Aside from a mortgage (which thankfully, I don’t have yet) and student loans, the next big debt that a large number of adults take on is a new car. With more Americans finding it difficult to save up enough money just to cover a few months of expenses, most car buyers choose to take on auto loan debt as the default solution, without even considering (or more likely, keeping a blind eye to) other options.
Point in case: me.
My Auto Loan Nightmare
My first experience as a car buyer was actually pretty disciplined from a financial standpoint. Finding a car that matched my personality was just as important to me as reliability, longevity and price; after a few months of research, I knew exactly what I was looking for:
- Mazda Miata (any model year)
- Odometer at under 80,000 miles
- Overall good body condition
- Mechanically sound
The maximum I could afford to spend on the purchase was $4,500 — not much, but enough to get me around to interviews after I graduated from college. I found a 1996 Mazda Miata M-Edition with 75,000 miles in excellent condition on AutoTrader.com, priced at $5,000. At the time, it was a steal since other sellers priced comparable models in similar condition closer to $7,500. After a couple test drives, a review of past service records and short negotiation, I was able to draw the seller down to fit my budget and all was well.
That is, until three years later when the transmission wouldn’t shift into the proper gear, the speedometer and odometer gave out and every drive on the freeway had me scared for my safety — worried I’d be stranded in the middle of downtown Los Angeles traffic. Instead of taking a financially sound approach to it all (i.e. having my car repaired or selling it and buying another used car), I decided to use my paltry $1,000 savings as a down payment on a brand new $23,000 car.
Now, I’m stuck with an auto loan of over $20,000 with a monthly payment of $399 for the next five years. Despite the fact that I’ve witnessed my friends agonize over their auto loan payments and complain that they’re always broke, I didn’t think twice about taking on the massive auto loan debt once I’d already had my eyes set on a car.
I might not have heeded the advice of my peers, but you can still avoid the financial burden of an expensive auto loan.
Use Dave Ramsey’s Approach to Budget for Your Next Car
When I decided to finance a new car, I made the fatal error of only looking at my monthly income and estimated payment. I crunched the numbers and somehow reasoned that I could afford to pay up to $500 per month on a car loan.
At no point in the process did I stop to consider, “Yeah, I could… but should I?”
Dave Ramsey argues that the total value of your vehicles (including cars, motorcycles, boats, etc.) should not equal more than half of your gross annual income.
“You are not wealthier by having a nice car and a big loan. If anything, you are poorer,” proclaims Ramsey.
Furthermore, Ramsey recommends that drivers purchase a beater car for a small cost of $2,000 cash, with the expectation of driving it for 10 months. The money that would have gone to an auto loan (in my case, $400 per month) can then be set aside for your next car purchase, which after 10 months, will be $4,000. On the other hand, if the $2,000 car is still running strong, continue saving to be able to buy your next vehicle in cash.
Ultimately, Ramsey poses the question to his followers: “What could you do with that [$400] if you weren’t paying for the car every month?” His answer — “anything you want!”
Photo credit: Jason