Tell me your income and how much of that income gets spent on car payments, and I can fill in the blanks. America’s obsession with cars is as old as it is severe. From the top of the economic food chain to the bottom, our cars are status symbols, temporary escapes from financial reality, and more disturbingly, albatrosses that hang around our necks and pull our financial lives down in the dumps.
The average new car payment in America has crept above the $500 per month mark for the fist time, settling in at $503, according to a recent study by Experian. And if that weren’t bad enough, the average length of a car loan now stands at 68 months. Nearly one-third of new car purchases in the first quarter of 2016 included loans that stretched from 73 to 84 months. If you have to finance your new car purchase over 73 to 84 months, you can’t afford the car. Buy something cheaper — much cheaper.
I've never witnessed a person consistently make poor transportation decisions while also living a reasonable financial life. Of course, the irony is people who drive new and expensive cars are often assumed to be financially sound. Show me a person who spends next to nothing on transportation costs, and I’ll show you someone who understands money.
Like in any borrowing scenario, when the consumer lets the seller determine what they can afford, too much of whatever will be the result. I can tell you instantly, a person earning $14 per hour can’t afford a $600 truck payment, yet I regularly encounter these deals. The end result is someone driving to work, in order to earn money, so they can afford to drive work. As if making $14 an hour wasn’t challenging enough, throwing $7,800 per year of car payments up against a $28,000 gross income is financially deadly, especially when you add in fuel costs and the cost of auto insurance. So much for upward mobility.
Overspending on transportation isn’t limited to hourly workers. Recently I met a 60-something couple who are supporting their adult daughter and three grandchildren. While their plan for financial stability certainly had several holes in it, $1,300 a month worth of car payments for the couple didn’t exactly do them any favors. “What? Are we supposed to lease or something? We’ve always been able to afford payments like this,” they told me. Frankly, I don’t really care if someone leases instead of buys, as long as the payment fits within their budget. I love when people eliminate financial obligations altogether, but a crazy-low lease deal may be able to help a struggling person get back on their feet.
Once again, what you are able to borrow and what you can objectively afford are separated by miles and miles of highway. I like for people to limit their total transportation spending to 15% of net household income (after taxes and paycheck deductions). Therefore, a household netting $4,500 a month shouldn’t spend any more than $675 on transportation, no matter how many drivers are in the house. The $675 includes car payment (purchase or lease), fuel, maintenance and insurance.
Don’t dismiss my insistence on transportation frugality as me being a stick in the mud. When you overspend on transportation, the rest of your financial life breaks down on the side of the road. Your future (saving and investments) doesn’t get the funding it thirsts for, your past persists as you slow your debt pay-down process, and your lifestyle constricts.
If you’re spending more that 15% of your net income under the guise of paying off a car and ridding yourself of a car payment altogether, you may be ignoring the brutal impact overspending has on your finances during the loan period. You cannot go 68 months overspending on transportation without significantly cutting your lifestyle or going deep into consumer debt. Given the recent Federal Reserve study finding 46% of Americans can’t come up with $400 for an emergency, how can the average American afford a $503-a-month car payment for just one month, nevermind 68 months? They can’t.
You gotta think that intoxicating new car smell somehow numbs the part of the brain responsible for math.
Like many consumer decisions, spending too much on a car payment seems benign. It’s not. You can’t overspend on a category for 68 to 84 months and expect anything other than a mess. Find a car that fits into your budget. Stop finding a budget that fits into your car payment.