Is a car loan a good idea?

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After I graduate, I’m going to need a car. However, I won’t have much money early on after graduation, because I’ll just be getting my first job and moving out on my own and all of that stuff. So, I figure that I’ll probably need a loan if I’m going to buy a car.

However, I’ve heard mixed things about car loans. I know that not all debt is the same, and some types of loans are worse than others. Where does a car loan fall on the spectrum? Is it a good idea to take out a loan to buy a car?

You’re absolutely right to note that not all types of debt are created equal. However, what’s the difference between healthy debt and unhealthy debt?

The best kind of debt is the kind 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 belongs in this category, since it helps you gain an asset (your home) that could appreciate. You could certainly argue that a loan that gets you a car could belong in this category, too, since you presumably 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 kind 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 borderline-predatory short-term loans are the ultimate example of bad debt, which is the sort of debt that tends to grow and grow while giving you nothing in return.

So, back to our original question: is it a good idea to take out a car loan? Financing a used car or a new car purchase is common, and most experts agree that car loans can be a reasonably healthy type of debt. Car loans don’t offer all the structural and tax advantages of mortgages, however, they’re also not nearly as dangerous as the bad types of loans we talked about earlier.

In a situation like yours, there may not be a real alternative to taking out a car loan, and that’s okay. The key is to make sure that you don’t take out more debt than you can afford. Experts recommend that you put down a reasonable down payment, limit the term of the loan, and keep everything within your means. One helpful rule of thumb is the 20/4/10 rule: a minimum 20% down payment, a loan term of 4 years or fewer, and a total monthly payment that’s less than 10% of your income over that same period.

If you follow reasonable guidelines like these, then there’s no reason at all that a car loan can’t be a part of a healthy financial situation for you after college. Good luck!

“Inspiration and genius–one in the same.” — Victor Hugo

 

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