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The Dumbest Way to Buy a New Car

Buying a new car is one of the biggest purchases many people ever make. But even for such a high-priced item, you should steer clear of what's becoming an increasingly popular way that many car buyers are financing their vehicles.

The scary trend in auto financing
Strapped for cash, more car buyers are taking on long-term loans to buy new vehicles. As a report in The Wall Street Journal discussed earlier this month, the average term for car loans late last year rose to a record-high 65 months. The proportion of loans ranging from six to seven years in length has grown by more than 50% since 2008, and some lenders are even offering 97-month car loans -- forcing you to make car payments for more than eight years.

Ford Focus. Photo source: Ford Motor Company.

The reason car buyers are taking on such long loans is pretty clear: Longer loans mean lower payments. With auto prices on the rise and even used-car prices remaining strong, buyers have little bargaining power in hoping for discounts and instead have to look to spread their payments out over longer periods of time.

3 reasons long loans are a bad move
Yet even with economic reality requiring many to consider longer auto-loan terms, there are many good reasons to consider alternatives. Even though you may have to put off buying a new car long enough to save more toward down payments, you'll be in a much better position to avoid these three pitfalls:

1. You'll be underwater on your car a lot longer.
As soon as you drive your car off the lot, its value drops below what you owe on your loan. With short-term loans, your payments quickly get you back to even, freeing you up to consider options like selling it or trading it in for another vehicle down the road.

With long-term loans, though, it can take years for you to get to the breakeven point. That means if you ever want to get rid of the car, you'll have to pay extra money upfront just to pay off your loan -- even after considering the trade-in value of your vehicle. That's not a good situation for anyone to be in.

2. You won't get as many promotional financing deals.
Many auto dealers offer low-cost loans as an incentive to buy. Over the years, Ford (NYSE: F  ) , General Motors (NYSE: GM  ) , and Chrysler all offered great financing deals to compete with more popular Japanese models. With Detroit now having rebounded, Honda (NYSE: HMC  ) and Toyota (NYSE: TM  ) have also renewed incentives that include financing deals. Even now, Ford offers 0% financing on some of its popular models, including the Focus pictured above.

But Ford's offer goes only with loans of up to 60 months. If you need longer-term financing, you may well end up paying a much higher interest rate, and combined with having to pay interest for a longer period of time, the result could be thousands of dollars in wasted money as a result of your needing lower monthly payments.

3. You'll strain your credit for other purchases.
Having an auto loan on the books may make it harder for you to get credit for other purposes, such as buying a home or getting a credit card. Even if you make payments on time, your monthly payment will sap available income to support other loan payments. That can leave you in the uncomfortable position of having your car keep you out of the home of your dreams.

The smarter move
As tough as it is to defer gratification, waiting until you can make a big down payment or settling for a less expensive vehicle to qualify for affordable short-term financing is the better way to buy a new car. Otherwise, you could end up digging yourself into a debt hole you'll have trouble ever getting out of.

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Read/Post Comments (15) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 14, 2013, at 10:47 AM, bobthegoodone wrote:

    After buying my first Ford Truck 1 YEAR AGO i WILL NEVER BUY ANOTHER ! MY DEALER QUIT HONORING MY WARENTEE AFTER 4 MONTHS !

  • Report this Comment On April 14, 2013, at 11:08 AM, TheSuperD wrote:

    Even though taking a six- or seven-year loan on a new car may be a bad idea, it's still a better financial decision than leasing a car. When you lease, you're basically making car payments, then giving the car back to the dealership for free once the lease is up.

  • Report this Comment On April 14, 2013, at 11:25 AM, EDDP5 wrote:

    Good read and good advice. Additional point would be the higher insurance costs over the life of the car.

    A car being leased or financed must have full coverage, while a fully owned vehicle can have minimum liability coverage only. Adds up over an additional two/three years.

    Whats the average life of a car anyway?

  • Report this Comment On April 14, 2013, at 11:32 AM, gdelzer wrote:

    The Foolish move isn't to buy or lease--it's to rent!

    I normally drive a 2003 truck for work with poor mileage. On the weekends, I go to Hertz and rent a 2012/2013 car with low miles and great mileage. This weekend, three days is costing me $34. I don't rack up debt, I don't even pay additional insurance (my American Express covers it), and I can get Hertz Gold points OR frequent flyer mileage (my choice) along with 3% cash back from American Express.

    I do this most weekends, particularly if I am driving out of town for any reason.

  • Report this Comment On April 14, 2013, at 12:01 PM, Hjin wrote:

    @EDDP5, many factors determine the "average life" of a car. Today's cars are capable of going at least 200,000 miles if proper maintenance is performed regularly. However, the average car ownership is about 70 months, or a little under 6 years. Assuming that the average driver drives about 15,000 miles per year, that translates to about 90,000 miles before an owner buys a new car. However, depreciation on the car slows down substantially after the first 2 years.

  • Report this Comment On April 14, 2013, at 12:30 PM, mr091468 wrote:

    The prolitariat is its own worst enemy. Blame yourselves. If you want car pmts to come down, don't buy a car!

    If you look at it from a pure accounting standpoint, three items make up the cost basis for a car: material, labor and factory overhead. All cars have 1 hood, 4 wheels, 1 engine etc, etc, etc. So why do you buy a Buick or a Lincoln or a Caddy or a 50k SUV when you can buy transportation for 15k?

  • Report this Comment On April 14, 2013, at 12:30 PM, dmacid wrote:

    Long term loans are an excellent way to go. Being dumb enough to actually take 6-8 years to pay your car loan off is another thing. I got a 6 year loan on the car I bought a year ago. Interest rate in between a 4 year loan and 6 year loan was almost identical (0.3% difference I believe). I took the 6 year loan and calculated that if I paid it off in 4 years I would end up paying $5,000 of my loan back interest free. This more than made up for the tiny interest rate difference.

  • Report this Comment On April 14, 2013, at 12:42 PM, wolfsram wrote:

    To TheSuperD, I would say, leasing is probably the BEST way to get a vehicle, within certain parameters. If you are not driving more than about 12k a year and enjoy having a new car every 3 years or so, it's perfect. I've been in the car business for 10 years, and I've found this is how the managers and salespeople who are not afforded a demo do it, and it makes sense... you never have negative equity, you get a new vehicle every 3 years or so which is always under warranty, and the monthly cost is lower, since you are paying for the use of the car instead of the car itself. Whats more, your comment is incorrect... you may turn the car into the dealership, but they don't get the vehicle unless they buy it from the leasing company (which is usually a division of the manufacturer). In my experience this is rarely done; the residual value of the vehicle is more than what the dealership could pay for one at auction. Leasing would not be right for me, for instance, because I drive 120 miles a day. But for those who live close to work, and enjoy getting a new vehicle often, it's perfect.

  • Report this Comment On April 14, 2013, at 12:55 PM, wolfsram wrote:

    dmacid has the right idea. Contrary to what the article states, no one is "forcing you to make car payments for more than eight years". That may be the life of the loan but no one says you can't pay it off early. Term reduces payments much more than rate does IN MOST CASES. I don't have a crystal ball, I don't know what's going to be happening with me in 5-6 years.... I would much rather be obligated to a $350 payment and pay $500 when (and while) I can, than be obligated to a $500 payment when, down the road, I can only afford $350. What's more, the extra $150 I pay goes to the principal itself, which in turn reduces the total interest paid on the loan in the long term. Thus in a few years, equity is born, which is thing rarely seen in the car business. Cars are a horrible but necessary investment, but if you buy within your means, I see nothing wrong with long term loans.

  • Report this Comment On April 14, 2013, at 2:12 PM, erickt wrote:

    to me, leasing is having to return a ding-free vehicle or pay to repair the dings. The way i see it is that a six year loan is reasonable on my pocket book. just at 5 years I get a new one year old very low mileage car but continue paying at the same monthly rate. In this way, I always have a relatively new car to drive and my payments remain affordable.

    Today's cars begin to break down mechanically after five years.

  • Report this Comment On April 14, 2013, at 6:19 PM, smith3459 wrote:

    Best advice, buy what you can afford. If you need even a six year loan on a car, you can't afford it.

  • Report this Comment On April 14, 2013, at 6:58 PM, oneofthemasses wrote:

    The contract for leasing should be called the "The lose, lose lease". They also didn't mention the best way to buy. Paid in full just like your washer and drier.

  • Report this Comment On April 15, 2013, at 12:38 AM, aWintersTale wrote:

    As a first time car buyer, I wanted to establish credit. So even though I had the purchase covered in cash, I took out a loan, then after several payments, I paid off the balance in full. Subsequently, all credit card purchases for any item were paid in full each month, which ultimately, when it came time, allowed through the establishment of a good credit rating, the borrowing towards a residence. I am not rich. But not being one to purchase items to impress others, nor having to acquire this month's "must have" gear, allowed a slow but steady savings. I did splurge on a hard-core, hard-tailed mountain bike, however.

  • Report this Comment On April 15, 2013, at 8:26 AM, ohiodale wrote:

    I always get 60 month loans but try to pay them off in 48 months. I keep my Fords for 10 years so I can easily save a substantial down payment for my cars which keeps my payments low. I usually have little to no maintenance costs in the 10 years besides tires, batteries, changing the transmission fluid once, the coolant once and oil a couple times per year. After 10 years I would need to replace brakes and the exhaust which is not worth the extra cost. I would never get a term longer than 60 months. If you need a term longer than 60 months than you cannot afford that particular car.

  • Report this Comment On April 15, 2013, at 2:21 PM, damilkman wrote:

    Another way is using your 401K. The advantage for us is we wanted to keep our cash but take advantage of the fact the sticker price was 2K less if we bought with cash. The payments are automatically deducted from my paycheck and my 6% loan is to myself. If I change jobs the 401K loan follows me. If I lose my job I can make direct payments to myself. Also my credit score looks better because the loan is not on the books. if at any time I want to pay it all off, I can. I can also itemize exactly how long I want to take to pay my loan to myself off.

    What I absolutely enjoyed is it took ten minutes of research and a 90 second call for me not to have to deal with the financing division of a car company. That is priceless.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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