Updated on 12.26.06

Is An Auto Loan Good Or Bad Debt?

Trent Hamm

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.

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  1. Bill K. says:

    I’d agree with you. The first car that I’ve bought (my 2005 Honda Element) was partially financed. Granted, I went with a new car, not late-model used, but my interest rate is a mere 1.9% thanks to some huge incentives on the Element from Honda back in ’05. The interest rate is so low that I feel like Honda let me borrow for free, and it allows me to throw some extra money at my house payment each month.

    Now if I can just find some extra cash to invest in a DRIP…

  2. ruthie says:

    An interesting aspect of commuting that some people don’t consider – many times if you are willing or able to live on the fringes of town or in a neighboring town, you will be able to get (sometimes significantly) less expensive housing. We looked into this when we moved into the Bay Area, but calculated that we would only break even between transportation costs into San Francisco, so plus the time expended we decided it wasn’t worth it to us. There are other benefits as well – for example, you may be able to get a larger home, you may be able to get a yard or a bigger yard, you may enjoy the peace of not living in the city, you may be able to live in a safer neighborhood, etc.

  3. Like Bill K. says, as long as you have a need for a car, if you can get a good rate, it can be a good debt. I’ll leave depreciation out of it, because many people just need to have a car to get to their jobs. If you don’t need a car, then it’s probably bad or neutral debt at best.

  4. I agree that the first car is the hardest especially when you have no parental help. We’re not into debt, and yet we had a car loan for both our cars, which we still have. But we had no help from our parents so what else could we do? And it turned out for the best.

    The only people who can do without a car loan had help. Even if it was living at home and borrowing a parental car. I saved since I was 12 for a car, but I still needed a loan. I didn’t have a car in college, but I got one because I needed it for a job. Now I don’t like loans, but unfortunately there are some starter costs in life.

  5. Ed M. says:

    Whether you finance or pay cash, the price you pay is the most important part of that purchase. Getting the best deal on any car requires preparation, knowledge and negotiating skills. One of the best sources has got to be Consumer Reports’ individual automobile reports. The price (less than $10) is worth it just to see the look on the sales managers face when you offer to pay the exact wholesale price the dealer paid. Priceless!

    Remember, don’t start at the sticker and work down…go from the wholesale price and make ’em sweat for the buck. First new car I bought was stickered at $17,999 (before tax). I got it for $14,545 (before a $500 dollar rebate) and a 4.9% finance rate (I prequalified with a bank so as not to give the dealer a shot at hosing me over with dealer financing). All totaled, (tax, transportation, damn dealer fee) I drove it off the lot for $15,350. OK for a newbie first time buyer.

  6. Cameron says:

    I think making “payments” even when you don’t have a loan at the time is a great idea. That’s my philosophy. My parents had an old car for me while I was in college. During college I saved up $8,000 and bought a 3-year-old Galant that’s much more reliable. No loan required because every month I saved what would otherwise be a car payment. Great advice, Trent, thanks!

  7. greg says:

    I knew what car I wanted, and I knew how much I could spend on a monthly payment. I didn’t have much time and needed wheels, so I rented on a bi-weekly basis with my “car money.”

    I waited for two things to happen:

    1. A 0% financing plan.
    2. Clearance pricing.

    I knew from watching the dealer that I didn’t have to wait long. Two months later I was rewarded with exactly the car I wanted, with %0 financing and over $7000 in reductions on an already low-priced model.

  8. car loan las vegas says:

    Do you have a source for this information? I’d love to read more about this.

  9. rodgerlvu says:

    thanks. you are the most intelligent person i ever met…Do you have a source for this information? I’d love to read more about this.

  10. Steve says:

    Your arguments “pro” car debt are really valid points — but not for using debt to buy a car. The first, “Automobile ownership opens the door to greater financial gain” is an excellent reason to own a vehicle, be it a 1 day old Lexus, or a 10 year old Ford Focus. It doesn’t justify debt.

    The second point, “Careful buying” will help make it more affordable in cash.

    The third point, about building credit, is bunk. Pay cash — you don’t have to apply for it!

  11. Tracy says:

    I am a single mother who is in desperated need of a car. I have a 1999 Bravada that is in need of a lot of repairs and which I still owe $2100 on. I want to trade-in my Suv and get an smaller car. My plan was to make a trade-in at negetive equaity and add the balance to a new car loan at an cheaper finance rate. However, I know that my budjet can not afford this. I am struggling paying the $2100 off. Can someone give me advice on what to do, I need a smaller car soon as yesterday. my current automobile use to much gas.

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