This is an issue that I continue to hear contradicting perspectives on. Is an auto loan considered to be “good debt” or “bad debt”? Let’s look at the viewpoints.
An auto loan is a “bad debt” because
- Automobiles depreciate quickly When you borrow money against an asset that depreciates rapidly, you’re simply purging money.
- Automobile loans are fairly high interest loans As a form of consumer loan, most auto loans have a fairly high (6% and higher) rate of interest. Any loan that has such a high rate means that you’ll be investing much of your monthly payment into interest.
- Automobiles can be paid for in cash with some careful planning If you plan your spending carefully, you can buy your next automobile in cash.
On the other hand, an auto loan is a “good debt” because
- Automobile ownership opens the door to greater financial gain With an automobile, you can commute to work, which greatly expands your potential employment and earning market.
- Careful buying can reduce the auto depreciation If you purchase a top-quality late model used car, such as a Lexus or another high-end model, your automobile will depreciate much slower than if you bought a new lower-end model. Hedge your bets by looking for solid deals instead of jumping on something shiny.
- Good credit will get you a good rate If you have strong credit, you can get a very nice interest rate on an auto loan, sometimes below 5%.
There are some reasonable arguments on both sides, but I tend to think that a loan for your first auto purchase is fine but it becomes a much worse deal on later purchases because of the financial losses. After some time, you have the capacity to save enough for a car by utilizing a strong savings program (i.e., continuing to make car payments after the car is purchased). In other words, paying cash for an auto is better once you’ve managed to pay off a car, but a loan is acceptable of you don’t have many assets at an early stage in your life. As always, readers are invited to offer their own thoughts here.