Since I was 21 years old, I have had three auto loans and two auto leases. Why? I have no idea except that it’s what everyone does so I followed the culture. By nature, I am a math nerd, but until a few years ago, I didn’t understand the true mathematics of an auto loan.
The Math of a Car Loan
- Annual Percentage Rate: The cost of your credit as a yearly rate
- Finance Charge: The dollar amount the credit will cost you
- Total Payments: The amount you will have paid after you have made all payments as scheduled
- Depreciation: The amount or percent a new vehicle loses value. A new automobile loses about 60-80% of its value in the first four years.
Here is an example of how much it would cost to finance a new Toyota Camry LE over 5 years with standard options (which I did in 2006):
- Price to purchase: $21,344
- Annual Percentage Rate: 6%
- Finance Charge: $1281
- Total Payments: $22625
- Depreciation: $16628
- Net loss per year: $3326
At the end of 5 years, you would have spent $22625 for a car that is worth $4716. That is assuming that you drive around 15000 miles a year. I drive more than that so the depreciation is even greater. The math shows a net loss of 79%!
The depreciation of $16628 is like flushing $277 down the toilet monthly. Now that is some expensive toilet paper!
Is There a Better Option?
The purchase of a vehicle is not an investment and you will lose money. However, you can limit the damage by doing the following:
- Buy with cash and buy to avoid finance charges
- Buy used. You can buy a reliable used car that is 2 to 5 years old. Most of the depreciation will have been realized and will save you some cash.
Here is an example of how much it would cost (if buying with cash) to purchase a 2009 Toyota Camry from a private party and hold it for 5 years:
- Price: $12,727
- Depreciation: $5549
- Finance Charges: ZERO
- Car worth at the end of 5 years: $7178
- Net loss per year: $1109
Instead of flushing $277 down the toilet monthly for a new car, you would be flushing $92 a month.
Reasons Why We Engage in the Stupidity
I believe Americans engage in this madness because:
- It is the culture
- We don’t pay attention the math
- We lack discipline and patience and we want it now
- We want to look good in our new vehicles
- We believe a new vehicle is more reliable. This is a myth, if you take good care of your vehicle, it will take you a long way. I have a 2006 Camry that has $170,000 miles on it and it is running very well.
Question: If you have an auto loan, what rational did you use to finance the purchase? Is it based on math or the culture? Follow @robertjacobs01