There are many decisions that have a huge impact on our financial lives. Some of these include where we go to college and how we pay for it and what degree you get. Or it could be when and what type of house we buy. But can your car really make or break you financially?
Oftentimes, a car is the first large purchase that people make that overextends them financially. The banks or the dealerships will tell you that they will be happy to finance a $25,000 car and most people then think that this means that they are financially ready to buy a brand new car. The bank is willing to lend you the money far before it is a smart decision. Our society reinforces this will the constant pressure to keep up with the Joneses. Most people continue to trade in their vehicles for something this new new and better and never actually pay off their car. They remain a slave to that monthly car payment.
Often, young people are the first ones to fall into this car buying cycle. The financial consequences are often greater for young people because the extra money that could have been saved has dramatically more time to grow and compound if invested.
Let’s compare two different scenarios. Fancy Fred bought his first car at age 22 and it cost him $28,000. He put $3,000 down and got a 60-month loan for the other $25,000. That comes out to a $450 monthly payment. Smart Stan, on the other hand, bought a $3,000 Toyota Corolla off of Craigslist with his savings when he was 22. He had no monthly payment for car loan. Let’s assume that Smart Stan takes the $450 that he doesn’t use for a car payment and saves $100 a month for another car in the future (so that he’ll be able to pay cash for the next car as well) and invests the remaining $350 in the market. His ride is not as cool, but it is reliable and gets him to where he needs to go. Let’s say that Fancy Fred continues to get new and nicer vehicles and always has a car payment of $450 until he is 62 when he finally pays off his sweet ride. Smart Stan continued his frugal ways (not-as-cool ways) to age 62 as well and lets assume he only invested $350 per month throughout his life. Now it is time to retire and Smart Stan is looking cooler by the second. His $350 monthly investment has since changed into about $670,000 through the power of compound interest (assuming a 6% market return) and 40 years. His retirement is bound to look much different than Fancy Fred’s. Although this is a very hypothetical situation, it shows us the power that a small difference can make.
I am not trying to say that there is anything wrong with getting nice vehicles. There are many people that should and deserve to drive nice vehicles. All I am saying is that people should not be carried away by what society or the dealership tell you. We need to take a long and hard look at what financial decisions we make, while understanding the long term consequences.