Automobiles: Depreciating Assets
Everyone loves a great ride, and for many of us, the kind of car we drive is part of our identity. But when you’re trying to build up your assets and net worth, splurging on a depreciating asset is a huge mistake. Depreciating assets become less valuable over time, and you don’t need a degree in finance to see how that can endanger your financial security. But you may be surprised at just how financially harmful it can be to overpay for a car.
Automobile Negative Vortex
When you’re in the market for a car, it’s natural to want one you love, and many dealerships exploit that desire to push people into expensive loans for their dream car. But the truth is, cars tend to become unloved by year 3. That shiny new ride isn’t so shiny anymore, and expensive repairs often start cropping up in years 3 to 5, just as you’re nearing the end of that five-year installment loan.
I’ve seen this vicious cycle so often that I’ve nicknamed it the Automobile Negative Vortex, or ANV. Here’s how it goes:
- Buy first car for $20,000 with a five-year loan.
- Enjoy and love the car for the first two years.
- By year three, minor problems begin showing up due to age/wear and tear.
- By year four, tired of the issues, you trade in the car before the loan ends, resulting in $5,000 negative equity.
- Buy second car for $25,000 plus $5,000 negative equity. Let’s say your credit score is less than perfect – maybe you’ve missed some credit-card payments or defaulted on a cell-phone agreement – so you agree to a new loan for $30,000 with six years of payments at 25% interest.
- That $30,000 loan breaks down to 72 monthly payments of $808, meaning the total amount repaid over six years will be $58,184, with $28,184 of that in interest! The price of your car just doubled, and paying all that extra interest will definitely restrict your cash flow. Is your beautiful, shiny new car worth it?
- At month 37 of the new loan, halfway through the term, your loan balance is now $20,324, you’re starting to see those repairs crop up again, and you wonder how you got sucked into this ANV. You may end up putting those repairs on your credit card at 29% interest, and the cycle continues. See how vicious it can get?
Now, here are a few simple suggestions that will help keep you from becoming a victim of the ANV.
- Buy used, not new. A car that’s three years old will still be in overall good shape, but you’ll pay much less for it because the bulk of depreciation happens in the first few years of a car’s life. That means the previous owner, not you, takes the hit of that steep drop in value.
- Buy only as much car as you can afford. Before car shopping, take a look at your budget and figure out how much you can comfortably pay per month – then find a car within that budget. Don’t compromise the rest of your finances with car payments that are a stretch.
- Keep up with maintenance. You might be tempted to skip your car’s regular maintenance appointments to save money, but odds are, doing so will translate into more expensive repairs later.
- Drive your car until the wheels fall off. Not literally, of course, but the longer you can keep your car on the road in good condition, the longer you’ll enjoy a lifestyle free of car payments. Your checkbook will thank you.