Car Loans
A car is often the first big purchase young adults finance. Understanding how car loans work — and the hidden trap of depreciation — can save you thousands of dollars.
The Depreciation Problem
Cars lose value fast
Unlike a house (which might appreciate) or stocks (which grow over time), cars lose value from the moment you drive off the lot. This is called depreciation.
Average new car depreciation:
- Year 1: -20% to -25%
- Year 3: -40% to -45%
- Year 5: -50% to -60%
A $30,000 car could be worth only $15,000 after 5 years — while you might still owe $18,000 on the loan.
Being "Underwater" on a Loan
When you owe more on your car than it is worth, you are "underwater" or "upside down." This happens easily with car loans because:
New cars depreciate fastest in the first 1-2 years
Long loan terms (72-84 months) mean you pay down the principal slowly
Low down payments mean you start with very little equity
Rolling negative equity from a previous car into a new loan
Key Loan Terms to Understand
Loan Term (Length)
How long you have to pay. Shorter terms (36-48 months) mean higher monthly payments but less total interest. Longer terms (72-84 months) lower your payment but cost more overall and increase the risk of being underwater.
APR (Interest Rate)
The yearly cost of borrowing. Rates vary based on your credit score, the lender, and whether the car is new or used. Good credit: 5-7%. Poor credit: 15%+ (or more).
Down Payment
The cash you pay upfront. A larger down payment (20%+) reduces what you borrow, lowers your monthly payment, and helps you avoid being underwater.
The Total Cost Trap
Dealerships love to focus on monthly payments. But stretching a loan to lower the payment dramatically increases the total cost:
| $25,000 car at 7% APR | Monthly | Total Paid |
|---|---|---|
| 48-month loan | $598 | $28,704 |
| 72-month loan | $427 | $30,744 |
| 84-month loan | $377 | $31,668 |
That 84-month loan costs almost $3,000 more in interest — and you will still be paying when the car is 7 years old.
Smart Car Buying Guidelines
Consider used cars (2-3 years old): Let someone else take the biggest depreciation hit
Put at least 20% down to avoid being underwater
Keep loan terms to 48 months or less if possible
Total car costs (payment + insurance + gas + maintenance) should be under 15% of income
Get pre-approved for a loan before going to the dealership — do not rely on dealer financing
Negotiate the total price, not the monthly payment
Key Takeaway
A car is a depreciating asset — it loses value over time. Financing an expensive car with a long loan is one of the biggest wealth destroyers for young people. Buy less car than you can "afford," put money down, and keep the loan short. Your future self will thank you.