Americans love our cars. According to U.S. Census Bureau data, 92% of households own at least one automobile, and 22% of households own three or more, totaling 291 million cars and light trucks on the road.
We are also paying more to own those cars, with rising prices of vehicles, maintenance, insurance and financing costs.
Data company Edmunds reported that 19% of buyers left the showroom with a monthly payment of $1,000 or more in the fourth quarter of 2024, another record. They are also signing up for longer payoffs, averaging 68.8 months, but some financing companies are extending terms as long as 96 months (eight years). By then, the car will be worth 20% of the purchase price.
To make matters worse, more owners than ever are upside down, owing more than the car is worth when it’s time to trade in for another model. One in four buyers has negative equity at trade-in averaging over $6,000, and a quarter of those buyers owe $10,000 or more. In some cases, new car finance contracts include debt carried over from the previous two vehicles.
For many families, purchasing a car is their second-largest financial transaction after buying a home. Since we do it relatively infrequently, it can be easy to focus too much on the monthly payment and disregard the total cost of ownership. Before you sign on the line, carefully consider all the costs and adjust your sights to a model and price range that is affordable.
Auto financing is nearly as old as the car itself. In 1924, Henry Ford offered a weekly prepayment program that amounted to a layaway plan: Customers took delivery once the full price was deposited at the dealership. In 1919, General Motors established its own financing arm, General Motors Acceptance Corp. (now Ally Financial), that allowed buyers to finance up to 65% of the price over one year. Ford followed suit in 1928 and by 1930, over 60% of new vehicles were financed.
During the post-WWII boom, a young Ford marketing executive named Lee Iacocca introduced a clever scheme dubbed “$56 for ’56” that allowed buyers to put 20% down on a new 1956 Ford and make monthly payments of $56 for three years. The promotion boosted sales and set the stage for increasingly creative and extended loan options. Today, Americans owe $1.66 trillion on car loans, recently surpassing student debt as the second-largest type of debt behind home mortgages.
The surge in auto loan balances and payment terms is not just an artifact of inflation. Vehicles have become more complex compared to a generation ago. And manufacturers have increased promotion of higher-end models and de-emphasized more affordable options. While average new car prices have risen by 51% or $16,500 since 2014, less than half that increase was due to inflation. The rest is accounted for by American buyers trading up.
When considering the purchase of a new vehicle, look beyond just the sticker price and the monthly payment. Consider the overall total annual cost of the ride. Each year since 1950, AAA has published a study called Your Driving Costs, which looks at the total cost of operating a car including depreciation, gas, insurance, maintenance costs, registration and taxes, and financing. For example, the average model loses $4,680 in value each year. This cost must be included since eventually the vehicle will have to be replaced.
The average annual ownership cost in 2024 was $12,297 but varies greatly across models. Electric vehicles depreciate faster than internal combustion models, but pickup trucks are 50% more costly to operate than compact SUVs. Buyers often overlook the ongoing costs of ownership but should fact them into your decision process. You can find a driving cost calculator at AAA.com.
To avoid over-committing to a lengthy and costly contract, spend some time budgeting for what you can afford. A useful rule of thumb is the 20/4/10 rule. Apply a down payment of at least 20%, finance the car over four years and ensure that the total annual cost of ownership is less than 10% of your income.
Your credit history is a huge determinate of the cost of financing, so you should know your FICO score before you walk into the dealership. Super prime scores (above 780) may qualify for below-market dealer incentive financing, while subprime rates could run two to three times higher, yet fewer than half of buyers know their FICO score in advance.
You can also gain leverage by getting pre-approval for a specific loan amount in advance. Apply to several lenders, including banks, credit unions and even online lenders. Criteria for rates vary, so shop around. And don’t be afraid that the inquiries will hurt your FICO score. Most scoring models now treat all applications for the same purpose as one credit pull, and many don’t count car loan applications at all.
Finally, watch out for costly add-ons. Extended warranties, road hazard coverage, and additional products or features like service contracts or gap insurance may only seem to add a few bucks a month but can mount up to thousands of dollars over the life of the contract.
Cars aren’t getting any cheaper, and interest rates may be stuck for a while. Before entering a multi-year obligation, run the numbers and mind the budget.
Christopher A. Hopkins, CFA, is co-founder of Apogee Wealth Partners in Chattanooga.