Americans have a complicated relationship with cars. Aside from buying a home, a car is probably the second-most expensive purchase you will ever make in your life.
After more than 10 years of writing about money>Never spend more than this much of your income>Why you may regret not following the 1/10th rule
According to a 2019 report from Experian, which tracks millions of auto loans each month, the average amount borrowed to buy a new vehicle hit a record $32,187 in the first quarter. The average used-vehicle loan also hit a record, $20,137. That's far more than what most American households can afford.
Even so, Experian found that 20% of borrowers are taking out loans of $50,000 or more. That means, median income earners who buy median-priced cars are essentially spending almost 80% of their gross salary.
Worst of all, after they pay a 20% effective tax rate on their annual gross income, they'll be spending almost 100% of their net income on the car!
Here are a few other major (though rarely considered) reasons why spending more than 10% of your annual income on a car is a horrible idea:
1. Maintenance (and other hidden) costs will eat up your savings.
The more you drive your car, the more expensive it will cost to maintain it. With thousands of parts to each vehicle, something will inevitably break, leak or need upgrading, especially after the warranty runs out.
And it's not just maintenance costs: You'll also have to pay for things like gas, interest on financing, insurance, parking and traffic tickets.
Furthermore, the thrill of owning a new or "new-ish" used car lasts for only several months, but the pain of paying the same car payment will last for years.
2. The opportunity cost is a huge bummer.
When you buy a car, you lose the opportunity to invest your money into assets that can grow and pay dividends in the future, such as real estate or stocks.
The effects of compound interest are more powerful when you save early and often. Spending beyond a realistic budget is like negative compounding. Think about how rich you'd be today if you had invested around $300 to $500 in the stock market since 2009 — instead of spending it all on monthly car payments!
I learned this lesson the hard way: In 2001, I purchased a one-year-old Mercedes G500 SUV for $79,000. It seemed like a great deal at the time, considering it sold for $150,000 the year before at a dealership that had exclusive import and selling rights to the model.
But shortly after, I experienced buyer's remorse. Owning the car was costing me more than I had anticipated, and it was ruining my finances. The biggest bummer? I later found a two-bedroom, two-bathroom condo facing the park in San Francisco that I really wanted to buy. Unfortunately, the SUV was too big to fit into the garage.
So in 2003, I sold the car for a $15,000 loss, took over a 1997 Honda Civic from my mom for $7,000 and bought the condo for $580,500. Buying property was the right move; the condo is now worth roughly $1.4 million and provides steady passive rental income for my family.
Still, not following the 1/10th rule and losing $15,000 hurt like hell.
3. You'll have a lot more to stress about.
When you spend more than 10% of your income on a car, your stress levels will likely increase.
Each time you park your car at the local grocery store, for example, you'll worry about getting a door ding. Or you may get stressed out for an entire week due to a wheel rash that incurred after you parallel parked too close to the curb. And when you're driving in traffic, you may feel more on edge because you're worried that someone will damage your car.
When you spend within your true budget, however, you stop caring about door dings and bumper scrapes. Driving and parking becomes a stress-free experience.
4. You may want to spend even more money on your car.
The nicer your car, the more you may be tempted to spend on other car-related luxuries. You might consider getting some nice driving shoes, for example, or a matching chronometer watch for your sports vehicle.
