These days almost everybody who buys a
car takes out a loan to do it. This is not really a great idea. The
problem is that when you borrow money to buy a car you end up spending
far more than you realise.
This often leads to buying a car that you really can’t afford.
In order to understand why it is a bad
idea to take out a loan to buy a car, you need to understand the
difference between good debt and bad debt. Good debt is when the money
that you borrow will help to increase your net worth.
The most obvious example of this is the
mortgage on your house. You are borrowing money but that money is being
used to purchase an asset that will increase in value. Other examples of
good debt would be things like borrowing money to contribute to your
retirement plan or business loans.
Bad debt on the other hand is when you borrow money to spend on something that will not appreciate in value.
It is almost a given that your car will
not increase in value, except in a few rare cases of classic cars you
can not consider a car an investment. It is a consumer product; you buy
it to use it knowing full well that over time its value will go down.
This is not necessarily a bad thing, after all if need a car then
spending the money to buy one is entirely reasonable. Where it becomes a
problem is when you are borrowing money to buy a car.
The problem with borrowing money to buy a
car is that the interest on the loan is going to greatly increase the
amount that you spend. Generally speaking the interest rates on car
loans are pretty high and this really costs you a lot of money.
If you take out a loan at ten percent
interest that takes seven years to pay it back the price you paid for
your car has just doubled. Given that at the end of the seven years the
value of the car will be a fraction of the initial cost this is not
really good money management. You would be far better off waiting until
you had saved the money to buy the car.
The other issue with borrowing money to
buy a car is that it makes it easy to spend more than you can really
afford on the car. When you see the cost of a car it is usually listed
as the monthly payment.
They tell you how much you have to pay
each month not what the car actually costs. If you save up and pay cash
for the car you will know exactly what you are spending and you won’t
buy a car that you can’t really afford. Off course there’s also a second
option, which is the purchase of a secondhand car.
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