Dave Ramsey has come up with a great argument as to why a car loan is a bad idea, akin to betting on the Mets or ordering that second helping of clams casino. Here’s his case, along with reasons why a car loan can really cost you big bucks.
Back in 2007, on Dave Ramsey’s radio show, the host took one of his first shots at the stupidity of car loans: “Car payments are the mantra of the middle class. As long as you keep a car payment, you're going to be mediocre in your finances. It's just stupid. Avoid that. Pay cash. Save up and pay for whatever you do.”
But could Ramsey back that up?
He certainly thinks so. The problem starts with longer auto loans, which can really eat up a consumer’s bank account. Ramsey cites a U.S. Bureau of Labor & Statistics stat that says more than 80% of all U.S. car loans are longer than four years. He estimates that by the time the loan is paid off in four or five years, the vehicle will have lost up to 70% of its total value.
As Ramsey writes, “That's beyond ridiculous ... it's stupid! Why would you get a $25,000 loan at 8% over four years, pay $598 a month, be stuck with a car worth $8,750 when the loan is done ... and think it's a smart idea?”
His problem is that, by the end of the loan, you’ll have paid way more than the car is worth. Ramsey points out that a car owner who pays $28,000 for a $25,000 vehicle (by the end of the loan) would never pay $200,000 for a house that was worth $175,000, or pay $20,000 to attend a college that offers a $15,000 education.
OK, so remember that $598 monthly car payment? Ramsey asks what would happen if instead, you plowed that $598 every month into a stock mutual fund. After 30 years, based on historical averages, Ramsey estimates you earn back almost $2.1 million.
He’s got a point. Sure, buying a car on loan is faster than saving for one, and you'll be able to buy a more expensive vehicle with a loan.
But think of the downside, which includes monthly payments that cut into your household assets, the lunacy of paying significantly more money for a declining asset, and the opportunity cost of using that money to make retirement more comfortable.
All in all, the math really adds up — taking out a car loan just might be at the top of the list of ding-dong dumb personal financial moves you’ll ever make.
—For more ways to save, spend, invest and borrow, visit MainStreet.com.