According to new data from Experian, consumers now borrow, on average, about $28,000 for a new car purchase, an increase of about 4%. Even with record low interest rates, the average car payment on a new vehicle is up as well, now almost $500 per month.
There are a myriad of reasons why people may feel like they can afford bigger car payments than in the past: low inflation and sinking gas prices are two that come immediately to mind. And, it may be simply that the consumer is weary of the “de-leveraging” process of the last five years. (Data shows that the average American household paid down debt over that period of time, instead of accumulating more of it.)
But the bigger question to answer before taking on a $500/month car payment, is not can I squeeze this payment into my budget, or can I qualify for this loan with my credit score? The bigger question is can I afford this payment given my longer-term goals? Unfortunately, many people haven’t gone through the process of quantifying their long-term goals, and the savings needed to meet those goals. Therefore, they don’t know what they are sacrificing in the future, to have the new car today.
This is something economists refer to as “opportunity cost.” Each decision to allocation capital (i.e. “spend money”) to something today, “costs” something in the future, because that money isn’t able to grow for you. In this case, a $500/month payment over 30 years at a reasonable 8% return is about $750,000.*
So, if you don’t have a long-term plan in place, you may want to consider hiring a fee-only CFP professional to help you get one. And if you do have a plan, but are having difficulty meeting your savings goals, you may want to consider taking out smaller auto loan now to maximize your future nest egg.
*Now of course, no one finances a vehicle for 30 years. This assumes that at the end of the loan period, a new car is purchased and a new loan is taken out at the same amount. Admittedly, that’s a simplistic assumption, but it makes the point.