After I graduate, I will need a car. However, I won’t have a lot of money when I start graduation, because I’m just going to get my first job and move out on my own and everything in between. So I think I will probably need a loan if I want to buy a car.
However, I have heard mixed things about auto loans. I know that not all debt is the same and that some types of loans are worse than others. Where does a car loan fit on the spectrum? Is it a good idea to take out a loan to buy a car?
You are absolutely right that not all types of debt are created equal. However, what is the difference between healthy debt and unhealthy debt?
The best type of debt is the one that helps you increase your net worth. Taking out a loan to go to school or to start a business fits this bill. A mortgage also falls into this category because it helps you acquire an asset (your home) that could appreciate. You could certainly argue that a loan that allows you to get a car could also fall into this category, as you probably need a car to get to work and build your career. Other signs of good debt include low interest rates and reasonable terms.
Bad debt is the type of debt that increases your liabilities without increasing the number of assets you own; short term, high interest debt like credit card debt would be the classic example here. Payday loans and other predatory short term loans to the limit are the ultimate example of bad debt, that is, the kind of debt that tends to grow and grow without giving you anything in return.
So, back to our original question: is it a good idea to take out a car loan? Finance a used car or buying a new car is common, and most experts agree that auto loans can be a reasonably healthy type of debt. Auto loans do not offer all of the structural and tax advantages of mortgages, however, they are not as dangerous as the bad types of loans we discussed earlier.
In a situation like yours, there may not be a real alternative to auto credit, and that’s good. The key is to make sure you don’t take on more debt than you can afford. Experts recommend making a reasonable down payment, limiting the length of the loan, and keeping everything within your means. A useful rule of thumb is the 4/20/10 rule: a minimum down payment of 20%, a loan term of 4 years or less and a total monthly payment of less than 10% of your income over the same period.
If you follow reasonable guidelines like these, there is no reason why a car loan cannot be part of a healthy financial situation for you after college. Good luck!
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