The credit union he worked with gave him several options – a 36 month loan at 6.75%, a 48 month loan at 6.875%, a 60 month loan at 7%, and a 72 month loan at 7.125%.
He took the 72 monthly car payment loan.
Afterwards, he bragged to me about his deal. “I’m only paying $549 a month for that ride,” he told me, believing that I’d be impressed at how cheap he got a very nice brand new Cadillac.
I went home later, though, and ran the numbers. If he had taken that three year loan, he would have paid $988.11 a month. Ouch.
But here’s the kicker. Here’s what he would have paid total on each of those loans.
The 36 month loan would have cost him a total of $35,568.
The 48 month loan would have cost him a total of $36,833.
The 60 month loan would have cost him a total of $38,160.
The 72 month loan, the one he took, will cost him a total of $39,562.
His “sweet deal” is going to cost him an extra $4,004.
Here’s the problem. He led with the wrong question. He focused heavily on the monthly payments without even considering the bigger picture, and for that focus, he’s being rewarded with an extra $4,000 in payments.
Here’s a better plan.
First, don’t buy something that you can only afford with a suboptimal payment plan. Because my friend wanted more car than his wallet should be able to really handle, he’s paying a $4,000 surcharge for the option. If he had waited and saved up a bigger down payment or simply settled for a bit less of a car than a Cadillac CTS, he wouldn’t be watching $4,000 walk directly out of his pocket for nothing in return.
Second, always calculate the total cost of your purchase. That’s the number you should be working with, not the monthly payment. The lowest total cost is the deal that will keep the most money in your pocket.
Third, if you can’t get what you want for that lowest total price, keep shopping. You don’t have to buy today. If you need wheels for the short term, buy a low-end used car that can just serve to get you from point A to point B and wait on the long-term purchase until you have an appropriate down payment so that you can swing the best total payment plan.
Or, best of all, save, save, save and buy with cash. With the 36 month loan, his payments would have been $988. But if he started saving $850 a month right now (yes, $138 less than his payment) and saved that each month for 36 months in a 3% savings account, he’d have enough to pay cash for the car he wanted. That plan would cost him only $30,600 – a savings of $4,968 over even the best payment plan.
What’s the take home message? Looking at just the monthly payment when you go to take out a car loan – or any kind of installment loan, including mortgages – will almost always hurt you in the end. Instead, look at how much you’ll pay in total – that’s the number you want to be low. If you can’t afford those monthly payments, then you’re buying something more expensive than you can really afford, anyway.