qualification (debt to boost consumption v investment) has now been mentioned but you again just say 'debt is bad' without that qualification.

But not that there's any 100% disagreement here. I agree if somebody is already established in life, a few cars down the road so to speak, it's better to save up and buy cars with cash.

PS- to various comments about low rates, it's true that's a valid input among other considerations. But it's not valid to compare car loan rates to expectations of stock returns to justify borrowing at car loan rates. The risk is different. The implied financing rate in stock index futures is only around .4%, also way below what one would hope stocks will return. The (quasi) riskless short rate is always less than the expected return of equities, that's neither here nor there and cars loans aren't necessarily the lowest cost loans with which to lever stock positions. And as to loan rate v inflation, that's also not really relevant. The relevant comparison is to the quasi riskless rate you could invest at, after tax, and that's also very low now, especially on a correct comparison to the average life, not the final maturity, of an amortizing car loan.

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Re: Are car loans really that bad?

Post by john94549 » Sun Feb 01, 2015 9:33 pm

Purchase price and financing should be entirely separate transactions. If you feel you have the best car deal available, then find the best financing available. Frankly, a five-year car loan at less than 2% compares favorably with 5-yr CDs at 2.25%. In all candor, I'm giving the credit union money for five years at 2.25%, and they're turning around and loaning it to you for five years at 2% or thereabouts. That's fair. Insane, but fair. Sort of, "right, we lose money on each loan, but make it up on volume". Cynic that I am, I suspect there might be some pesky "fees" to place the loan, and that's where the profit lies.

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Re: Are car loans really that bad?

Post by grabiner » Sun Feb 01, 2015 11:34 pm

kafshar1 wrote:The reason I ask is that my last two car loans were for 1.99%. That doesn't seem too bad to me. I know that a car is a depreciating asset but, unfortunately, I am going to need to own this depreciating asset no matter what.... so what is the big deal about 1.99% interest vs cash. The only thing I can see that makes getting a car loan not great is that the insurance coverage required by the bank for your car (until you pay it off) may be more insurance that you would otherwise purchase.
The issue isn't that the asset is depreciating, but that the loan is a somewhat expensive way to get money; you have to decide whether other sources of money are less expensive. Normally, the longer the term of the loan, the more interest-rate risk the bank is taking, and thus the higher the rate. Thus banks charge more interest for 30-year mortgages than for 15-year mortgages, and more for 15-year mortgages than for 5-year car loans. But you don't get the benefit of the difference between 15-year and 5-year loan rates, because mortgages are usually deductible and car loans are not.

So you need to look at the alternatives. When I bought my first car, I didn't have enough cash to pay for the car; I could have sold stock but would have paid more in capital-gains tax than the interest on the loan. Therefore, I took out a three-year loan, and paid it off much faster than the original schedule to minimize the interest. (Similarly, when I bought my condo a year ago, I could have sold stock to pay cash for the condo, but I would have had a huge tax bill. Therefore, I put 20% down, and borrowed the rest at a low interest rate.)
john94549 wrote: Frankly, a five-year car loan at less than 2% compares favorably with 5-yr CDs at 2.25%. In all candor, I'm giving the credit union money for five years at 2.25%, and they're turning around and loaning it to you for five years at 2% or thereabouts.
There are two reasons this doesn't work out. One is that you pay tax on the CD interest, and don't deduct interest on the car loan. The other reason, which is why the credit union is willing to do this, is that the car loan has a duration of only 2.5 years, not 5; you are giving the credit union money for 60 periods ranging from 1 to 60 months, and the credit union is offering a lower average rate on 60 CDs than it is receiving on the loan.
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Re: Are car loans really that bad?

Post by powermega » Mon Feb 02, 2015 12:00 am

I don't think there is anything wrong with a car loan, provided the loan interest rate is less than the after-tax rate of return of the investments that you would need to liquidate to pay for the car in cash. Especially for someone young, I think it makes more sense to maximize saving and to leverage income for a loan than to decreasing investments (paying cash) for the sake of having higher investable income in the future.
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Re: Are car loans really that bad?

Post by kafshar1 » Mon Feb 02, 2015 1:17 am

I appreciate all the responses. I learn a tremendous amount for all of you. It seems that the most pressing reason why car loan debt is so bad is that it tends to make people buy cars that they may not truly be able to afford.

However, I also learned that the decision is very individualized and includes many factors and alternatives to consider.

I went through college and medical school and four years of residency and four years of fellowship, so debt is something with which I have become very comfortable. For me, I can choose to pay cash for my car versus pay off the remainder of medical school debt that is about 3.8% on average. Seems that the 1.99% car loan is not that bad. Also, allows me to maximize my contribution to 401k with match, Backdoor Roth for me and my spouse, and HSA account.

I may very well be able to pay off my car payments by the end of next year, but the reality is that I need a new car and have had horrible luck with used cars in the past. Don't want to deal with it. Also, used cars or certified pre-owned used to be much more of a value than they are today. Somehow used cars don't depreciate much in value when I am trying to buy one, only when I am trying to sell one.

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Re: Are car loans really that bad?

Post by HIinvestor » Mon Feb 02, 2015 1:32 am

We bought a new van in 1999. I didn't have the cash in hand at the moment the car was delivered, so was able to charge the car on two credit cards. One gave us 1-2% cash back on the amount charged & I paid it befor the balance was due. The other was 0% interest for 18 months, as long as you paid the minimum payment and paid it all off before the 18 months ended. We were able to pay it off in month 17.5. It was a win/win for us, as we knew we had money coming in from various sources as long as we had the float of a few weeks for some of the funds and 17 months for the rest. It worked for us.

If you have a plan and will be paying your car off in 36 months, and will be using your funds to pay off higher interest debt and your retirement and other savings, it sounds like a car loan at LOW interest rates would be OK.

I agree that you should negotiate the price and only after it is firm decide where you want to finance it--credit union, dealer, credit card with 0% interest that you will pay off before the balance is due, etc.

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Re: Are car loans really that bad?

Post by robert88 » Mon Feb 02, 2015 1:36 am

Johno wrote:The Suze Orman 3 yr test sounds reasonable to me. If you can't afford afford a basic new car with a 3 yr loan, there's probably nothing special about your job that you couldn't get an approximately equivalent one along a bus route, etc.
That advice works in NYC. If you live in the Midwest(Chicago excluded) or the South, public transportation is truly abysmal. If you can't afford to own a car, your best bet is to make friends with someone who can or live close enough to walk or bike to work.

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Re: Are car loans really that bad?

Post by leonard » Mon Feb 02, 2015 12:14 pm

kafshar1 wrote:I have noticed that a substantial number of BH have commented that car loans are unwise and instead cars should be purchased with cash. I was wondering if someone can elaborate to exactly why this is.

The reason I ask is that my last two car loans were for 1.99%. That doesn't seem too bad to me. I know that a car is a depreciating asset but, unfortunately, I am going to need to own this depreciating asset no matter what.... so what is the big deal about 1.99% interest vs cash. The only thing I can see that makes getting a car loan not great is that the insurance coverage required by the bank for your car (until you pay it off) may be more insurance that you would otherwise purchase.

Are there other reasons that car loans are considered a bad idea? Am I missing something?

Thank you in advance.
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Re: Are car loans really that bad?

Post by camptalcott » Mon Feb 02, 2015 12:36 pm

kafshar1 wrote:I have noticed that a substantial number of BH have commented that car loans are unwise and instead cars should be purchased with cash. I was wondering if someone can elaborate to exactly why this is.

The reason I ask is that my last two car loans were for 1.99%. That doesn't seem too bad to me. I know that a car is a depreciating asset but, unfortunately, I am going to need to own this depreciating asset no matter what.... so what is the big deal about 1.99% interest vs cash. The only thing I can see that makes getting a car loan not great is that the insurance coverage required by the bank for your car (until you pay it off) may be more insurance that you would otherwise purchase.

Are there other reasons that car loans are considered a bad idea? Am I missing something?

Thank you in advance.

As with any advice you have to take what you hear here with a grain of salt. Personally I try to basically live below my means and make decisions with that in mind.

My job is 48 miles up I-95 each way, so a reliable, comfortable, safe care is not a "luxury". I generally have kept my cars 8-12 years and the last car I turned in had 280K miles on it.
I have a 2 year car note with a 0.9% interest rate. I have no problem with that.
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Re: Are car loans really that bad?

Post by Quickfoot » Mon Feb 02, 2015 12:39 pm

We lease new cars every 3 years, we don't mind car payments or rent / mortgage but prefer to avoid other forms of debt. Leasing / financing a car is not bad if you can afford to do it and meet your other financial goals like saving for retirement or putting food on the table and if you have sufficient cash reserves to pay the debt should an emergency happen.

Interest rates are extremely low right now so car loans are not necessarily a bad thing, should interest rates go back up to 10% or so for a car loan then cash makes a lot more sense. Also a lot of people cannot afford car payments and save for retirement, those people would be better served by not carrying a car loan.

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Re: Are car loans really that bad?

Post by staythecourse » Mon Feb 02, 2015 12:58 pm

The key to investing, as it is in life, is to think for yourself. Get as much info. as you can and decide what is the right decision for yourself.

My wife bought a car 2 yrs. ago with an APR of 0.5% for 5 years. Stuck in the numbers based on how much I wanted to put down and the APR in a calculator and it came out to a whopping extra $500 I would be paying. I thought the chance of not making more money taking the extra money I was going to pay to have the care paid in full and instead dropping it in my portfolio was slim.

Every decision needs to be done with what works for YOUR situation and what makes you feel comfortable.

Good luck.
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Re: Are car loans really that bad?

Post by bs010101 » Mon Feb 02, 2015 1:01 pm

Some Bogleheads will extensively research a car price, then once they've negotiated the lowest possible price, will take a 0.9% loan so they can keep all their month, worth many times the car price, fully invested in their target asset allocation. This is probably a reasonable thing to do. Others prefer to avoid debt, and even though they could earn higher market returns, prefer to pay cash. This is also a reasonable thing to do (and what I have done).

The other 99% of people taking out car loans will not even both multiplying the monthly payment by the number of months, but will rather just say things like "only x per month!" or "free money!" and will buy way too much car, or overpay for a car (I have done this too). So, they would be better advised to save up and pay cash for a car they can afford. You can regularly hear these folks featured on the Dave Ramsey show making $50K a year and trying to pay down $40K truck loan.

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