Most Americans Are Doing This One Thing That Destroys Their Finances
Why overspending on a car now could cost you retirement later
This money tip is going to sound a lot like Nancy Reagan lecturing
elementary-aged school children on what to say when offered drugs, “JUST SAY NO!”
Americans are obsessed with debt — and it’s wrecking their finances.
The average household owes over $24,000 on car loans alone. That’s not freedom — that’s financial handcuffs.
Plotted below are several debt components of the average US Consumer, each one showing how much they have grown in the past ~20 years.
For now, we want to focus on the Auto Loan balance. The total outstanding balance across all US households is $1.64T with the average auto loan balance being $24,035 according to credit reporting bureau, TransUnion. The average payment is $734 for new cars and $525 for used cars, with the average term being 68.48 months, that’s almost 6 years!
People are spending a lot more on cars and spreading the payment across a much longer timeframe than they did in the past.
Transportation is a necessary purchase and it is a heavily depreciating asset on your balance sheet. The advice we would give is to carry it in the asset column and not the liability side, meaning try to not have a car payment and pay cash if possible.
So, how much car should you purchase?
Financial Samurai, in our estimation, has two of the best and easiest formulas to follow:
Income-Based Car Purchase Rule
If you follow one rule when buying a car, make it this:
Never spend more than 10% of your gross income on a car. Anything more and you’re robbing your future self — literally.
For example, if you make $100k/year you should purchase a vehicle that is no more than $10,000. $200k/year would get you a $20,000 car, etc.
By following this simple formula, it allows you to focus on growing your wealth long term by participating in your company match 401k, HSA, and after-tax investments. It also has a MASSIVE benefit; it keeps you from going into other consumer debt like credit cards! That new car feeling? It fades in a month. But the payment sticks around for six years — and steals your chance at real wealth.
This is a VERY conservative way of approaching a car purchase, but let’s say you give the middle finger to the entire idea and go buck wild and violate the rule big time, like 20% of your gross annual income on a car. In this direct violation you purchase a $20,000 car while making $100k. We would say that is probably not a big deal, but we would limit anything past 20% and stick to the 10% as much as possible.
You can find great, reliable, cheap cars if you look hard enough. Resist the urge to go all out like your neighbor who just bought a $75k new car and making $50k/year. When times get tough, which they will, you will be able to harbor the storm with fewer problems.
Net Worth-Based Car Purchase Rule
When your net worth exceeds $1MM you should purchase no more than 5% of your net worth on a car.
For example, if you have a net worth of $1MM you would purchase no more than a $50,000 vehicle. This component of the rule ignores the income but looks at the balance sheet in its totality.