What would your life be like with no car payments? Many of us have been in car debt for so long that we can’t remember what that feels like. I recently paid off my BMW more than a year early. The feeling of relief that I felt making the final payment is something I want to share today, because this topic isn’t talked about enough in the car community.
America’s Car Debt Crises
I believe that we have a car debt crises in America. Let me hit you with a few statistics. The average monthly car payment at the time of this writing is $726 for a new car and $533 for used. The average interest rates on those loans across all credit scores is 7.18% for new cars and 11.93% for used. The total that we owe on our cars is in excess of 1.6 trillion dollars. Meanwhile, roughly 28% of Americans have less than $1,000 in savings. On top of all of that, 4.4% of car loans are currently delinquent by 90 days, putting those cars into repossession territory.
I noticed a trend on TikTok where people announce their car payment like it’s a flex or competition to see who’s paying the most. While others talk about their car expenses with a sense of desperation in their voices. People call into financial shows with ridiculous car expenses and you realize, this isn’t just a few isolated cases. This is a massive problem. Watching videos like these lit a fire under me to get my car paid off ASAP.
I think as car enthusiasts, we are even more vulnerable to going into deeply into debt for our cars. For us, a car is so much more than an appliance that gets us from here to there. It’s our hobby, our source of entertainment and a gateway into a community of likeminded people.
“Life is short”
Something we hear a lot in the car community is, “Life is short, so buy whatever the hell you want.” But I think this is a short-sighted take. Life is short, and you work too hard to give so much of your paycheck right back to the bank for car payments. When you look at those statistics that we just talked about, people having astronomical payments and little to no savings, ask yourself, are these people really living their best lives because they financed the car they really wanted? I think a lot of people are scared right now. They’ve gotten in over their heads and are one layoff or one emergency away from losing it all.
There are a lot of factors at play here. Cars are more expensive than ever, supply chain issues caused scarcity that drove up the price of used cars, and banks are allowing people to borrow irrisponsible amounts of money to pay for them. With an average new car price of $48,000, it seems almost unfathomable to save up and pay cash for a car like our parents did. I think we do have a choice though to buy something reasonable, whether that means saving for a while, or taking a small, low interest loan and paying it off quickly.
The question you should ask yourself is, “What is this costing me?” And I don’t just mean the monthly payment or the interest. What is it costing your mental health, your sleep and your ability to save and invest? I have to tell you, my sleep has improved since becoming debt free. When you don’t have debt, you have options. For you, maybe it’s the option make that career change. Maybe you can finally take some time off for yourself. Heck, maybe you’re a true car enthusiast and you can buy those wheels that have been in your shopping cart for years.
The Case for Car Loans
It’s not all bad, is it? I want to explain the situation with my BMW 340i. Prior to buying the car, my wife and I already had a six month emergency fund in addition to a large downpayment that we saved for the car. Because the payment was a small percentage of our income, we continued our savings and retirement investing after purchasing the car. Even though having a payment wasn’t ideal, it also wasn’t killing us.
We have friends who will spend $400 a week on fine dining and cocktail bars, and what’s the return on investment on that? For my wife and I, as car enthusiasts, we always rationalized the car payments as an entertainment expense. It was a small portion of our income that we could afford to give up each month, and now that they’re both paid off, we have a couple of fun, reliable and relatively low milage vehicles as a result.
I’m not advocating that you go get a car loan, but I do think that there’s an amount that people can borrow that’s not financially ruinous. It’s not always the car loan itself that’s a problem, but rather the extremes we take it to - like the people on TikTok with car payments that look like mortgages and interest rates that look like credit card interest. In case anyone’s curious, my BMW 340i payment was $414/ month at 4.64% interest.
Depreciation
"The total value of your vehicles should not exceed half of your annual income."
When I paid off my car I posted a screenshot on my instagram story and out of thousands of people who saw the post, and numerous congratulations, the only person who had something negative to say was a friend of mine who works in… take a guess.. finance. He said sarcastically, “Good job paying off a depreciating asset.” This is a bad take in my opinion. The car is depreciating whether you pay it off or not. If anything, depreciation is even more reason to pay your car off early. A lot of people are under water on their car loans right now, in other words, they owe more money on the car than it’s worth.
This can happen if you overpay for the car to begin with, especially brand new cars which have a steeper depreciation curve. Or having such a long loan term that the car depreciates at a faster rate than you’re paying it off. This can become a big headache if you need to get out of the car quickly. Maybe you lost your job and don’t have enough saved to make the payments. Maybe the car is starting to have expensive issues that you’re sick of fixing. If you owe more than it’s worth, you’ll have to somehow come up with that difference before you can sell it. If your car is paid off and you want to get rid of it for any reason, you simply sell the car.
Another issue that people run into is getting in an accident when the car is underwater. Since insurance pays out based on the current value of the vehicle, you may end up with a payout that doesn’t quite cover what you owe and you’ll need to come up with the difference. You can opt for GAP insurance, which is a policy that would cover that difference in the event that the car is totaled before you pay it off. Better yet, pay down the loan aggressively so the car doesn’t end up underwater in the first place.
Because cars go down in value, it is important to be mindful of how much of your net worth is in vehicles. There’s a consensus in the personal finance community that the total value of your vehicles should not exceed half of your annual income. That way as your cars go down in value, they’re not taking your entire net worth with it. By the way, the “50% of income” rule of thumb is the max that you could safely have in vehicles. The less that net worth is tied up in things with motors, the better.
Early Payoff
So, you already have a car payment, what should you do? If you are like the 100 million Americans with a car payment right now, I would encourage you to pay it off as quickly as possible. Here are a few tips:
Make extra payments toward the principal balance. This will lower the total amount of interest you’ll pay and will allow you to pay it off more quickly. You just have to be sure that any extra money you put with your payment is actually going to principal rather than an advance on your next payment. The bank my BMW loan was through had any additional money going toward the next payment by default, so I’d have to manually change it to principal each month. Remember, the bank doesn’t want you to pay it this way because it works in your favor, not theirs.
IMPORTANT: Because of the compounding effect of interest, the sooner you start making larger principal payments, the more money you will save!
Get creative. I decided to pay my car off early by writing a check for the last $7,000 I owed. I looked around my house and sold a bunch of stuff on eBay. Everything from shoes and video games, to camera gear I wasn’t using. I ended up selling $1,700 of stuff that was just sitting in my closet. Nowadays, it’s easier than ever to monetize your hobbies, be it YouTube, TikTok and I finally just got re-monetized on Instagram. I have a video showing how to get started with affiliate marketing and one commenter said they were making an extra $150 a month with Amazon Associates thanks to my video, and you could put that extra cash toward principal each month.
Get aggressive and intentional about paying it off early. Rounding up the change on your payment each month isn’t going to cut it. Get serious, make some sacrifices, and throw any extra money that you can at it. In my case, I did have cash savings to cover the remaining $5,300 balance, but I was conflicted because it was earning 5% in a high interest savings account, which was more than the interest I was paying on the loan. Ultimately though, the peace that comes with being debt free far exceeded the small spread I was earning.
Note that some banks charge a penalty for an early payoff. I haven’t encountered that with any car loan I’ve had, but double check with your bank to be safe. Also, your credit score will go down when the loan is paid off and your account closes. Mine dropped 5 points as a direct result of paying off my BMW, but remember your credit score is going to go down a few points whether you pay it off early or drag the loan to it’s maturity, so don’t let this hold you back from an early payoff.
It’s my finance buddy’s opinion (the guy who made fun off me in the last section) that people should hold on to their low interest car debt and try to invest at a higher rate of return instead. Here are my counter arguments. 1 - If someone’s priority is to invest more, they could simply buy a cheaper car to begin with. 2 - Paying off debt is a guaranteed rate of return, unlike the stock market. 3 - His plan is great… in a perfect world where nobody gets laid off, never has big unexpected expenses, and always makes solid returns in the market. 4 - His plan doesn’t take into account the emotional toll that consumer debt has on us.
My Car Buying Rules
Personally, I think I’m done financing cars. But I want to leave you with a few car buying tips. I’m not a financial advisor or a car salesman, this is just what I would do.
Save a 6 month emergency fund before buying a car that’s not included in the car purchase. Emergencies and job losses happen. Be prepared.
Buy used and let the first owner take the big depreciation hit. I saved over $20,000 on my 340i compared to the original sticker price by buying used.
Don’t buy a car that costs more than half your annual income. Cars go down in value, don’t let your car destroy your net worth.
Consider the total cost of ownership including insurance*, gas and routine maintenance, all of which add up quickly.
Pay the loan off early. Just because you have a 5 year loan doesn’t mean you have to take 5 years to pay it.
*Pro tip: Get a quote from your car insurance company before making a car purchase. Many people end up with sticker shock when they receive their first updated insurance bill in the mail after buying a new car. If you call your insurance company ahead of time and provide them with the make, model and year of the car you’re considering, they should be able to give you a quote instantly over the phone. Also note that your bank will require you to keep a full coverage policy on the car until it’s paid off. They want to make sure that the loan gets repaid even if the car is totaled in an accident.
Even for us car enthusiasts, there are so many cool cars out there that you could save up and pay cash for. My friend who bought my BMW 330xi from me paid cash, and he is still daily driving the car 4 years later. He just sent me pictures of him tearing up Tail of the Dragon in it. And by the way, I’m not saying that you shouldn’t buy an expensive car, I’m just telling you to be careful using debt to do it.
Consider this
One commenter on my YouTube video had a different approach. Rather than financing his dream car, a Porsche Cayman, he figured out what his payment would have been and put that amount into his savings account each month instead. After several years of setting aside $800 a month, he began to reflect on the time, effort and discipline that it took to save that amount of money and is now having second thoughts about buying the car.
When we finance a car, we get the reward up front and become numb to the payments. When we have the discipline to save first, it gives us a unique perspective of the value of our time. Saving up to buy a car comes with some other benefits as well. Rather than paying interest on a loan, you’ll be earning interest on your savings. Personally, I use a high interest savings account with Wealthfront (affiliate link) that currently pays 5% APY. Additionally, if you have an emergency along the way, the money is liquid in your bank account, not tied up in a hunk of steel sitting in your driveway.
tips from the comment section
“Another good piece of advice is to never roll your debt from one car into a new car alone. Or before you know it, you’ll be paying $1,000 a month for a Civic” - @speedcircuit
“If you’re younger and living at home or renting, your car payment will have a huge impact on your debt-to-income ratio, which affects what kind of house you can qualify for. Try and keep your car payment as ~10-15% of your income. It’s better to be invested in assets that appreciate!” - @KevG
A Lesson in Humility
When I bought my E90 330xi back in 2014, the payment and related expenses were a stretch for me financially. On top of that, I had no savings at all. At the time, I was working for an online vitamin company doing graphic design and marketing, and even helped get their youtube channel started, which unfortunately they didn’t see a lot of value in at the time. The company fell on hard times and I got let go.
A few weeks later, the manager called and told me they didn’t have anything in the office, but if I wanted to come back and work in the warehouse for $10/ hour until I found something else, they’d have me back.
So with my back against the wall, having a car payment and no savings, I took that job. I’ll never forget my first day as a warehouse worker. Pulling up in my fancy BMW that I could barely afford. The way the building was set up, you had to come in the front to punch in, then walk through the air condition office, past my old colleagues who are wearing nice clothes. And here I am in gym shorts and a t-shirt ready for my first lesson in packing boxes in a hot warehouse.
That whole situation could have been avoided if I had some money saved and actually had a plan. Even though our financial situation was completely different when we bought the 340, it was still a risk that I don’t think I’ll take again. It just feels so good to not have car payments anymore.
Sources:
Average car payment Yahoo! Finance https://finance.yahoo.com/news/average-auto-loan-payments-expect-174817148.html#
Average new car price KBB https://www.kbb.com/car-advice/when-will-car-prices-drop/
Average interest rates Market Watch https://www.marketwatch.com/guides/car-loans/auto-loan-interest-rates-by-credit-score/
Total car debt Investopdia https://www.investopedia.com/personal-finance/american-debt-auto-loan-debt/
Average American savings Forbes Advisor https://www.investopedia.com/personal-finance/american-debt-auto-loan-debt/
Cars with late payments Lending Tree https://www.lendingtree.com/auto/debt-statistics/#:~:text=Auto%20loan%20delinquency%20rates%20are,the%20first%20quarter%20of%202023.
*This blog contains affiliate links. If you click my custom link to purchase a product, I earn a small commission at no extra cost to you.
