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Carla Fried: Big cars, big car loans make for household financial fiasco

Carla Fried, Rate.com on

Published in Home and Consumer News

The Federal Reserve Bank of New York reported that at the end of the third quarter of 2019, our collective car loan balance was a record $1.32 trillion. That's up from the previous (pre-financial crisis) high of $823 billion in late 2005.

Used-car prices have risen, too, but the monthly loan average of $400 is still much better than the average $550 for a new car. The average used-car loan is for 65 months. Over 65 months, saving the $150 a month and earning an annualized 5% would add up to about $11,000. Keep that $11,000 growing for another 25 years, and you could have $37,000 waiting for you in retirement.

If you can manage to borrow less for a shorter amount of time, you will do yourself a huge favor. Let's say you choose a used car with a $400 monthly payment that lasts for "just" 48 months. If you have a solid credit score, that's a startling loan balance of about $17,000. With a trade-in and/or down payment, that might give you a budget of $20,000.

Like new cars? Focus on the potential longer-term payoff. Compare a $550 car payment that runs for 70 months -- the current average -- with a $400 payment over 48 months.

Your payments for the first 48 months will be $150 lower. If you invest that money and earn an annualized 5%, that's nearly $8,000. Then, from months 49 to 70, when you would still be paying off the new car, you're loan free. So, let's assume you save the entire $400 a month. Assuming the same 5% annualized return, that works out to having another $9,500 or so by age 70.

 

That would put you $17,000 ahead of paying off the higher-cost new car over a longer term. If you left that $17,000 growing for another 20 years it would be worth about $45,000 in 20 years. Got 30 years until you retire? It would be worth more than $73,000. If you're a two-car household, borrowing less and paying it back faster becomes a six-figure win for your retirement.

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