Creating wealth and paying for expensive cars go together like oil and water.
- Dave Ramsey says car payments are the biggest detriment to wealth creation.
- Car payments cost an average of $733 in July.
- The problem is that cars depreciate quickly and the payment for your car is money you could have invested.
For many Americans, paying for a car is practically a reality. Cars are expensive, so if you want to buy a new one, chances are you need a car loan. And once that car isn’t so new, it’s time to repeat the process.
It might be a normal part of American life, but it can also hold you back financially. On his radio show, Dave Ramsey recently said that “paying for the car hurts your wealth, your ability to get rich, more than just about anything else.” If you’re considering buying a new car, Ramsey’s advice is worth hearing.
The problem with car payments
There are several reasons why car payments are so problematic, starting with their usual cost. The latest data shows car payments are at record highs, costing an average of $733 in July. The average cost of a new vehicle is $48,182, also a record.
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That’s part of why Ramsey doesn’t recommend car payments. The other problem, he says, is that “cars lose value. It’s the biggest purchase we as consumers make that loses value.”
People often think of car payments as a monthly expense, but that doesn’t really show you the true financial impact. Let’s say you buy a car and you have a monthly payment of $733. In one year, you paid $8,796. In five years, you paid $43,980.
Now let’s compare that to something else you could have done with that money. Instead of shelling out $8,796 a year for a new car, you invest in stocks with a basic S&P 500 index fund. Although the stock market can be volatile, its average return has been 10% per year over the past 50 years.
Assuming an average return of 10% per year, you would have $59,071 after five years. If you spend the same amount of money buying a car, instead of ending up with almost $60,000, you would have a vehicle that is worth maybe half of what you paid for.
How many cars do you need?
There is nothing wrong with buying a car. And even if Dave Ramsey is against it, there’s nothing wrong with getting a car loan and having a payment for the car. The problem is when you don’t consider how much car you can afford and you end up spending too much. It’s the kind of decision that can have serious repercussions, as you could be locked into an expensive loan for years.
Unfortunately, many people fall into the trap of buying cars they can’t really afford. It can be tempting to buy the most exciting and shiny new toy, and when it comes to a vehicle, it’s easy to justify. You tell yourself that this is the car for you, even though a used model would work just as well at a much lower cost.
To compound the problem, it’s often not a one-time thing either. Because if you spend too much to have the latest car, you’ll probably want to do it again in a few years.
If paying for a car isn’t going to put a big dent in your budget, then go ahead and buy the car you want. But if you’re trying to improve your financial situation and build wealth, a car payment that’s 20%, 30%, or more of your income will be a major hurdle.
How to avoid an expensive car payment
Ramsey recommends avoiding car payments altogether, and he has some recommendations for handling that. If you need a car, he suggests buying a cheap used one. Or, if you already have a car and you’re fine with it, keep it.
To be honest, keeping your current car is probably the best option right now. The auto market has not been good for buyers lately, with prices for new and used cars rising more and more.
What if you don’t have a reliable car and need to buy one? In this case, here are some tips to avoid overstretching yourself financially:
- Start a savings account specifically for your car fund. Contribute to it monthly to save money when you’re ready to buy.
- Take Ramsey’s advice and look at used cars. Although still higher than normal, used car prices have come down in recent months, and there are reasonable deals available.
- If you require take out a car loanlimit your monthly payments to a maximum of 10-15% of your net salary. Make sure you don’t get an extra-long loan for lower monthly payments, though. Stick to 60 months or less for a new car loan.
Ramsey is right about expensive car payments. They may be common, but that doesn’t make them a good idea. If you can keep your car payment affordable, or better yet, avoid a car payment altogether, it will give you a big head start as you build wealth.
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