One of the greatest penalties in buying a vehicle is that the monthly car payments are much higher than when you lease. Also, the dealership will ask for a nice sized down payment if you’re buying. This is usually about 5%, but sometimes the down payment is a flat minimum of $1,000. Since you don’t want to accept the minimum down payment, the down payment can end up being a hefty sum, especially in today’s unstable economy.
You may assume that as long as you pay the loan on the vehicle that you will soon have some equity in the car. This is not usually true. When you buy your vehicle, the payments are stretched over a number of years; let’s say five. Within the first two years, depreciation on the vehicle is heavy and you may find that at the end of this time that you still owe almost as much as your vehicle is worth. Another scenario is that you put only the minimum down payment of $1,000 down on the vehicle and finance a large portion of the cost. At the end of the five year financing term, you may find that your vehicle is not worth near as much as you paid for it.
Monthly Payments
Monthly payments on your vehicle are divided into interest and principal. When you first buy your car, all of your payments go to pay on the interest. As you pay down the loan, the interest portion goes down and you begin paying on the principal. In the last few months of the financing agreement, you are paying very little interest and a lot of principal.
While you are paying only interest (within the first two years) your vehicle will depreciate 25% to 40% and you won’t have paid one cent off the principal. You owe as much on your vehicle today as you did the day you drove it off the lot. This means your loss is double. The payments haven’t reduced the principal on the loan, but your car is worth far less than the day you bought it. It’s enough to make your head spin.