Dave Ramsey Warns That One Financial Decision Is 'the Largest Detriment to Your Wealth'

Building wealth and expensive car payments go together like oil and water.

For many Americans, a car payment is practically a fact of life. Cars are expensive, so if you want to get a new one, there's a good chance you'll need an auto loan. And once that car isn't so new anymore, it's time to repeat the process.

It may be a normal part of American life, but it can also hold you back quite a bit financially. On his radio show, Dave Ramsey recently said that "the car payment is more of a detriment to your wealth, your ability to become wealthy, than just about anything else." If you're considering getting a new car, Ramsey's advice is worth hearing.

The trouble with car payments

There are a couple of reasons why car payments are so problematic, starting with how much they typically cost. The latest data shows that car payments are at record highs, costing an average of $733 as of July. The average cost of a new vehicle is $48,182, also a record high.

That's part of why Ramsey doesn't recommend car payments. The other issue, he says, is that "cars go down in value. They're the largest purchase that we as consumers make that goes down in value."

People often look at car payments as a monthly expense, but that doesn't really show you the true financial impact. Let's say you buy a car and have a $733 monthly payment. In a year, you've paid $8,796. In five years, you've paid $43,980.

Now let's compare that to something else you could've done with that money. Instead of shelling out $8,796 per year for a new car, you invest in stocks with a basic S&P 500 index fund. Although the stock market can be volatile, its average return is 10% per year over the past 50 years.

Assuming an average return of 10% per year, you'd have $59,071 after five years. If you spend the same amount of money buying a car, instead of ending up with nearly $60,000, you'd have a vehicle that's maybe worth half of what you paid for it.

How much car do you need?

There's nothing wrong with buying a car. And even though Dave Ramsey is against it, there's also nothing wrong with getting an auto loan and having a car payment. The problem is when you don't consider how much car you can afford and end up overspending. That's the kind of decision that can have serious repercussions, because you could be locked into an expensive loan for years.

Unfortunately, many people fall into the trap of getting cars they can't really afford. It can be tempting to buy the most exciting, shiniest new toy, and when it's a vehicle, it's easy to justify. You tell yourself it's the car you need, even if a used model would work just as well at a much lower cost.

To compound the issue, this often isn't just a one-time thing, either. Because if you spend too much to have the latest car, you're probably going to want to do it again in a few years time.

If a car payment isn't going to make a big dent in your budget, then by all means, get the car you want. But if you're trying to improve your financial situation and build wealth, a car payment that takes up 20%, 30%, or more of your income is going to be a major obstacle.

How to avoid an expensive car payment

Ramsey recommends avoiding car payments entirely, and he has a few recommendations to manage that. If you need a car, he suggests buying a cheap, used one. Or, if you already have a car and it isn't giving you any problems, just keep it.

To be honest, hanging on to your current car is probably the best option right now. The car market hasn't been good for buyers lately, with new and used car prices rising higher and higher.

What if you don't have a reliable car and you need to get one? In that case, here are a few tips to avoid overextending yourself financially:

• Start a savings account specifically for your car fund. Contribute to it every month so you have some money saved when you're ready to buy.
• Take Ramsey's advice and look at used cars. Even though they're still higher than normal, used car prices have been coming back down in recent months, and there are some reasonable deals available.
• If you need to take out an auto loan, limit your monthly payments to no more than 10% to 15% of your take-home pay. Make sure not to get an extra-long loan for lower monthly payments, though. Stick to 60 months or fewer for a new car loan.

Ramsey is right on the money about expensive car payments. They may be common, but that doesn't make them a good idea. If you can keep your car payment affordable, or better yet, avoid a car payment entirely, it will give you a big leg up as you build wealth.