Why Car Loans Can Be Bad Debt
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UPDATED: Oct 3, 2012
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Car loans are useful for borrowers looking to obtain vehicles. However, like many forms of debt they can be considered “bad” debt or debt that is simply more harmful than helpful. Borrowers will be in a more informed position to manage their debt if they educate themselves by reading car loan articles. Doing so prior to applying can help borrowers better understand how car loans can be a hindrance. Even though they are a modern necessity, car loans can often be bad debt for a number of reasons.
Unless someone uses public transportation, carpooling, a bicycle, or lives close enough to key points to walk around, chances are they will require a car to travel to and from work, school, and interviews. Therefore an automobile is an enabling purchase. By purchasing a vehicle, a borrower enables themselves to freely commute to wherever they wish. Cars are usually not purchased in full since they tend to be expensive purchases. As a result, most people must obtain financing in the form of a car loan. In the case of people who must commute, then an automobile is a clear necessity, vital to their employment and financial wellbeing.
Vital or not, debt is still debt and must be repaid. The purchase of certain types of vehicles can influence how much debt must be repaid.
Expensive vehicles, such as luxury vehicles, will of course cost more money to either pay in full or finance with a loan. This means a greater balance will have to be paid off in the long run.
Additionally, borrowers should never take out auto loans under the assumption that their vehicle is a profit-making “investment.” Borrowers looking to sell off their vehicles for profit can be in for a rude awakening, as cars lose 15 to 20 percent of their value each year.
On top of that, since car loans accrue interest, most borrowers are never ahead of the immediate loss they incur at the time of purchase. Although not all car loans carry high interest rates, depending on a borrower’s credit history and debt-to-income ratio certain borrowers’ interest can be very high. This means that a sizable amount of money in each monthly payment will simply be paying off interest. Predictably, this can prove costly as interest compounds for borrowers who only make minimum payments.
As a result, a car loan is not a good purchase from an investment standpoint. Using a loan to purchase something—in this case a car—that loses value almost immediately is both an unwise use of money as well as a poor investment.
Car loans, like many debts, can allow borrowers to purchase items that they could not afford otherwise. However, this debt must be repaid and borrowers should remember that repayment requires income and budgeting. Without proper oversight, debt can balloon and lead to defaults, extra fees, and collection agency pursuit as well as years of damaged credit.