Car and Vehicle Financing

You want to buy a good car not just good financing. You need to be shopping for the best overall deal. That is the one where you get the best car, for the best price with the best financing. You want to minimize your operating cost and maybe build some vehicle equity. You are shopping for the best long term value. The best way to make a vehicle financing decision is to use our 3 basic Financial Therapy tools to make that decision.

The first rule of budgeting is to spend less than you earn. When you buy a car you want to make sure that you do not cramp your budget to pay for a car. The maximum percentage of your income that should be paying debt including your mortgage is 40% and that is very high. If your mortgage or rent are use up 33% or more of your income, that leaves 7% or less to finance a car and other debts. That means that if you make $50,000 per year, you can only afford $3500 per year or $300 per month to finance a car.

If you can restrain yourself you can buy an old car and just fix it up. If you buy wisely you can reduce your car costs substantially on your monthly budget. If you buy a new car and pay it off you may want to keep it. This leaves room in your budget to save or reduce other debts.

If you need a good vehicle to produce your income then this may justify the impact of taking on debt. It may be a cost of making your income. This factor can be weighed out in your life plan.

If you have paid for your house and have lots of room in your budget because that 33% is freed up, that may be the time to indulge in a car that you need to finance. You can shorten the terms and get the cash price. Both of these items impose on your budget but you can afford it if you own your house.

Vehicles are a depreciating asset. If you finance the vehicle you will find that in most financing plans, the amount you pay off on the principal of the loan is about equal to the amount of depreciation. That means that even though you may have a nice shiny car that makes you look like a million bucks, the impact on your net worth is zero unless you pay the loan down to zero. Then you have an asset but after 5 years it is worth about 30% of what you paid for it.

If you trade it in for a newer vehicle you just run on the spot as far as your balance sheet is concerned. You build no equity and you make no gain on your net worth from your vehicle. It is strictly a budget item.

What is the impact on your balance sheet of leasing a car? The most important impact of a lease on your balance sheet is that 100% of the amount left on the lease is entered on your balance sheet as a liability. The value of the car cannot be entered as an asset. You do not own it. A lease reduces your net worth. You are poorer for leasing a car. If the car holds its value enough that it is worth more than the final payout amount, there may be some positive impact on the balance sheet for buying out the lease. In the mean time it is a negative drag on your balance sheet.

What is the impact on your balance sheet of using a home equity line of credit to buy a car? The first concept to consider here is that you are borrowing from an appreciating asset (your house) and investing in a depreciating asset (a vehicle). The vehicle loses value the minute you drive it off the lot. The impact on your balance sheet is that you reduce your net worth. The car continues to depreciate. The house may or may not. You have set your net worth back. This is not so bad if you have your house paid off and your retirement investments are building in a separate part of your balance sheet. This is why you need a life plan to keep purchases as a vehicle in perspective.

The marketing wizards for the car manufacturers work night and day to make owning a bright shiny new car important to you. It is an indication of success. You get career prestige and social prestige for owning a neat car. Your kids are not embarrassed to ride to school in a neat car.

A life plan is about organizing and focusing on what is most important at different times in your life. It is about perspective. You really need to fill out a life plan table to sort it out. Short term goals like bright shiny cars often get in the way of the less glamorous goals in life. When making your car financing decision remember to use a life plan table to help you make that decision as part of the big picture of your life.


Always use your budget, balance sheet and life plan to analyze opportunities. Sometimes there are windows of opportunity for you to find a vehicle financing deal that you never expected. You may suspect that it is a good deal but the Big 3 proves it to you one way or the other.