Auto Loans and Personal Finance
Personal finance gurus seem to have differing opinions on many subjects. Some of them believe that mutual funds are good investments whereas others think the exact opposite. They seem to agree on very few things and auto loans are one of them.
Almost every personal finance guru in America believes that auto loans are bad for a persons financial wealth and therefore advise against keeping one.
In this article, we will have a closer look as to what auto loans are and how they impact the financial health of the person carrying these loans.
Numbers Dont Lie
The gravity of the auto loan problem can be understood with the help of a few statistics. Lets have a look at some of them below:
- Close to 100 million Americans have car loans that are yet to be paid! This works out to about 45% of the adult population of the United States. In a way, nearly everyone has a car loan! This makes auto loans one of the most used credit products in America. It is right there with the mortgage and student loans.
As of now, the total value of auto loans outstanding is more than a trillion dollars! This number is alarming since it has never reached so high in the past.
- Out of these 100 million people, more than 7 million are three months behind on their car payments. These statistics were taken before the pandemic.
Hence, it is likely that the situation would have worsened by now.
- More than one-third of the car loans are for a seven-year period. This is alarming because the vehicle deteriorates a lot during the seven-year period. Hence, many Americans are still making car payments while their brake pads are failing or their wheels need to be changed!
- The average car payment for an American is $500 a month. This means that over $6000 per annum are spent on car payments per person in an average middle-class American family. It is common for families to have two or three cars.
Hence, the number becomes much larger. Also, the $6000 is only towards car payments. There are other costs such as insurance, servicing, repairs, etc. which are not even being taken into the equation. If that is taken into account, cars stand out as the most wasteful expenditure in the household budget.
- Many auto manufacturing companies have their own companies to finance the cars that they manufacture. It is a known fact that these companies make more money off the auto loans than they make off the cars!
Why are Auto Loans Such a bad Deal?
The automotive companies have marketed their product so well that many people believe that they will always have a car payment. They believe it is like a utility payment and hence they are supposed to pay it for the rest of their lives.
However, this is not true since auto loans are considered to be a predatory financial product that negatively impacts the financial health of the investor. Many financial planners are advising their clients against taking auto loans for the following reasons:
- Auto loans get people to spend more. Several studies have confirmed that people tend to buy more expensive cars on loans than they would have purchased with cash.
The auto manufacturing companies price cars in such a way that there is always a tendency to buy the next, more advanced model. Also, they tend to aggressively market products such as extended warranties and accessories which people tend to buy making the auto loan more expensive.
- When you buy an expensive car, not only does the finance company make money but you also have to pay more money to other companies such as the insurance company, the garage, etc. A more expensive car may also consume more fuel. In a way, it raises your overall household expenses to some extent.
- Auto loans charge interest on this high amount while the car is losing value at the same time. The average interest rate charged on an auto loan is close to 7%.
Hence, in 7 years, the borrower pays close to 1.5 times the value of the car. At the same time, after 7 years the car may not be worth even 30% of its original value!
- If the $500 which an average American spends towards car payments, is invested for 30 years in a mutual fund giving average returns, the resultant corpus would be greater than $2 million. This is more than what a lot of middle-class Americans have when they retire.
Hence, in a way, it can be said that car loans are keeping people poor in America.
The bottom line is that auto loans are bad and should be avoided. When a person buys a car with cash down, they seem to be more mindful of the costs.
The financial logic about this is clear. However, as we know, personal finance seldom works on financial logic. Instead, it works on emotions.
This is the reason that people continue to take self-destructive auto loans in order to impress people that they dont like with money that they do not have!
The bottom line is that the right thing to do is to buy a car with cash down and the value of the car should not be more than 5 times the monthly income of the person.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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