Welcome to the ninth installment of our 10-week video series, which will help you avoid the most common red flags that are keeping you broke. If you’d like to follow along with our FREE guide, you can download your copy here.
Our ninth red flag is your car is likely way too expensive!
Yep, I said it, but someone had to tell you.
First, let's talk about the payments.
Cars and car payments can be detrimental to your financial plan and here’s why:
Your biggest asset in saving money, getting out of debt, and reaching any financial goal you have is your income. There are too many people who are taking their income and tying it up in crazy car payments.
Often people are confused as to why they can't save or pay off debt or finally get ahead, and usually, the simple answer is, GET RID OF THE CAR!
The average car payment is floating right around $500, give or take a few dollars. When you take that big of a chunk of money from your income and invest into an item that drops like a rock in value, it’s hard to win.
Also, when you have payments, you are likely paying interest. And for those that are living paycheck to paycheck and struggling, you're not getting the best interest rates on that loan. So not only is your car payment high, but a good portion of that payment is going to pay for the other product you bought, which was the debt to purchase the car.
"Brad, I have a 0% loan! I am not paying any interest on my new car, so this doesn't apply to me!"
Not so fast! That's the least of your worries.
When most people shop for a new car, they may consider expenses like gas mileage, insurance rates, interest rates, and the overall car payment. But what most people tend to forget about is the most expensive part of owning a car, the depreciation.
It's difficult to calculate the exact depreciation you may experience in a new car because many factors come into play. Things like the make and model of the vehicle, options on the car, is it desirable, resale value, etc.
For this example, we are going to use some overall percentages to give you an idea. Let's say you buy a $30,000 car, in the first year alone you can expect to lose 20 percent of its value. That means that $30,000 car you bought is now worth $24,000. That's right. You lost $6,000 in value in the first year alone! Great deal, right?
Then, over the next three years, on average you will lose anywhere from 10-15 percent. So for this example, we will go with 12 percent, which is being conservative.
$30,000 Vehicle Purchase
Year 1 - 20% / $6,000
Year 2 - 12% / $3,600
Year 3 - 12% / $3,600
Year 4 - 12% / $3,600
Total - 56% / $16,800 in LOST VALUE
So let's look at this insane math here. In four years, you invested on average $500 of your hard earned income into a $30,000 investment, I mean car, that has lost at least $16,800 in value. Tell me about that ZERO percent interest rate again?
Also in many cases, people would still have two or more years to pay on the car because six-year loans have become the new normal. Do you see how that math doesn't work in your favor?
Let me put it another way that will be clear as day. Let's say I asked you to give me $30,000 cash right now, and in four years I would pay you back $13,200. Would you take that deal? HECK NO YOU WOULDN'T! But that's the deal you are making when you buy a new car. The only difference is that the vehicle deal is being masked by well, a car with a fresh new car smell and all the emotion that goes along with buying it. But the math is the same.
The single most expensive way to own a vehicle is to own it during its period of greatest depreciation. Buying brand new cars, whether you have payments or a lease, is owning it during its worst reduction in overall value.
And if you lease, your deal isn't much better. It's been documented and proven by many sources that leasing, in the long run, is more expensive than buying. And you're always going to have a lease payment.
But Brad, I need a car! If you're telling me that a brand new car is a bad deal and is causing stress on my finances, what should I do?
Buy used vehicles and pay 100% cash, so you have no loans or payments, period!
When you buy a used car, someone else has already taken that depreciation hit for you saving you tens of thousands of dollars. The used car will still depreciate, but it will depreciate at a much slower rate. Also, if you are wise and patient and you set aside money each month to pay cash for that used car, you will NOT have a car payment. Ditching the car payment will free up more of your income to save money, pay off debt, and reach all of your financial goals.
Many years ago when I was getting out of debt, I ditched my $500 car payment, and I bought a 1996 Toyota Corolla. It had 129,000 miles on it and a little rust. I paid $3,000 for it because that is what I could afford to pay cash for.
I drove that car for four years and put another 120,000 miles on it driving over 100 miles a day to and from work. So yes, that means I drove that car 500+ miles a week for four straight years. That is almost five times around the entire world in a 1996 Toyota Corolla!
“But Brad, I don’t want to drive an old car, that’s not cool,” you think. Yeah, well I don’t want to be broke all my life. That’s not cool either.
Do I want to drive an older car all my life? No way, but if sacrificing now can make my life a heck of a lot easier financially and allow me to win that much more in the future by being patient, I’m all for it.
Even today, I drive a 16-year-old pick-up truck, and my wife drives a 13-year-old SUV. These are fantastic vehicles, and they are paid for!
So today, I am challenging you, and for many of you, this is a tough challenge. If you’re putting more money into a car payment than a savings account, or if that car payment is preventing you from paying down debt, it's time to rethink your vehicle situation.
Kicking car payments was a major factor that got me out of debt, and will be for you too!