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  • How Much of Your Car Should You Finance? Zero percent.

    Today we're offered by Yahoo! Finance what passes currently for mainstream financial press advice on matters of personal credit. This Quick Comment is directed mostly to our younger readers.
    How Much of Your Car Should You Finance?
    November 20, 2006 (Yahoo! Finance)

    Kicking a few tires is only half the battle. Before you begin looking for a new car, you should know your limits and what you should be spending. Experts say you shouldn't spend more than 10 percent of your gross income on car expenses, which includes the cost of the car along with insurance, gas and maintenance.

    Once you decide on a price range, you'll want to decide how much you can put down as a down payment and then negotiate the price of your car. Too many buyers accept long financing arrangements in order to minimize their down payment. If they decide to trade the car in the first year or so, they often find that they actually owe more on their car than it's worth. A good rule of thumb is never to finance more than 80 percent of the true cost---the dealer's invoice---of the car. At least 20 percent or more should be paid in cash or the equity of your trade.
    If "experts" advise a person to spend no more than 10% of gross income on financing and other auto costs annually then "experts" are wrong. The correct answer to the question, "How Much of Your Car Should You Finance?" is: zero percent.

    The reason is that a car, unlike a home, is a rapidly depreciating asset. A house is not a depreciating asset, and so is a better–but still not a good–use of credit, long term. As Professor Robert Shiller points out in Irrational Exuberance: Second Edition, a house appreciates at a rate more or less equal to the rate of inflation, except during real estate bubbles, the topic of his book. That means you will not realize real gains on your "investment" in a house over the long term. From a depreciation standpoint, a house is a "neutral asset," although there are a lot of costs involved in maintaining the value of property that most real estate sales people don't like to talk about. (No, precious metals don't earn interest, but you don't have to mow and water the lawn or paint them every few years either.) But whereas the price of a house at least more or less keeps up with inflation, a new car depreciates around 20% instantaneously when you drive it off the lot. The only exception to this during a dollar depreciation and you happen to have bought a car exported by a country that has a currency that's appreciating relative to the dollar.

    For example, I purchased a Honda Civic in 1975 for $1,800 and sold it in 1978–to help pay for college–for $2,300.



    Nice! I "felt" like I was making money, on a car I bought new, no less, the most notoriously money-losing, rapidly depreciating major purchase a person can make. At the early stage of an inflation, everyone thinks they're getting richer, as nominal incomes rise along with interest rates on CDs and other short term interest bearing securities. The problem is that in nominal, that is, inflation-adjusted terms, the purchasing power of these securities is declining. Once the average person realized that, which they did around the year I sold that Honda, and it looked like the government lacked the political will to tackle the inflation problem, the rush to hard assets and the gold bubble got going.

    Currency re-valuation is one of many stupid pet tricks that governments backed into a corner cause economies to do. We are assured, of course, that that can never happen again–a dollar depreciation and inflation to lighten the U.S. foreign debt load, which is why governments re-value currencies. We shall see. But that's an unusual case. Usually, cars depreciate both in nominal and in real terms. Back to our topic: using credit to finance depreciating assets.

    There are two kinds of transactions: cash and credit. The amount of cash you have depends on your past actual savings rate relative to your income and expenses. The amount of credit you have depends on your future potential savings rate relative to your future income and expenses. Thus your credit is as mutable as your savings, that is, it goes up and down over time depending on your circumstances, although the "balance" in your "credit account" is not as apparent as the balance–or lack of balance–in your cash account. Your "credit account" balance can also go up and down based on circumstances beyond your control, such as a credit squeeze in the markets, as typically happens after credit cycles top. For now, let's stick to matters you can control.

    If you take a hit on your income, your expenses spike, or you take out a big loan, the amount in your "credit account" declines. Most importantly, unlike a cash transaction, a credit transaction results in a debt. A debt is a lien on future labor; and you derive most of your income from your labor. So, you never, ever want to put a lien on your future labor except for the purpose of investing in an asset that is likely to increase in value over the life of the loan, that is, to exceed to total cost of the principle plus interest on the loan.

    To do otherwise is to discount the value of your labor. When you use your credit to purchase a product–a depreciating asset by definition because it will always be worth less later–you are taking a portion of your future income and spending it on a product that you could otherwise have purchased in the future with savings–plus the interest paid on your savings–at a lower cost. (The loss in purchasing power of savings due to inflation while you save to buy with cash versus paying today with credit is a wash because the same number of dollars will buy more car in a few years, as has been the case since cars were invented.) So, when you purchase a product like a car on credit you are losing out on both the total price you are paying (principle plus interest) and the loss of interest income on your savings if you had saved up to buy a car with cash in the future instead. I think your future labor is worth a lot, and hope you do, too. You owe it to yourself to not devalue your future labor.

    Since a car is a depreciating asset, the correct answer to the question, "How Much of Your Car Should You Finance?" then is zero. You can "afford" the car you can buy with cash. There is one exception, and that's the zero interest rate loan. If you buy a car that qualifies–usually the least desirable cars–and you qualify, that's almost like buying a car with cash. The loan will consume some of your credit, and will be offered by most dealers at a lower price if you buy with cash, but at least you're not also putting an interest lien on your future income, and you are freeing up cash to use for other purposes where you might be tempted to use credit, such as meals and holiday presents. A meal, obviously, depreciates very quickly in your stomach, after which its value is about equal to your average economist's economic forecast.

    Yours truly has not always purchased cars this way. I leased a car for a year at very high rates when I was young and had just I experienced a big jump in income. I was feeling flush. So I understand what leads to these decisions, from time to time. And, yes, life is short, so live it up. But in the long run, the continuous practice of using your credit–devaluing your future labor–is the habit of buying into a system that, not happy to take your income only in the form of taxes, has set up government sponsored institutions like the Fannie Mae to separate you from your future income as well.

    "But there are tax advantages to holding a mortgage," you say. The government raises a tax on your current income via an income tax, then offers to partially reduce it if you accept a tax on your future income via interest on a government sponsored loan to buy a house that bearly keeps up with the rate of inflation–except during a housing bubble, such as we just experienced. This is what passes for good household finance? How long have North Americans been falling for this nonsense?

    "But I can't afford any car I can pay for with with cash–I don't have any cash–and I need a car to get to work," you say. You're not alone. Americans have been falling for the bad idea of purchasing depreciating or neutral assets with credit for so long that they no longer save. The Frankenstein Economy encourages them to see their credit not as finite, like their savings, but as a bottomless well: there's always another loan coming, more credit to be extended.

    In the recent words of and FOMC vice-chairman Gerald Corrigan, "very creative financial services companies" offer financial products to foreign investors, which investment results in a constant expansion of U.S. credit available to U.S. citizens."

    In the same breath, he says that his big worry is U.S. savings rates: “The first point I would make is related somewhat to the one Bill just made–its kind of the other side of it. That is that the United States savings rate is virtually zero. The household saving rate is negative. And for the reasons that Bill mentioned and a whole bunch of other reasons as well, this is a potentially very dangerous situation, not only in terms of economic and financial terms, but it brings with it, I think, some potentially very serious problems down the road in terms of the well being of our own citizens."

    Somehow Corrigan hasn't put these two ideas together. Idea one, that "very creative financial services companies" offer foreign investors products that have led to the "potentially very dangerous situation" with, idea two, that the "United States savings rate that is virtually zero."

    Just because he's confused, doesn't mean you need to be.

    The practical answer for anyone who needs a car to get to work but has little cash is to buy the cheapest used car you can tolerate–a shitbox, to be precise–take out as small a loan as possible, and drive it proudly as symbol of your understanding of the principle "don't buy depreciating assets with credit" and of your unwillingness to knuckle under and discount the value of your future labor by putting a lien on it to purchase an overpriced car from a bank.


    The shitbox: New symbol of self-worth?

    The paradox is that if you do this, you are more likely to wind up in a position to afford a really great car some day from savings, because you will not have squandered your future income by buying depreciating assets with credit.

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    Last edited by EJ; 05-05-09, 05:55 PM.

  • #2
    Re: How Much of Your Car Should You Finance? Zero percent.

    people pay for "zero interest" loans. whatever price is paid with the loan, the car can be bought for a still lower price for cash.

    Comment


    • #3
      Re: How Much of Your Car Should You Finance? Zero percent.

      Originally posted by EJ
      How Much of Your Car Should You Finance? Zero percent.
      Here here!
      Finster
      ...

      Comment


      • #4
        Re: How Much of Your Car Should You Finance? Zero percent.

        I agree completely with the sentiment.

        I agreed with it when I read it in 1992, in "Your Money or Your Life" (Dominguez) and in "surviving without a salary" by Long. There were also some good dumpster-diving books in Loompanics at the time. No car-living resources, though ; )

        I agreed with it when I read in in the 80s from various authors (Andrew Tobias stands out in my mind, maybe because he's the only one out of my memory that I could find online).

        What I find really funny today about the dominguez book was the line (paraphrased through a bad memory) "we're entering a new era where frugal is cool". It's made even funnier for me personally because the early 90s recession hit me hard - I had just graduated engineering, 1/2 my class did not have work (90% of the previous year's class had offers upon graduating, and 3/4 of the next year's class had no offers) and what work I could get was not "optimal"[*]. This book was written just for me (not that I had a choice about being frugal).

        The ensuing 14 years kind of puts the lie to that prediction about frugality becoming cool, dunnit?

        The advice to avoid credit gains urgency when given in the context of vacations ("spend ONE week in Hawaii on credit, pay for it for TWO years").
        [*] a little engineering humor for you.

        Originally posted by EJ
        Today we're offered by Yahoo! Finance what passes currently for mainstream financial press advice on matters of personal credit.

        Comment


        • #5
          Re: How Much of Your Car Should You Finance? Zero percent.

          or buy a '74 Buick Century for $100. (that was the only car I ever owned, bought in 93 in Houston).

          Other than that, I've lived in cities with good public transit. Public transit (and the implied lack of car) is not a great chic magnet, but it sure helps build up the savings.

          Originally posted by jk
          people pay for "zero interest" loans. whatever price is paid with the loan, the car can be bought for a still lower price for cash.

          Comment


          • #6
            Re: How Much of Your Car Should You Finance? Zero percent.

            Originally posted by Spartacus
            I agree completely with the sentiment.

            I agreed with it when I read it in 1992, in "Your Money or Your Life" (Dominguez) and in "surviving without a salary" by Long. There were also some good dumpster-diving books in Loompanics at the time. No car-living resources, though ; )

            I agreed with it when I read in in the 80s from various authors (Andrew Tobias stands out in my mind, maybe because he's the only one out of my memory that I could find online).

            What I find really funny today about the dominguez book was the line (paraphrased through a bad memory) "we're entering a new era where frugal is cool". It's made even funnier for me personally because the early 90s recession hit me hard - I had just graduated engineering, 1/2 my class did not have work (90% of the previous year's class had offers upon graduating, and 3/4 of the next year's class had no offers) and what work I could get was not "optimal"[*]. This book was written just for me (not that I had a choice about being frugal).

            The ensuing 14 years kind of puts the lie to that prediction about frugality becoming cool, dunnit?

            The advice to avoid credit gains urgency when given in the context of vacations ("spend ONE week in Hawaii on credit, pay for it for TWO years"). [*] a little engineering humor for you.
            In capitalist societies, it will never be cool to be frugal for long. The last true "poor is cool" anti-capitalist movements in the U.S. were the 60s/70s hippie movement and the early 1980s punk rockers. Then lot of hippies and punker rockers got rich along with the aspiring capitalists during the decades that followed. Both movements started in the UK. I suspect in the next prolonged downturn, there will be a social movement to wrap "cool" around "poor" and the movement will arise from the UK.

            Frugality works in any case, but even better when times are good. Saving doesn't preclude making money, but when things are good you can save more money more quickly with less deprivation. The level of deferment of gratification depends on a person's goal. Mine has always been personal liberty, and to me that means not having to work for anyone I don't want to work for, or doing any work I don't like. Not working at all is not an option for me; I like to work. But I really have a hard time understanding anyone who, given a choice, decides to take on a lot of debt to maintain a standard of living that requires them to work for people they don't want to work for and/or doing work they don't like. That's the opposite of liberty. And if and when things get tough, a heavy saver's life goes from many options to fewer, while the indebted person's goes from few to none. Dread of finding myself in the latter position has also been a motivator to defer gratification and save more.

            Comment


            • #7
              Re: How Much of Your Car Should You Finance? Zero percent.

              EJ

              rock solid advice. Spend only what you have and not more. Better take the commute when you cannot afford a car.

              When I see my neighbours here on the lake of Zürich (the Miami Beach of Switzerland) with their 7series BMW or X5es plus the Mini or convertibles for their spouses with lots of financing ontop of their overleveraged condos and houses I know exactly where their salary is being left. Unfortunately for me I paid my car (even though it is a new one) in cash. I was a rare exception at the Saab dealer, who of course advised me immediately to take on a loan to get the better model...
              Christoph von Gamm
              http://www.interenterprise.eu - with Queer-O-Pinion!

              Comment


              • #8
                Re: How Much of Your Car Should You Finance? Zero percent.

                Words of wisdom and so against every message the media and financial organizations throw at people today, especially the unschooled and unwise.

                My first car was a $300 1967 VW Bug, then 13 years old. I had to rebuild the heater boxes and use screen door springs to keep the foot pedals off the floor, but it took me a hard several thousand miles, and living on a remote Vermont mountain top through a long hard winter. Then I sold it for $300.

                The 12 years after that were mostly a nightmare of expensive leases (what was I thinking?) low down payments and lifetime terms, and even a repossession. (Repo man’s compassion quotient=0).

                I’ve paid cash for every car I’ve bought since 1995. South Florida is full of highly leveraged, overpriced “dream” houses that usually have the “Dade County Duo” out front- a new (leased) Hummer3 and a new (leased) S class Mercedes. I enjoy asking “What are your payments?” while riding past on my bike. An amazing number will proudly throw out numbers over $1,000 and more a month and I just cringe for them.
                Last edited by Jeff; 11-20-06, 05:07 PM.
                "The test of our progress is not whether we add more to the abundance of those who have much it is whether we provide enough for those who have little." - Franklin D. Roosevelt

                Comment


                • #9
                  Re: How Much of Your Car Should You Finance? Zero percent.

                  Originally posted by Christoph von Gamm
                  EJ

                  rock solid advice. Spend only what you have and not more. Better take the commute when you cannot afford a car.

                  When I see my neighbours here on the lake of Zürich (the Miami Beach of Switzerland) with their 7series BMW or X5es plus the Mini or convertibles for their spouses with lots of financing ontop of their overleveraged condos and houses I know exactly where their salary is being left. Unfortunately for me I paid my car (even though it is a new one) in cash. I was a rare exception at the Saab dealer, who of course advised me immediately to take on a loan to get the better model...
                  Except for the instance of leasing an Audi S4 when I took a US director high tech sales job years ago, I always pay cash for cars. But I give in to the temptation to buy a new car versus a used one every ten years or so... purchased a new Infiniti FX 35 with cash in 2003. (Not an especially politically correct car, for sure.) Why a new car every ten years? As near as I can tell because that's how long it takes me to forget how stupid I feel after I've done it, leaving 20% there on the lot as I drive off.

                  My thought process largely reflects the way I was brought up, and I suspect yours does as well. I recall driving through town with my Dad when I was maybe 12 years old, and pointing out a new Caddilac in the driveway of a run down three family house. I asked, "Why do we live in a nice house but drive around in a five year old car when they live in a crummy house and drive a new car?" "Because," he said, "they are compensating. If they spent the money on education instead of on a car, they'd soon enough be living in a better house, and later driving a better car, but they don't know any better."
                  Last edited by EJ; 11-21-06, 08:29 AM.

                  Comment


                  • #10
                    Re: How Much of Your Car Should You Finance? Zero percent.

                    Eric,
                    Agreed 100%. But I'd like to throw something in.
                    I graduated from college but didn't buy my 2nd car, a new Acura Integra, until 4 years later (my first car was an "inheritance" that cost me nothing and like everything else in life that's free it was an old one that didn't look nor run good). One of the reasons I waited was because I didn't believe in financing its purchase but it took me that long to save enough to pay cash for it.
                    I remember at a party with old friends, I was having a discussion with one of them (we're all of similar age) who bought a 300Z right after college (with credit of course), then went on to other sports cars every now and then.
                    I was armed with arguments similar to yours, numbers & figures, depreciation, etc.
                    He on the other hand, went on and on about how the cars helped him in the girls department.
                    In the end, I think most of the guys agreed that he'd won the argument.

                    Comment


                    • #11
                      Re: How Much of Your Car Should You Finance? Zero percent.

                      Originally posted by lewman
                      Eric,
                      Agreed 100%. But I'd like to throw something in.
                      I graduated from college but didn't buy my 2nd car, a new Acura Integra, until 4 years later (my first car was an "inheritance" that cost me nothing and like everything else in life that's free it was an old one that didn't look nor run good). One of the reasons I waited was because I didn't believe in financing its purchase but it took me that long to save enough to pay cash for it.
                      I remember at a party with old friends, I was having a discussion with one of them (we're all of similar age) who bought a 300Z right after college (with credit of course), then went on to other sports cars every now and then.
                      I was armed with arguments similar to yours, numbers & figures, depreciation, etc.
                      He on the other hand, went on and on about how the cars helped him in the girls department.
                      In the end, I think most of the guys agreed that he'd won the argument.
                      No, he merely discovered the age-old way to attract women who care about how much money a man is willing to spend carelessly to impress them. Check back with him in 20 years. I bet he's happy neither with his partner in life nor with their financial situation.

                      Comment


                      • #12
                        Re: How Much of Your Car Should You Finance? Zero percent.

                        In Caught In The Housing Bubble, Jennifer Wheary says

                        Since 2001, homeowners have been tapping into their home equity at a record pace. Households cashed out $715 billion worth of equity between 2001 and 2005. In the three years between 2003 and 2005, owners extracted $150 billion more in equity from their homes than they did in the previous eight.
                        .
                        .
                        .
                        Our newly elected Congress can take action to help families out of this mess.

                        Where can they start?

                        Eliminate the need to dip heavily into home equity to make ends meet by controlling health care costs and guaranteeing a living wage to anyone willing to work for it.

                        Create legislation to protect borrowers from the excessive credit card rates and fees and capricious terms which are legal but which end up strong arming honest families trying to make ends meet into financial peril.

                        Support hard working families in severe economic distress by re-examining and, where appropriate, reversing the sweeping changes to bankruptcy laws passed by Congress in 2005 which removed many protections available to average Americans.

                        Protect Americans from real estate appraisal fraud by ensuring that brokers are prevented from coercing or intimidating appraisers in order to receive a desired property appraisal value.
                        Any Thoughts?

                        Comment


                        • #13
                          Re: How Much of Your Car Should You Finance? Zero percent.

                          More at Demos

                          House of Cards

                          Debt Research

                          Comment


                          • #14
                            Re: How Much of Your Car Should You Finance? Zero percent.

                            Ha I love this thread.

                            The 'new car on credit' is such a perfect summary of bad financial plans and such a universally accepted practice.

                            I am a proud cheapskate especially where cars are concerned. The last car I had to buy was picked by searching craiglist for the biggest glut of used cars. First by make then by price range. Once I had my search dialed in I spent a week or two looking through the results for a well maintained but ugly example of the 'glut car'. Then I bought it cash...

                            1997, 80k miles, saturn, full services, nice sound system and safety stuff, One owner from new, not too good at parking, scuffs on all corners and a missing mirror. Price $2200.

                            Its been perfect now for 20k miles, but there is no way I could convince any of my friends to do the same. The social pressure is just too great for most people. I am often the target of jokes at work about my crap car and matching $100 golf clubs (also craigslist). The joke generally comes in the form of disbelief from people who get paid less than me ;-) It just makes me feel better. Occasionally I see the car from someone elses eyes and a squirm a little ;-)

                            If asked with any type of seriousness why I have such a cheap car when I have a well paid job. I just explain I am saving/investing until I have $1mill so I can be independent of any jobs I don't like (I love my current job) and because I haven't got there yet and until I do, I consider my self poor. This always seems to add to the confusion. As if trying to save $1mill is nuts compared to buying a $40k car on credit.

                            At that point I have to decide if I tell them I live in a trailer or not ;-) Yes also bought cash.

                            http://captain3d.com/dayoff/mobilehome/index.html

                            My goal is to be $1million dollar, Marin, CA, trailer trash. Its going quite well so far.

                            phil
                            Last edited by Captain3D; 11-21-06, 04:40 AM.

                            Comment


                            • #15
                              Re: How Much of Your Car Should You Finance? Zero percent.

                              Glad too see EJ post a thread we can all agree on


                              Chicks still dig my 99' Buick
                              I one day will run with the big dogs in the world currency markets, and stick it to the man

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