Financial risks when buying a car
Depreciation and negative equity
Cars lose their value, or depreciate, quickly. Your new car drops in value as soon as you drive off the dealer’s lot. It keeps decreasing over time.
After 1 year, your new car may be worth 25% less than the price you paid. Within the next 4 years, your new car will typically lose 15% to 25% of its value each year.
You have "negative equity" when your car is worth less than the amount you owe on your car loan.
Example: Long-term negative equity
Say you buy a new car worth $31,300 with the following conditions:
- you pay $3,700 in taxes and fees
- you pay for the car with a $35,000 car loan
- your interest rate is 4%
- you have an 8-year term
- your monthly payment is about $425
| How long you’ve owned the car |
Depreciation (25% after 1 year, 40% after 2 years) |
Value of your car |
Balance of your loan |
Amount of negative equity |
|---|---|---|---|---|
| 0 years (new car) | $0 | $31,300 | $35,000 | $3,700 |
| 1 year | $7,825 | $23,475 | $31,200 | $7,725 |
| 2 years | $12,520 | $18,780 | $27,300 | $8,520 |
*This example is for illustrative purposes only.
After 2 years, your car will be worth $8,520 less than what you owe on your car loan. It takes longer to get out of a negative equity situation in a long-term loan.
Financial risks of negative equity
If you need to sell your car quickly, you may lose money. For example, you sell your car, which is worth less than what you owe on your car loan. You might have to borrow money to cover the difference.
You may get into an accident where your car is a total loss. What you get from your insurance company may not cover what you still owe on your car loan.
You may also end up paying more if you trade in your car to buy another one. You may need to borrow to pay for the new car and cover the amount you still owe. In this situation, you may end up with a larger car loan and more interest to pay.
Risks associated with long-term car loans
Long-term loans come with terms of 72 months (6 years) or more. They may allow you to have lower regular car payments but consider the risks.
Paying more for the same car
The total cost of your car will be higher if you choose a long-term car loan. That’s because of the interest you’ll pay over the loan's term.
| Price of the car | Loan interest rate | Loan term (months) | Total interest paid | Cost of the car with interest |
|---|---|---|---|---|
| $25,000 | 5% | 36 | $1,974 | $26,974 |
| $25,000 | 5% | 84 | $4,681 | $29,681 |
*This example is for illustrative purposes only.
In this example, you would pay more than twice as much in interest with a long-term car loan. The total cost of the car would be $2,707 more.
Reducing the risks of auto-financing
Consider these tips to reduce the risks associated with financing a car:
- buy a car that fits your budget
- choose the shortest term loan you’re able to afford
- if possible, put a down payment
- consider both options of buying a new or used car
- consider whether your needs may change in the future. For example, you may want to have children at some point and need a larger car
- avoid trading in your car if you’re in negative equity
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