When is an Auto Loan a Good Debt

What is a good loan? To be honest, there are very few such critters inhabiting this planet. However there are useful loans that can do you enough good to overcome their bad points. An auto loan can be such a useful loan if:

1. The loan is the only reasonable way for you to get a car,

2. You really need a car for work or some other purpose,

3. The loan does not lead you to buy a more expensive car than you need, and

4. Most importantly, you have a plan to pay off that loan and the plan is realistic.

The biggest problem with debt is that it tempts us to spend money we don’t need to spend on things we don’t need to own. How many people really need a $20,000 car? The first few miles you put on that shiny new vehicle will depreciate its value considerably. It is much more cost effective to buy a good used car. Yes, it may have a few problems but if you are careful you can avoid most of those problems and be prepared for the rest. Have a good mechanic check the car before you sign any papers, many will actually guarantee that evaluation and fix at their expense any problems they don’t find. Sock away a bit of money for emergency repairs and you will still be paying much less than the cost of a new car.

Also, even in used cars don’t buy more than you can afford. Fancy interiors and stereos etc. run up the price without adding to reliability. If you don’t regularly use four-wheel drive, don’t pay for it. If you don’t need a big gas-guzzler, get a smaller vehicle.

Now back to loan issues. I like to divide debt roughly into two categories, investment debt and consumption debt. Consumption debt is things like vacations, clothing etc. which will not bring a financial return. Investment debt can bring a financial return and includes things like an education, business start-up expenses etc. A car can be either, or can even be part investment and part consumption. If you need a car to get to work, that can be an investment. However if a $5,000 used car will get you to work and you buy a $15,000 new car on credit, then you’ve just incurred a $10,000 consumption debt to go along with your $5,000 investment debt.

You should never, ever take out a consumption debt. To do so exposes you unnecessarily to all the evils of debt and guarantees you will pay interest you could use elsewhere. Investment debt can sometimes be worthwhile but only after careful consideration of all the issues involved. Can you get what you need in some other way? Can you cut back elsewhere to avoid this debt? Can you pay it off?

And what about those no or low interest auto loans? Aren’t they a good deal? Well, they might be but usually you can get an even better deal. A used car is still cheaper and even if you can afford to buy new you can usually get a lower price if you are able to offer cash on the barrelhead. Negotiate a to the dealer’s lowest price before you tell him how you will pay, then offer less than that in cash. Often he will take the offer. If he won’t and you can get a zero interest loan, set the money aside in an interest-paying account so you can pay it off. Do that only if you have the self-discipline to not touch that account for anything else.

Remember, debt never sleeps and is always sucking money out of your pocket. Incurr it only for good reasons and after careful consideration of all aspects of taking out the loan.