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Considering how much of our modern infrastructure was designed around car ownership, cars are essential to many people’s lives, providing transportation to work, school, and just about any other facet of life. However, financing a vehicle is often categorized as “bad debt” in personal finance. This classification doesn’t mean you shouldn’t buy a car—rather, it highlights important financial considerations that affect your long-term wealth.
If you’re in the market for purchasing a car, let’s explore why automotive debt typically falls into this category and what this means for your financial planning.
Understanding good debt vs. bad debt
Financial advisors typically categorize debt into two types:
Good debt refers to borrowing that can potentially increase your net worth or generate income over time. Examples include:
- Mortgages (real estate typically appreciates).
- Student loans (education can increase earning potential).
- Business loans (can generate profit).
Bad debt refers to borrowing for assets that decrease in value or don’t generate income. This debt typically:
- Finances depreciating assets.
- Carries higher interest rates.
- Doesn’t contribute to wealth building.
Why car loans are typically considered bad debt
So now that you have some context, let’s break it down:
Rapid depreciation
The moment you drive a new car off the lot, it loses approximately 10% of its value. Within the first year, most vehicles depreciate by 20-30%. This depreciation continues at a slower rate throughout the car’s life.
Consider this scenario: You purchase a $30,000 car with a 5-year loan. After just one year, the car might be worth only $24,000, but you still owe close to the original loan amount. This creates negative equity—owing more than the asset is worth—a hallmark of bad debt.
Interest costs
Car loans typically carry higher interest rates than mortgages or certain other types of secured debt. Over a 5-7 year loan period, you could pay thousands in interest, further increasing the total cost of an already depreciating asset.
For example, on a $30,000 car loan with a 6% interest rate and 60-month term:
- Monthly payment: approximately $580
- Total interest paid: approximately $4,800
- Total cost: $34,800 for a car that’s worth significantly less by the time it’s paid off
Maintenance and operating costs
Unlike investments that might generate returns, cars require continuous financial input:
- Insurance.
- Fuel.
- Maintenance and repairs.
- Registration and taxes.
These ongoing costs add to the financial burden without contributing to asset growth.
Opportunity cost
Perhaps the most significant factor is opportunity cost—what you could have done with that money instead.
If instead of financing a $30,000 car, you purchased a $15,000 used vehicle and invested the difference ($15,000) in an index fund averaging 8% annual returns, after 5 years that investment could grow to approximately $22,040. After 30 years, it could be worth about $150,000—a substantial difference for retirement planning.
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When car debt might be more justifiable
While car loans are generally considered bad debt, several factors can make them more reasonable:
- Necessity for income: If reliable transportation is essential for your employment or business, a car becomes a tool for income generation. In this case, the debt enables your ability to earn.
- Low interest rates: During promotional periods, manufacturers sometimes offer 0% or very low-interest financing. When the time value of money is considered, these deals can be financially advantageous compared to paying cash.
- Opportunity cost considerations: If your alternative investments would generate returns lower than the interest rate on the car loan, financing might make mathematical sense.
- Cash flow management: Even wealthy individuals sometimes finance vehicles to preserve liquid capital for other investments or emergency funds.
Strategies to minimize the financial impact
Since having a car is a necessity for most Americans, here are some ways you can mitigate the cost of ownership:
- Buy used vehicles: Purchasing a 2-3 year old car allows the original owner to absorb the steepest depreciation period.
- Shorter loan terms: Though monthly payments will be higher, shorter loans reduce total interest paid and decrease the period of negative equity.
- Substantial down payment: A 20% or larger down payment helps offset initial depreciation and reduces the loan principal.
- Maintain and keep vehicles longer: The most economical approach is usually to maintain a vehicle well and keep it for many years after the loan is paid off.
- Consider leasing vs. buying calculations: In some circumstances—particularly for luxury vehicles with steep depreciation curves—leasing might represent a lower total cost of ownership than buying.
The bottom line
While car loans are typically classified as bad debt due to depreciation, interest costs, and opportunity costs, they remain a practical necessity for many people. The key is making informed decisions that balance transportation needs with sound financial planning.
Rather than avoiding car debt entirely, consider it within your broader financial picture. Minimize its negative impact through thoughtful purchasing decisions, favorable loan terms, and a realistic assessment of your transportation needs versus wants.
By understanding why car loans are considered bad debt, you can make choices that provide necessary transportation while still supporting your long-term financial goals.
There’s always JG Wentworth…
If you have $10,000 or more in unsecured debt there’s a good chance you’ll qualify for the JG Wentworth Debt Relief Program.* Some of our program perks include:
- One monthly program payment
- We negotiate on your behalf
- Average debt resolution in as little as 48-60 months
- We only get paid when we settle your debt
If you think you qualify for our program, give us a call today so we can go over the best options for your specific financial needs. Why go it alone when you can have a dedicated team on your side?
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* Program length varies depending on individual situation. Programs are between 24 and 60 months in length. Clients who are able to stay with the program and get all their debt settled realize approximate savings of 43% before our 25% program fee. This is a Debt resolution program provided by JGW Debt Settlement, LLC (“JGW” of “Us”)). JGW offers this program in the following states: AL, AK, AZ, AR, CA, CO, FL, ID, IN, IA, KY, LA, MD, MA, MI, MS, MO, MT, NE, NM, NV, NY, NC, OK, PA, SD, TN, TX, UT, VA, DC, and WI. If a consumer residing in CT, GA, HI, IL, KS, ME, NH, NJ, OH, RI, SC and VT contacts Us we may connect them with a law firm that provides debt resolution services in their state. JGW is licensed/registered to provide debt resolution services in states where licensing/registration is required.
Debt resolution program results will vary by individual situation. As such, debt resolution services are not appropriate for everyone. Not all debts are eligible for enrollment. Not all individuals who enroll complete our program for various reasons, including their ability to save sufficient funds. Savings resulting from successful negotiations may result in tax consequences, please consult with a tax professional regarding these consequences. The use of the debt settlement services and the failure to make payments to creditors: (1) Will likely adversely affect your creditworthiness (credit rating/credit score) and make it harder to obtain credit; (2) May result in your being subject to collections or being sued by creditors or debt collectors; and (3) May increase the amount of money you owe due to the accrual of fees and interest by creditors or debt collectors. Failure to pay your monthly bills in a timely manner will result in increased balances and will harm your credit rating. Not all creditors will agree to reduce principal balance, and they may pursue collection, including lawsuits. JGW’s fees are calculated based on a percentage of the debt enrolled in the program. Read and understand the program agreement prior to enrollment.
This information is provided for educational and informational purposes only. Such information or materials do not constitute and are not intended to provide legal, accounting, or tax advice and should not be relied on in that respect. We suggest that you consult an attorney, accountant, and/or financial advisor to answer any financial or legal questions.