It's not that simple. If you plan on keeping the car and the interest rate is low enough you are likely better off taking the longest term loan possible.
Consider a $30,000 vehicle. I can finance it at 1.9% for 48 months or 84 months. The payment on the 48 month loan is $650/month (scenario 1) and the payment on the 84 month loan is $380/month (scenario 2).
In scenario 1 I invest $0/month for 48 months and then $650/month for 36 months. After 7 years I paid $31,178 for the car and earned ~$26,000 from investing (at 8%).
In scenario 2 I invest $270/month for 84 months. After 7 years I paid $32,062 for the car and earned ~$30,000 from investing (at 8%).
In scenario 2 I paid $884 more in interest but earned an extra $4,000 from investing.
There is a lot more that goes into this type of calculation but it is not nearly as cut and dry as "you're an idiot if you financed a car for 84 months."
That there is a scenario that, effected perfectly if you stand on one leg and squint and get super-favorable rates at just the right times, makes an 84-month loan not the worst economic choice possible does not mean that it's not the worst economic choice possible. Because it is the worst economic choice possible.
> After 7 years I paid $32,062 for the car and earned ~$30,000 from investing (at 8%).
Nitpicking, but you didn't earn $30k from investing. You contributed $22,680, and ended up with $28,910, assuming dollar-cost averaging contributions monthly (bulk contributions at the beginning of the year would get you $31,223). So your total return, assuming 8% annual growth, is $6,230.
I'd be willing to bet that MOST people who take out 7 year car loans don't invest half of their interest rates in stocks that average at 8% or higher...
If you listen to Freakonomics, they often say that we aren’t “Homo Economicus”. While what you say may make sense economically, that’s not how most people operate.
If you have kids or intend to have them in the future this is a life lesson they need to have drilled into them.
I bought the cheapest house within commuting distance of where I work (in London) and am still trying to figure out how the hell to get out of that mortgage sooner than the final term. My car was bought outright as was my campervan.
I don't know how the people who drop half a million on a house and 50k on a Chelsea tractor, earning the same wage as me, sleep at night.
Maybe a warning like on a cigarette pack could help? e.g. "spending more than 15% of your income on a car can lead to a financial ruin". Warning on cigarettes reduced smoking by a few percent.
So I have rocks in my brain for taking a 2.9% interest loan? I don't see it that way considering my investment horizon allows me to earn 8% in a vangaurd sp500 etf with the money I could have used to pay for my car outright.
This doesn’t make sense. You’re arguing that this was about capital allocation for you, but if that’s the case, buy a used car for half of what a new car would cost. If you buy from someone like Carmax, you can get access to loans which are almost as cheap as what you’d get on a new car, and you’re buying a car with very little wear and tear.
The alternative isn't to buy a brand new car for the same amount of money. The alternative is to actually buy a car you can afford.
You are still losing maybe 50% in the first year in depreciation. If you are paying it over 7 years then you are under water on the car from the minute you pick it up until it's paid off in full.
> Anyone that signs up, of their own free will, for a seven year loan on a depreciating asset has rocks in their head. For fucks sake.
Whether this is good or not is completely dependent on the loan interest rate, a person's cash flow situation, and what they will do with the free cash flow otherwise..
$50-100/mo saved due to lower 7y payments reinvested elsewhere could quite feasibly offset the higher cost associated with the (assumed) higher interest rate of the 7y loan.
And, according to the assumptions in financial/economic theory anyway, if you can get a loan at or below inflation rates, you're getting a 'discount' on the total price w/r/t paying 100% cash now
But yes, this should be made as a 'financing' decision, not an 'affordability' decision - if you can only afford the vehicle with 7y loan at all, and aren't taking the longer loan as an savings/investment decision among weighing the TCO you probably should be buying a cheaper one.
Alternatively, there are individuals who live month to month and having tired of beaters and decide this looks affordable. While clearly a false economy, some individuals may have other motives, like status seeking.
This doesn't mean they are rock-headed. Like all of us, they could have a blind-spot where a decisions made may not be in our long term economic interests.
I think if you are living paycheck to paycheck and don’t have disposable income, it may make more sense to buy a cheap new car with a warranty than a cheaper used car.
It’s much easier to get a car with a $350/month car note where you won’t have unexpected repair expenses than getting a $200/month car note on a car without a warranty and then have an unexpected expense.
Now we have a credit card with the car shop we used that has a six months/no interest program. I use that even if I do have the money. But if we had bad credit, we could get a car loan much easier than an unsecured credit card.
I am at a point in life now where I can afford an expensive car repair bill and it just stings a little bit. When I was first starting out decades ago working at night as a computer operator while I was in graduate school during the day, any unexpected expense meant a call to my parents. Many people don’t have that luxury.
They do although they don't necessarily call it that. When I had to get my dad a phone in a hurry from AT&T, the only option was to pay for it monthly as part of my phone bill.
hurricanetc|6 years ago
Consider a $30,000 vehicle. I can finance it at 1.9% for 48 months or 84 months. The payment on the 48 month loan is $650/month (scenario 1) and the payment on the 84 month loan is $380/month (scenario 2).
In scenario 1 I invest $0/month for 48 months and then $650/month for 36 months. After 7 years I paid $31,178 for the car and earned ~$26,000 from investing (at 8%).
In scenario 2 I invest $270/month for 84 months. After 7 years I paid $32,062 for the car and earned ~$30,000 from investing (at 8%).
In scenario 2 I paid $884 more in interest but earned an extra $4,000 from investing.
There is a lot more that goes into this type of calculation but it is not nearly as cut and dry as "you're an idiot if you financed a car for 84 months."
pwinnski|6 years ago
atombender|6 years ago
Nitpicking, but you didn't earn $30k from investing. You contributed $22,680, and ended up with $28,910, assuming dollar-cost averaging contributions monthly (bulk contributions at the beginning of the year would get you $31,223). So your total return, assuming 8% annual growth, is $6,230.
dirktheman|6 years ago
scarface74|6 years ago
VBprogrammer|6 years ago
I bought the cheapest house within commuting distance of where I work (in London) and am still trying to figure out how the hell to get out of that mortgage sooner than the final term. My car was bought outright as was my campervan.
I don't know how the people who drop half a million on a house and 50k on a Chelsea tractor, earning the same wage as me, sleep at night.
ed_balls|6 years ago
mrep|6 years ago
toasterlovin|6 years ago
VBprogrammer|6 years ago
You are still losing maybe 50% in the first year in depreciation. If you are paying it over 7 years then you are under water on the car from the minute you pick it up until it's paid off in full.
imtringued|6 years ago
scarface74|6 years ago
cat199|6 years ago
Whether this is good or not is completely dependent on the loan interest rate, a person's cash flow situation, and what they will do with the free cash flow otherwise..
$50-100/mo saved due to lower 7y payments reinvested elsewhere could quite feasibly offset the higher cost associated with the (assumed) higher interest rate of the 7y loan.
And, according to the assumptions in financial/economic theory anyway, if you can get a loan at or below inflation rates, you're getting a 'discount' on the total price w/r/t paying 100% cash now
But yes, this should be made as a 'financing' decision, not an 'affordability' decision - if you can only afford the vehicle with 7y loan at all, and aren't taking the longer loan as an savings/investment decision among weighing the TCO you probably should be buying a cheaper one.
scarface74|6 years ago
passer_byer|6 years ago
This doesn't mean they are rock-headed. Like all of us, they could have a blind-spot where a decisions made may not be in our long term economic interests.
scarface74|6 years ago
It’s much easier to get a car with a $350/month car note where you won’t have unexpected repair expenses than getting a $200/month car note on a car without a warranty and then have an unexpected expense.
Now we have a credit card with the car shop we used that has a six months/no interest program. I use that even if I do have the money. But if we had bad credit, we could get a car loan much easier than an unsecured credit card.
I am at a point in life now where I can afford an expensive car repair bill and it just stings a little bit. When I was first starting out decades ago working at night as a computer operator while I was in graduate school during the day, any unexpected expense meant a call to my parents. Many people don’t have that luxury.
c0wb0yc0d3r|6 years ago
ghaff|6 years ago