Cars have become a financial danger zone. The average price of a new car is around $50,000, and about half of that for a used car. And car loan rates are a lot higher than they were a few years ago. That’s pushed the average monthly payment to more than $750 a new car and close to $550 for a used car. No wonder so many of you tell me you are stressed about saving enough for retirement or building up your emergency savings.
I realize some of this is out of your control. There simply aren’t a lot of affordable models being sold in America these days, and used car prices have remained high since the pandemic shortage.
But I also see signs that some of you are making a bad financial choice.
Nearly one in three car purchases (new and used) involved someone trading in their existing car, even though they still owed money on the loan for that car. This is called negative equity, and the current average is more than $7,000. About 20% of trade-ins are for cars with loan balances of more than $10,000.
Look, if you are driving an unreliable car, or your family has expanded to the point your small sedan doesn’t cut it, I understand. But I think this is often just some sort of very costly lifestyle choice.
According to JD Power, 20% of all new car buyers went shopping for another new car within three or four years. Are you kidding me? Cars today are built to last. Unless you are putting 50,000 miles or more on your car in a year, why would you need to trade it in? Even more disturbing to me is that more than 40% of people who took out a very long car loan (at least seven years) were looking to trade it in in just a few years.
I need you to stand in the truth: do you need to trade in a car, or do you want to trade in a car? If that car is reliable and if you still have an unpaid loan balance, I say you are denied, denied, denied! Keep the car you have and thank me later.
I know car lenders make it so easy to trade in. They tell you that it’s no problem to roll over any unpaid balance on an old car loan into your new car loan. I am telling you it is a huge problem. Right now, that likely means you are giving up a lower-rate loan and taking out a much bigger new loan at today’s higher interest rates.
But my biggest issue is that you are setting yourself up for a life of making car payments. You think it’s no big deal to just keep trading in and rolling over negative equity into a new loan.
Hello? Are you also going to tell me you can’t possibly save more for retirement? Or that you have credit card debt? Or your emergency savings can barely cover 2 months of living costs, let alone the 8-12 that I think is smart and necessary in today’s economy? If any of those rang true, I sure hope you are not on the trade-in treadmill.
And don’t tell me that a car becomes unreliable after a few years. That is just not true. Will a car need more maintenance? Of course. But spending $1,500- $2,500 a year to keep a 4-10 year old car running great is a far better financial move than buying a new car that is under warranty, but your loan cost is more than $750 a month.
Let’s say you follow my advice and keep driving a reliable car for five years without any loan payments. Let’s also just assume that the payment was $750 a month. That’s $9,000 a year in loan payments you won’t need to make. Now, let’s also acknowledge that you might need $2,000 or so a year on upkeep for your older car. You’re still $7,000 ahead.
What if you simply saved that $35,000 over five years, so when it does come time to buy another car, you may be able to do it without a loan, or you would need a very small loan. That’s a huge win!
Or maybe you take the $7,000 a year and invest it in a Roth IRA. Earn an annualized 7%, and you will have more than $54,000. If you then keep that $54,000 growing and it continues to compound at an annualized 7% for another 20 years, it will be worth nearly $210,000. All because you were car smart.
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