Last Week, Joe from Retire by 40 published an article, Why I Hate Auto Loans*. On almost every financial topic, I find myself feeling that Joe and I share the same brain. This appears to be the exception that proves the rule. That makes it a topic worth digging deeper.
Before I get into why I love car loans, I’d like to bring up some of the great points Joe made.
Psychology of Making Payments
“We could have taken out a car loan with near 0% interest, but we didn’t want to do that. I’ve had auto loans before and I despise sending in those monthly payments.”
I can understand the pain of making monthly payments. We got solar panels so we can avoid making electricity payments. However, a lot of the pain can be avoided with automatic payments. We pay off our house, our credit cards, kids’ daycare, and all sorts of things every month. I don’t feel that adding a car loan is any different. It’s not as if I hate our mortgage so much that I’m going to skip investing in order to pay it off early. I’m also not going to prepay a year of the kids’ daycare.
Looking at the Math
Joe does some math and concludes that getting an auto loan at a low interest rate (3%) might allow him to invest and make between $11,000 and $20,000 (with the $11,000 number being more accurate).
I agree with the math. From a high level, if someone is going to give you a loan at 3%, you are likely to do well investing in the stock market (except maybe not this market).
Joe turns his attention back to psychology, so we will do the same.
Psychology of Car Payments
The first thing that Joe mentions is that there’s a “temptation to buy more.” I can see how consumers could get wrapped up in that, but I don’t know if most consumers pick their car based on interest rate. I know that hasn’t been one of my top considerations in any of my car buying decisions. I created a budget first and then matched the car to that. Maybe I’m not like everyone else?
I will grant the “temptation to buy more” one valid point. In the northeast a remote starter is a great value. It’s great to get in a nice warm car that’s ready to go on the coldest of days. I was going to get an aftermarket one, which wouldn’t have been very expensive. I probably paid a little more to spread the payments out over 60 months. It was a relatively cheap upgrade that I was getting either way, so the difference was paying the dealer’s price vs. the aftermarket price.
The second thing Joe brings up is “are you going to really invest the money?” He reasons that most people would take the $15,000 and invest it in something fun like a jet ski**. I can definitely see this happening. However, I’d counter and say that most people don’t have the $15,000 sitting around anyway. If they do, it’s probably a large part of their emergency fund.
I have two auto loans, one at 0% and another at 2.5%. I can’t say that I’ve taken the leftover money and invested it in the stock market. However, being able to spread the payments has made it easier for us to manage other expenses such as my wife’s online master’s degree or some of our home maintenance.
Being able to manage those expenses has allowed us to max out Roth IRAs/TSP (government 401k) and things like that. So even though we might not directly take the exact same $15,000 and investing it, the flexibility of spreading out expenses does allow us to invest more.
Finally, I’m also not big fan of big sudden expenses. I’d much rather have them spread out over time. It makes it easier to budget when expenses are smaller.
Next Joe brings up that cars are “a depreciating asset”. I can’t argue that, but I don’t understand the significance. A car is necessity for our ability to earn income, so whatever the value is later on down the line isn’t a big deal to me. While there is a comparison to made towards another large expense such as a home, we have to remember that the home itself depreciates without maintenance and it is the land/location that is appreciating.
Lastly, Joe brings up how paying for the car upfront helped him lower his expenses while he plans for early retirement. While I can appreciate that view, I prefer to plan for a car payment… unless until the Uber gPod is invented. If buying cars do become a thing of the past the same money will be used for however the transportation works.
Final Thoughts and Your Turn
Everyone is entitled to their own opinion and I can certainly respect Joe’s here. Personally, I feel differently. I try to go with whatever reduces my stress, which means spreading the payments over a long time. It’s different things for people, so there’s no right or wrong option here.
Do you love or hate car loans? Let me know in the comments.
* I’m going to totally take credit for this article. His response to my comment a week earlier included the phrase: “I hate car loans.”
** This is really eerie. A jet ski is always the example I use with my wife. Like I wrote in the beginning, sometimes we seem to share a brain.
One thing to note is that the low interest loan is often in lieu of cash back. So you get a 0% loan OR $1500/$2000/$2500 cash back. So that’s something to account for.
But if you can get a 0% loan without giving anything up, you absolutely should do it.
My parents once had a 0% loan on a car and paid the loan off early. I felt like beating my head against a wall.
As you can imagine, I have an opinion on this topic. With any transaction on the planet, there are 4 main drivers for any purchase. The genesis (or reason) for the purchase, the utility of the purchase, the deal on the purchase, the financing on the purchase. Everything you every buy you have to equally manage those four aspects. Picture a square, and on each of those four sides, you have each of those four items. The location of the resultant purchase can be placed within that square and you generally want to have it close to the center of the square.
So lets map this. I am going to buy romaine lettuce. The genesis for the purchase is food, sustenance, something that tastes good with chicken and Caesar dressing. The utility of the purchase is to sate hunger (which for me is rather high on my list). The deal on the purchase is $1.99 for an organic head from Kroger. The financing is immediate as I pay for it as I walk out the front door. So is it worth it for me to immediately pay $1.99 for an organic head of romaine lettuce, to sate my hunger. The answer is heck yeah.
Now back to car financing. I look at the overall purchase when I make decisions. I bought a new car (well truck) a few years ago. I at the time had a 10 year old Nissan CUV which worked well, had about 100k miles and was by far paid off. I just wanted something different, and also needed to tow more, so was looking at something more capable. So that was the genesis of looking for a car (I took 2 years to get the right deal before I pulled the trigger). Since I was looking, I sat in everything and it came down to 4 vehicles (which I could fit in comfortably). I hit the holy trifecta of big, tall, and wide. I don’t fit in most cars, especially those with large or high center consoles (which seem to be the rage now days). So I had to look at what would work for me and provide maximum utility. I looked, and talked to dealers and looked at inventory and even considered ordering, but could not be guaranteed any specific rebates or deals as who knows how long it would take to get into the dealer.
So close out of model year, I found what I wanted, had everything but 2 options I wanted. I went into the dealer and told them I was looking and what I wanted. I negotiated the deal to better than GM pricing (before rebates) and they threw in 4 options. So the deal was very solid, now came the financing. Well they offered 0.9% financing for 6 years. Hmmm. Over the term of the loan I will pay $1,100 in financing (if I don’t pay it off early) on a $38k. All I have to pay is $525 a month. I can do that. So the financing was fine by me. If you gave me a week I could pay off the truck and I would not have a problem with it.
So the real issue I see is people don’t like to be beholden to someone. They don’t want to know they owe money to someone. They don’t want to have to worry in the future if they lose a job, or something, that they will also lose the asset. Better to pay $10k for a car and own it, than to pay $40k for a nice new item and pay it off over time. Yes it is a depreciating asset but so is everything, including houses. The issue is you get utility for the item (cars take you places so we don’t have to bike or walk). That is just the way our society is. If you cannot trust that you wont spend like a madman because you have money in the bank but you don’t realize it is for your car payments, then I can see you don’t want car payments.
It is 100% up to the individual. I don’t mind car payments. If I have a surplus after the end of the month, I am happy, and that is all that I care about. There are very few hard truths in financial management or to levels of frugality. It is all personal, and how one person manages themselves. My son is a great example. He has the most messed up way of thinking of budgeting. I don’t understand it (I have an MBA in financing, trust me, I know math and numbers). Every time he explains something to me I just cannot follow his logic but it works for him. He typically has a surplus, has never run out of cash, and never had a late payment on anything. So my point by that example is, you do you, I do me, and we all can share what works for us, to help others get ideas to do what comes best for them.
Time value of money is never really a factor with our consumer purchases. We never take a car loan simply because it would limit our monthly cash flow.
We actually do invest all the money in various investments. Any extra cash flow gets invested. If we want a new car, we have to think twice how many investments to sell. It helps us choose a more practical car when we write a check.
Thanks for the mention!
It’s not all about the numbers. :)
Hey guys, I have a dilemma. Im the market for car. Thinking about buying Honda fit 2019 or 2015.
2019 fit is $16.5k,
2015 fit is $9k with 75k miles on it.
Which one should I pick?
I’d go with the 2015, but that’s just me. It’s pretty close though, I could see how someone else would say the 2019 is a better deal.
One key question is how long do you typically drive a car before moving on to the next one?