Why I’ll Be Buying My Next Car With A Car Loan

One of the tenets of the personal finance community is to never take on debt, especially bad debt. What the Handy Millennial means by this is that consumers are not supposed to take on any kind of debt that is not a mortgage, and the mortgage is supposed to be as small as possible.

At face value this seems to make sense. After all, who wants to pay interest? And while you can take a loan for everything from a Big Mac (credit card) to your own personal island (jumbo mortgage), is it really smart to pay interest on that?

But why the heck not?!?

Well today I’m going to challenge this tenet a bit and tell you, my dear reader, that I will be buying my next car with a loan. Gasp… what!!!… did the Handy Millennial lose his mind? No my dear reader, I have not.

You see, a car loan is a tool, and if there is anything that the Handy Millennial loves, it’s tools!! I love tools so much that I film myself using them and I pretend it’s for your viewing pleasure.

But seriously, like any good  tool, a car loan can be misused. It can get you into trouble. And it can hurt you, financially speaking. But you won’t let that happen, now, will you? You’re much too smart for this.

So with this in mind, let’s walk through some of the reasons why buying a car on credit might not be such a terrible idea.

Seven Facts About Cars, Car Loans, Investing, and Inflation

Fact #1: Car Prices are Plummeting (Cars, not SUVs)

Cars are a commodity. There, I’ve said it, now let me go cry a little bit. As much as the Handy Millennial loves cars, it’s pretty obvious that cars are a commodity now. How did things get this way?

Sometime around the mid to late 1990s, car companies finally figured out how to make cars reliable. Gone were the days of the Ford Pinto, and in were the days of the little Honda hatchbacks that lasted 200k+ miles. On top of this we somehow figured out how to make cars rust slower. In fact, there is a legendary Volvo built in the early ’90s that had to be killed off via marketing because it was virtually rust proof. Not so good for business.

And because cars simply lasted longer, this meant it was easier and cheaper to own one. So more and more people could afford to own a car. Great because our society depends on owning a car; bad because we get to sit in more traffic and pollute the planet.

At the same time, car rentals became a big business and auto makers decided it would be a great idea to push millions of cars into rental agencies. The trouble was that rental agencies turned over their fleets every few years, so a tidal wave of used cars entered the market around 2001-2003, just in time to flood used car lots during the 01-03 recession.

The dive in car prices was briefly held off with the Cash for Clunkers program, which was well-intentioned but in practice simply resulted in putting a floor under used car prices.

Not to worry, 8 short years later, car makers have found a way to flood the market again. This time under the guise of cheap ownership, millions of leased cars are flooding the market. This at the same time as electrification is putting a big question mark on the future of the internal combustion engine and therefore driving the used market prices toward zero.

So in summary, cars are cheap, dirt cheap. Want an example? 2016 Ford Fusion – new: $28,000, used (30k miles): $13,000. Now that’s a car that will probably last you at least another 150,000 if you know how to take care of it.

Fact #2: You should be buying something reasonable. Do you really off-road on the weekends?

Nobody has any business buying a truck unless they are hauling something, and no your dog doesn’t count, that’s just cruel.

That’s right, Cujo wants to ride up front!

Nobody needs an SUV to drive alone to work. Seriously, why do you think that you need a car that’s bigger than a tiny house to sit comfortably through boredom?

Somewhere along the way we allowed marketing to associate our natural inclination to feel powerful when we are big with necessity. Instead of up-spending to have a safer SUV, spend a few hundred on defensive driving lessons. Bonus: This will decrease your insurance rates.

Lastly, buy something you can actually afford. This will get you there:

So will this:

Now there is a range of options in between that will fit every single budget. Pick something that you can afford. How much is that? Well ask yourself: Self, if this car was hit while parked, could I afford to replace it? Self, if this car was keyed while sitting on the street would I freak out? Self, are you comfortable losing this much money?

If the answer to any of these questions is NO, then simply lower your price budget. Personally, I like the Financial Samurai’s budget: 10% of your take home income. Anything more than that and you start to run into trouble with your self while asking questions.

Fact #3: Save your Emergency Fund.

Emergency Funds are for EMERGENCIES. Buying a car does not equal an emergency. What’s that? You’ve been keeping a spare account with monthly savings for a car? Really?!? Well, why would you do such a dumb thing?

See, for the last 10+ years while you were driving your old jalopy, your extra account could have been invested and making a heck of a lot more money! And if you’re like me and have had your car for 15+ years, then you’re really shooting yourself in the foot.

See what you’ve been doing is keeping an EXTRA emergency fund. And since you, my dear reader, are already diligently holding 6-12 months in a bank (you are, right?), any extra money should be invested, minting more dollars for you!

Now if you’re following this advice, then there is only way way to purchase a car.

Fact #4: Loan rates are still cheap, and car loans are just a type of tool

A wonderful aspect of our current Goldilocks economy (I swear I didn’t make this term up) is that nominal inflation is low. And because of this, the Federal Reserve and a whole host of other banks around the world have kept their own internal interest rates low. Which means we as consumers benefit from low loan rates.

What does this mean? It means that right now, I can get a 3-year car loan at 2.29% percent per year.

Now here I’m going to warn you, my dear reader, to never walk into a dealership looking for a low loan rate. You see, the difference between the loan you sign and the one actually given to the dealership by the bank is called the spread. And guess who pockets the spread as profit? Not you.

So get yourself pre-approved before car shopping. And if you were to get such a low rate, let’s see what you would pay in interest over the course of the loan.

Plugging these numbers into Google’s trusty car loan calculator I get:

$357 in interest!!! For the privilege of taking $10,000 from a bank and letting them take the risk that I can’t pay it back I have to pay them $357. That’s really not very much money at all!

If you think it is, read the next Fact.

Fact #5: Inflation Exists and IS a real thing

But wait, the low interest rate isn’t even the best part. While paying off the car loan, each year you will pay it off with depreciated money. What does this mean? Because of inflation, each year money is worth less. And while your salary is hopefully getting an inflation adjustment, the loan amount and payments are not.

Now the last 10 years have allegedly had minimal annual inflation as measured by our friends at the Fed. This means that this period makes an excellent choice for my example here. Since inflation was so “tame,” you my reader, will hopefully not object to the following napkin math.

From 9/2014 to 9/2017 (3 years) the value of a dollar fell a little less than 4%. How do I know this? Well I used the CPI Calculator of course!

So then let’s say that we took an auto loan in 9/2014 for $10,000 at 2.29%. Then by September 2017 we would have paid $10,357, right? Not so fast: the key question is according to which year.

Let’s say we want to know how much we paid for the car in 2014 dollars. Then what we do is divide 10,357 by 1.04 and find that in 2014 $$$ we paid … drum roll please… $9,948.65.

That’s right, we paid less than we would have paid in cash in 2014. Now this is coarse math to be sure, and the real answer is probably a hair over $10,000 due to the incremental loan payment, but you see my dear reader, the case for NOT borrowing is rapidly being chipped away.

Fact #6: The Market Return Still Beats the Interest Rate (Yes, even if it’s 4-5%)

The stock market has historically gone up like this:

And this isn’t even a terrible cartoon. Every crash has led to an economic boom and we have marched forward. Don’t believe the Handy Millennial? Just listen to Warren Buffet. Be an optimist because the optimists have won for the last 120(!!!) years!

Now there are naysayers. They point to historical comparisons and tell us that stocks will tragically have weak returns going forward… blah blah blah. And the weak returns are in the range of ONLY 4-5%.

First of all, no one, not even the Handy Millennial, has any idea what the stock market will do. Second, 4-5%… per year?!? And that’s bad? Sure maybe on a historical basis, but it sure is better than the <1.5% inflation that we have been having annually. That 4-5% dwarfs the interest rate of 2.29%.

So rationally, would you keep your money making 5% while you spend 2.29%? Even if you aren’t good at the math, which one is bigger, the + or the – ?.

Fact #7: I Invest For the Long Run

This is a simple one. I’m invested and I keep investing for the long run. I ignore the noise and keep my scheduled investments on track. And you should too. This is how you, my dear reader, and the Handy Millennial will survive and thrive into retirement.

And in the long term, on a retirement time horizon, the market has returned around 7% (annually) after inflation. So there is no reason to forgo 7% average returns for a 2.3% loss.

Conclusion

So in conclusion, as long as you keep the overall cost of the car low (and you should be able to do that because of Fact #1), you buy something reasonable (Fact #2), you remember to get a low interest rate (Fact #3), and you are regularly saving large chunks of your income (Facts #6 and 7), then the Handy Millennial sees no problem with taking a loan to buy a car.

Just remember to cut some other expense (ex. hefty mechanic and gas bills) to make up for the new car loan payment. 😉 Otherwise, it’s just lifestyle inflation.

15 thoughts on “Why I’ll Be Buying My Next Car With A Car Loan

  1. Well presented argument and one that I made at your age myself and it is absolutely solid logic. I did buy a new car with a low interest car loan back then. Now however as a FI and early retired older version of myself I’d never dream of borrowing money for anything. I could write a check for a $250,000 Ferrari if I wanted to but I prefer to buy two to five year old cars with cash and run them to 200,000 miles. It isn’t the math that has changed but when you haven’t owed anyone a cent in fifteen years you just don’t want to get back into that feeling that you have debt. Free feels way too good. Some of us can justify SUV’s here in flyover country to pull our fishing boats and ATV’s and to off road with but I agree, city folk driving big 4wd super duty pickups confuse me.

    • Hi Steveark, thanks for your comment and thanks for the compliment! I agree with what you’re saying here. I’m thinking in the short term, as in during the accumulation phase, it may be beneficial to employ some of this logic. What I mean by this is, while you are still in the run up to FI, take a small payment and keep money invested.

      However, once FI, there isn’t really a point anymore in taking such complicated steps. So from your point of view, there really isn’t a point to doing this.

  2. For me, a car loan is just another bill in life to deal with – one I’d rather not have the hassle of. Sure, perhaps historically your investments may perform better, but on such a short timeline the volatility isn’t worth it to me.

    I’d rather pay cash, deal with any potential 3-4% opportunity cost, and not have to worry about it. The removed stress is worth something to me.

    But alas to each their own 🙂

    • Hi Dave, thanks for stopping by! You’re right that is the reason to buy cash is to reduce your stress. I’d say that the reason to pursue FI or extreme saving is at least initially very much to reduce stress.

      I just wanted to showcase for people that loans are a tool. And like any good tool you can use it either way.

  3. I second that – you present a good argument. It’s tough because no one wants to be in debt, but at the same time it doesn’t make sense if you need a car and the only way to do that is to empty out all your savings. I think that’s a big no-no. For me, I would probably pay half the car in cash and get a small loan, or if I couldn’t do that – get a car loan and then immediately pay half the loan off immediately. I think it’s important to save some money for a car. Also, it only makes sense IMO to take out a car loan and buy the car completely then lease. I think leasing is the worst option, but that’s just me!

    • Hi Jen! Thanks for stopping by! I totally agree with what you are saying. It is tough, you need a car both for work and to enjoy the outdoors. I also like your strategy of going half and half. I would put down some money to make the monthly payment less egregious in my Quicken and then slowly pay off the rest. I would also only do this under the condition that I could pay off the car any time I want. This would go a long way to reducing the stress of having a loan.

      As for leasing… I need of those Twitter GIFs right now…

  4. You mentioned the 2016 Ford Fusion as a deal. Any other particular models and years that are bargains? My daughter is 15, just started her first job, must save some money, and then we will help with a car. As a HS physics teacher, I hear lots of car wreck stories, and we need a deal.

    • Hi Mr. Jump Start. Thanks for reading my part! I’m glad you enjoyed it. Right now is a great time to buy a car. By the time your daughter is 16 it will be even better. The reason is that leases are coming in at record rates. 2018 and 2019 should see a lot of pressure on used car dealers.

      To get a good deal you want to look at cars, the smaller the better. Since gas is cheap people have decided to go after SUVs. Avoid this and you should be able to do well.

      I would also stay away from hot brands like Subaru, Toyota, Honda. If you can find a deal with those then great. They are good cars but people are up bidding them.

      I would look at something like the Ford Focus 14+. You should be able to find lower than 30k miles at less than 10k. I’ve seen them go for as low as 8k. People also like the Fiesta, small and cheap. The Korean brands offer pretty good warranties and their reliability has been climbing a lot. Check out consumer reports. But start with say a focus at rock bottom prices like 8-9k and compare from there.

      Lastly, with regard to safety. Yes p=mv but your best and first defense is you! You should never rely on the car to save you. Have your daughter take a classroom driving theory course – see AAA in your area. I did this at 16 and don’t regret 1 minute of it.

      Of course do make sure you buy proven life saver technologies -ABS brakes, stability control, side curtain airbags (all exist on the focus) and some now even have preventative braking.

  5. Hi there HM! I think since you are on top of your finances its not that big of a deal. I think why I enjoy no car payments is because keeping overhead low is huge to set yourself up for future opportunities. When you use debt to buy something that you have to keep paying into (car) vs something that pays you (investment property) I think you lock yourself into a higher overhead. I would rather have the money to invest and no worries of high overhead should things correct in the markets (which leads to job loss).

    Thanks ,

    DM

    • Hi DM! Thanks for stopping by. Great point, as long as your on top of your finances it’s no big deal. That’s why I would actually take on a car loan I could pay off, I’m merely using this as a tool to reduce the overall cost. But we share similar sentiments: keep yourself open to invest when downturns happen, keep your costs low!

  6. I went through the car replacement process early this year. Our older car turned 20 years old and started to develop some serious problems which were not worth fixing. I ran the numbers myself on the new car with a loan and the used car debate. The options were buying a used car for roughly $5k or buying a new car with throwing the $5k in and then paying back the rest in a short period (probably 3 years or less). This way it would have cost only a couple of hundreds of interest which in my opinion could be a rational choice, even when I did not have potential return and inflation in mind. Thanks for pointing them out btw. My biggest driver for the new car was, that I am not a handy type and I can be easily tricked when buying a used one. Also, there is a chance that you will earn the couple of hundred bucks in the lower fixing costs of the new one. Still, in the end, the used car version won, because of two personal reasons. First, I was changing jobs and the bank needed 4 more months of salary proof and the older car did not have that much time. Second, a friend of mine, who is a car dealer found a used one in good condition for a reasonable price. So we went that way this time and we did not regret yet. But I would consider the car loan scenario again once we have to replace this one.

    Three things to consider/include in the decision process.

    -Check if the loan allows early repayment or if has a penalty for that. I have heard stories when someone took the loan for a longer period, thus paid smaller monthly payments and after a year or so paid back early with no penalty. This way the overall interest paid back was less than if he took the loan for a shorter period.

    -Maybe you read this(http://mymoneywizard.com/the-car-negotiation-strategy-i-used-to-save-3000/) story from the MoneyWizard where he explained that he even got a $1k discount in case of using a loan. He took the advantage and paid that loan (almost) immediately when the payments kicked in.

    -Buying a new car can result in less fixing and repair prices which can exceed the interest alone. Buying a used car can be a pig in a poke. I am satisfied with our used one, still have to befriend with the check engine light (because of medium quality fuel and aging lambda sensor combo).

    Interesting read, thanks for sharing.

    • Hi HCF, thanks for stopping by! And thank you for sharing your story. I think that you explained very well the back and forth that goes on in your head when you purchase a car. There are always a lot of factors to consider. Seems like in your case you made the best decision in the end!

  7. This is my favorite post so far. Debt is not inherently evil. It can be used as a tool to help you achieve your goals.

    Would love a follow up post on how not to buy a lemon. I know nothing about cars. The math says to buy used. How do I know I’m not getting a piece of junk? Many people buy new to avoid this risk.

    • Hi Jason, thanks for stopping by! I really appreciate this comment. I have gotten responses on both sides here. However, this line “Debt is not inherently evil. It can be used as a tool to help you achieve your goals. ” is exactly what I was hoping that readers would get from this post!

      Thanks for the great post idea too. I think that would be an awesome post. I will put it in my queue! There is an interesting sub-question here. We buy new because we don’t trust that others have maintained it well. However, we does this because we don’t know about cars. In this case, how can we be certain that we will maintain the new car as well as possible?

Leave a Reply

Your email address will not be published. Required fields are marked *

*
*
Website