Car loans

Your selection of a car is one of the biggest financial decisions you will make, after the choice of a house. It is very difficult to come out ahead with your car, since it constantly loses value.

Here are some numbers to think about. The average new car loan today has a rate of 7% APR (Annual Percentage [interest] Rate). If your credit is poor, you might even pay significantly more. Note that this does not include car insurance, or the principal of the loan itself. Only the interest (complete waste) portion. This is how much your family loses each month by having a car loan of various sizes.

Cost of Car Interest paid per month (7% APR)
$12,000 $70
$14,000 $82
$16,000 $94
$20,000 $117
$24,000 $140
$28,000 $164 - this is the current national average!
$32,000 $187

First, choose a car that is at least 1-2 years old. If you buy a new car, it looses several thousand dollars "when you drive it off the lot", as they say. This is true. So why spend the first year of payments ($300 X 12 payments = $3,600) paying for what you lost 20 minutes after you bought the car? It seems like a
great waste. In fact, it might take longer than 1 year to pay for the initial depreciation, since that $3,600 in payments would include interest, which goes right to the bank's coffers—not to the balance of your loan (principal).

Second, choose an appropriate car.
Ignore the advertisements and peer pressure. An average-looking man in a red corvette is...still an average-looking man. A skinny 5'6" man in a Hummer is still short. The shy computer programmer will be just as awkward around women if he drives a BMW. Besides, any woman that falls for a man because of his car will obviously be drawn to another man with a better car at some point in the future. It is a loosing battle, and one that is best avoided from the start. If all your friends have diesel trucks that get 9 MPG or SUVs that get 10 MPG, just laugh at them every time they have to fill their tank. He who laughs last, laughs best!

Owning an SUV does not mean "I've arrived" A family of 3 (or even 4) does not need to go out and buy a huge SUV. Regular cars are not without the ability to tote things around—that is what the trunk is for. A sedan (mid-sized car) will do just fine for virtually all tasks. Pay attention to the gas mileage, not just how the car looks. Gas prices are not negligible, especially today with $3 gas. $5, $6, or even $9 a gallon gas is a very real possibility in the near future. It is possible that by 2015, cars might become prohibitively expensive to drive. This is very possible if demand for oil/gasoline keeps increasing worldwide, while production remains stagnant (as it is right now).

Explorer. Pathfinder. TrailBlazer. Navigator. Excursion. Expedition...to Wal-mart down the street? Give me a break. As if the average suburbanite is blazing a trail through the wilderness to explore uncharted territory. (Actually, I'm sure the commercials display such imagery all the time. See
how TV rots the brain?) I assure you that not just hundreds, but thousands of your neighbors have been to the same mall you are driving to. And I seriously doubt that 4X4 traction is needed to traverse the well-paved road to your local, boring, nondescript strip mall.

Third, do not take on payments for more than 4 years to pay for a car. To convince people to buy that car they "want" instead of the one they could get by with, salesmen flash a low monthly payment in front of customers' eyes. But that payment requires paying on a car for 5, or even 6 years! Anyone who falls for this will also be the type to want a new car more often than every 6 years (they obviously are not too strong against advertising and sales pitches, right?) Try to limit yourself to what you can pay off in 3 or 4 years. It is a fact that cars start to need a bit of attention/service after about 4 years.

Fourth, buy instead of lease. Yes, when leasing they hold you in the palm of their hand, but that tender loving care comes with a price tag. Think about it: if the cost of servicing your car was not less than the monthly payments they get, they would never offer you such a deal. The dealership is not in business to
lose money. Keep in mind that the occasional trip to the garage will not break you, especially if you are no longer making car payments! Drive a paid-off car until it becomes not worth fixing, and you will save tens of thousands of dollars over your lifetime.

Fifth, do not fall for "more horsepower". A 4-cylinder car can reach 40 MPH almost as fast as a 6-cylinder, especially in rush hour or city traffic. Who cares if the sports car can theoretically reach 210 MPH? How many roads in your area have a speed limit above 70? (zero) Most of your driving will be in the city, where a fast car is a source of frustration. On the highway you might be able to outrun cars easier, but you might also get lots of speeding tickets. Police love to pull over the fast and flashy cars.
Suppose we had a race: I get in my 4-cylider Saturn, and Frank gets in his 6-cylinder vehicle. We drive from one side of our town to the other (approximately 30 miles), and see who can get there first. There is a good chance that the results would be more due to luck (hitting the fewest red lights) and managing to cut people off in traffic, etc. than on our respective cars' engines. If Frank did manage to beat me, it would likely be by 30 seconds or so. Is he REALLY going to use that 30 seconds so productively that it is worth the $6 or $7 more he spent on gas during the 30 mile trip? Not likely. (Note that Frank is also
paying extra money every month in car payments and insurance—a 6-cylinder vehicle is always more expensive than a 4-cylinder.)

Remember that a car is basic transportation. It is not going to make you into a rock star, sex symbol, or prom queen.

Putting it all together

Now some people think that everyone carries a balance on several credit cards, or that everyone will pay a house payment every month no matter what, or that it is impossible to avoid a monthly car payment. I must say that is a dangerous way of thinking—those people have apparently given up without a fight. Since they do not believe it is possible to be debt free, how can they avoid being in debt?

But I will answer each of these 3 objections.

First, the idea that everyone these days must owe something to the credit card companies. If you want to keep up with the Joneses, then yes. If you watch TV and expose yourself to its many advertisements, you will be driven to insanity by all the things they will make you want. Since you probably cannot afford most of them with your current income, they expect you to eventually freak out and buy at least some of those things using credit cards—especially if you get credit card offers in the mail every day (credit card companies send out 6 billion every year!)

But the Joneses are actually quite unhappy. Mr. Jones and his wife both have to work to meet their monthly expenses, and despite that, they wanted to wait several years before having only 2 children. Why is that? Plenty of people can afford children right away, many more than just 2, and right after they are married, even on a modest single income. That shows that Mr. Jones is not thinking things through deep enough, or perhaps he is not thinking for himself. His kids each have their own bedroom and TV, they have tons of stuff (which only makes them materialistic and spoiled), but Mr. Jones is too busy to spend time with them. Deprived of the love they really need, his kids end up depressed, cynical, withdrawn, anorexic, and dysfunctional in general.

Mr. Jones obviously thinks that children are more expensive than they really are. Who gave him that idea? Probably the television that he watches every night, and many of his co-workers who spend too much money on their own children. But children are NOT that expensive, which is proven by the existence of large families (with as many as 9 or 10 children) which do just fine on a modest income. Yes, Mr. Jones is a sad case, who should be pitied instead of envied or "kept up with".

Second, a house payment is not just part of life. It is a big part of most people's monthly budget for a good portion of their working years, but a house can be paid off in as little as 2 years, depending on the cost of the house and one's income. Just because most people have a mortgage from age 21 through age
60 does not mean that you have to.

Your mortgage has a balance, just like any credit card. You can mail in an extra payment at any time, which comes right off what you owe. Your normal monthly payment—say, $800—includes property taxes, home insurance, principal and interest. So only $150 or $200 of that monthly payment actually
brings down the principal (balance) of your mortgage. Therefore every $200 principal payment you send is like another monthly payment of $800, as far as what it does for your mortgage balance. Send in $2,400, and it is like paying a year's worth of payments ($800 X 12 = $9,600). See what a great effect such principal payments have? Such extra payments are really the best place to spend your extra money.

The interest portion of your mortgage payment goes down every month, as the principal balance decreases. The bank looks at your daily balance to calculate how much interest you owe on a given month. So when you make an extra payment, it has the immediate effect of lessening how much interest you owe every month from then on.

Your monthly payment stays the same, so as the interest portion decreases, the principal portion (which actually pays off the house) increases. To give a simplified example: last year you paid $800, with $400 in interest and $150 toward the principal (the other $250 is property taxes and insurance). After
making a years' worth of payments, plus an extra $1000 payment, the same $800 is split up differently. Now only $300 is interest, and $250 goes toward the principal. So you are wasting less, and paying off the house faster every single month, even with the same monthly expense ($800).

As to the third myth, that "it's impossible to avoid a monthly car payment", everything said above refers to car loans as well. It is true that cars decrease in value while houses increase, but you can choose a reasonable car, and buy it rather than lease it. Even if you need to make a few trips to the garage now and then, it will still be much cheaper than eternal payments to a car dealership for a "we'll take care of everything" lease.

Leasing a car (getting a new one in the process every 4 years or so) is much like renting an apartment. In exchange for someone else taking care of all maintenance, you give up all hope of ever owning one yourself. Every month you work hard, pay a bunch of money to some landlord and/or car dealership,
and life goes on. You never gain anything long-term. You own at 45 exactly what you owned at 25, give or take a few DVDs.

There are a few good reasons to rent rather than buy—if houses are too expensive in your area, or your health is poor, or you are not planning on staying in the area longer than 2 years. But most people who rent are forced into it, because they either cannot save up a down payment on a house, or they have bad
credit due to past bankruptcies (caused by debt). So Debt Slavery is the cause of this problem as well.

So neither mortgage payments, nor car payments, nor credit cards are a necessary part of life. I have plenty of living proof, including my own experience. For example, my house is nearly paid off (as of this writing), and I am nowhere near retirement age. I carry no credit card balances, and both of my cars are paid for. Because I only have to support my family and not a bunch of bankers, we get by just fine on my income.

Conclusion

Now that you realize what a drain interest is on your monthly budget, you should strive to avoid debt at all costs. Being in debt makes you dependent on your life situation staying the same—keeping your current job, having no accidents or illnesses, etc. When gas prices rise, home values fall, taxes are raised, or the economy takes a downturn, those in debt are the first ones to be affected.

By controlling your spending a little, you gain much control over your life. Once you are out of debt, you can spend, save, or invest your own hard-earned money however you please. That is the fun part!

Appendix A: How to get out of Credit Card debt

If you carry have credit card debt, all is not lost. When it comes to freeing oneself from Debt Slavery, better late than never!

1. Be convinced of the possibility, and necessity, of not being in debt and keeping the bankers rich with your interest payments. This is important because some sacrifices will be required, especially during your visits to the mall, shopping centers, etc. It takes a bit of self-discipline, and most people around you will be a bad influence, since many of them are still blissfully ignorant Debt Slaves. (Give them a copy of How to avoid Debt Slavery, so they can help rather than hinder you!)

2. Make sure you do not consider the "available credit" on your credit card(s) as "money in the bank". That is not a checking account balance! It just tells how much they will let you enslave yourself to them. You should not have to borrow anything—many people live VERY happy lives debt-free. (In fact, they live happy lives partly BECAUSE they are debt-free!) The only time anyone should go into debt is from necessity. If you have unexpected medical bills, or if you lost your job, you have a good reason to go into debt. But getting a new computer, car or plasma TV is not worth the high cost of being in debt.

3. Realize that every credit card purchase is like taking out a loan. Do you really want/need to take out a bank loan to pay for that $3 latte? If you only make the minimum payments on your credit card, that latte will cost you $12 before you finally pay it off. Talk about expensive! Remember, if you are in credit card debt, there are no good sales for you to take advantage of. Unless they are selling something for 90% off, you are best off leaving your credit card in your wallet where it belongs, undisturbed. Even an honest-to-goodness bargain should be passed up if you cannot pay cash for it, as I will demonstrate: A $30 shirt is marked down to $10 (Nothing is wrong with it, the store is just having a crazy sale). Anyone not in debt would be stupid not to buy this shirt. However, if you put it on your credit card, and you can only afford the minimum monthly payment, it will take you decades to pay for that shirt, during which time it will cost you about $40. Is $40 for a $30 shirt a great deal that you "can't pass up"? But it is true that you will pay $40 for that $30 shirt. So why fall for the sale, when you know better? The trick is to know better. In fact, the shirt would likely be destroyed, go out of fashion, be tossed out, or sold at a garage sale long before it was paid off.

4. Form the habit of not using credit cards. It would be a good idea to switch to a cash/check system for a while (maybe 6 months), until you get used to the idea of buying only what you have the cash for. Credit cards are fine if you use them only for convenience—if you pay off the entire balance every month. They can actually help your bottom line if you get "cash back" or other rewards for your purchases. I have a card that gives rewards, and I just spent $100 in Home Depot gift cards that I earned with little or no effort (just paying my bills, buying groceries, etc.)

5. Use any savings you have (making what, 3% interest?) to pay off your most expensive credit cards (costing you what, 18% interest?). If you have any retirement accounts, cash them out, even if you have to pay a penalty. Your best hope for retirement is using the time from now until then to keep all the
money you earn, and stop sending it off to the bankers. If you really want to secure a bright future for yourself, paying off your credit cards needs to be your first priority. I know that conventional wisdom says, "Save for retirement!", but that is for those who are not paying hundreds of dollars a month in interest. Saving 50 cents for every 10 dollars you pay in interest makes no sense. Besides, you will never be able to live off your nest egg in 10, 20, or 30 years if you are still paying on your credit cards! Having an insufficient retirement account will not ruin you—but having a load of debt will make post-retirement living nearly impossible. As long as you have credit cards and other debt, you simply will not be able to retire. Every year that you have no debt means thousands of dollars (per year) staying in your household. That will make a nice contribution to your future retirement fund!

6. Once you have put most of your savings toward killing credit card bills, then you are ready to use a very powerful technique. Many finance gurus and authors have made a lot of money pushing this system. I call it, "Avalanche of Debt Destruction". First you make a list of what credit cards you have, and their interest rates. Sort them from the highest interest rate (say, 21%) down to the lowest (say, 14%). This is the order in which you must pay them off. Every month, send every spare dollar you can to that first credit card. When it is paid off, send the money you would have sent THAT card to the next card on the list, and so on. Pretty soon you are throwing some pretty big sums at your cards! It is like a snowball rolling down a snow-covered mountain. It starts out baseball-sized, then it grows to soccer ball size, and soon the ball is the size of a small house. Part of the reason this system works so well, is that you pay less and less interest every month, which can then be spent on the cards you have left. Pretty soon you have no cards left, and you will have tons of money left over in your budget every month—not only the interest you were paying every month, but the principal as well. That could be hundreds (or even thousands) of dollars!

7. Another possibility is debt-consolidation loans. The interest rate is always less than most of your cards. You should not be afraid to put your house on the line with a 2nd mortgage. Your finances are practically ruined already if you have credit cards, and you must free yourself at all costs. Home equity loans have a better (lower) interest rate, because your house is offered as collateral. Think about it: If you lost your job, and could not get another, you would be bankrupt either way (with or without the 2nd mortgage). In some states, they are not allowed to take away your primary residence. But assuming that you do not lose your job, there are two possibilities: 1) You stay in debt for the rest of your life 2) You manage to get out of debt by taking out a 2nd mortgage. The 2nd mortgage (Home Equity Line Of Credit, or HELOC) should not be as much as your 1st mortgage, of course, unless you owe that much in credit card debt. So you have nothing to lose. But with any of these means of paying off credit cards, the key is to faithfully obey the following step:

8. Cut up any credit cards you manage to pay off, whether by cashing in savings, getting a debt consolidation loan, 2nd mortgage, or by following the "Avalanche of Debt Destruction" system. It does no good to pay off your credit cards if you charge them up again.

9. Try to avoid temptation as much as possible. Many people have fallen into consumerism and materialism. Advertisements are everywhere. Try to excuse yourself from this onslaught as much as you can. Television is a big source of ads. Either use a Tivo, or only watch DVD movies. But the best solution is to throw out the TV (or at least stop watching it—move it to the basement or a side room—get it out of the family room). Your children will not scream for tons of licensed merchandise and clothing if the TV is not there to tell them what they "need". Children are not nearly as expensive as the consumerist society makes them. Children raised without TV can entertain themselves, have good imaginations, and are much more well-behaved. Studies have shown that children cannot develop certain skills nowadays—those which require patience and repetition—because of the distraction of TV. Newspaper ads come in a bundle (in the middle of the Sunday newspaper, for instance) and can easily be thrown away in a single swift motion. There are enough ads out there that we cannot escape, without inviting them into the sanctuary of our home. When an advertisement is tempting you to spend money, just keep your eyes on the prize. Think about how much better off you will be when you can keep all the money you currently pay in interest. The very item you are desiring might be within your reach soon—and you will be able to pay cash for it—if you get/stay out of debt. If you really need something, then save up for it. This is a good test to determine, "Do I really need this item, or is it just a whim?" If you still feel a strong need for an item after you've saved up for it for months, then by all means go buy it—you earned it! Do this, and your house will seem more spacious, since it will not be storing a bunch of useless junk!

10. Keep in mind, that when you are out of debt (even partially), you will have much more spending power. Though you may have to tighten your belt while you get out of debt, you will be so much better off in the long run. When all your income belongs to you, you will get to spend it all on your own family, and not some banker's private jet! Better to improve your home, send your kids to a private school, give to charity, go on vacation, or give $200 Christmas gifts every year than to spend $2,000 a year on interest, for which no good people benefit.

11. Re-think how you see the banks and credit card companies. Do not consider them beneficial businesses, helpers or friends who care about you. That is what their advertising campaigns would like you to believe. The truth is they are tyrants, vultures, who would just love to enslave you, drive you into poverty, and take the food out of your children's mouths. Consider them a necessary evil at best, and only go to them when you are absolutely desperate.