Why I Took Out a Car Loan for More Than the Purchase Price of the Car
When I bought my car (the one that is currently not being driven) in 2008, I needed to borrow $3,500 on top of the $1,000 I had saved to pay the private seller. However, I ended up taking out a loan for $5,000. Why in the world would I take on more debt than was necessary?
First, I need to explain that I was in a little different mindset in 2008 than I am now. I thought taking out a car loan was a reasonable thing to do. As I said, I only had about $1000 available (and NO emergency fund!) to put toward the car but I wanted one worth a little more than that. Our plan for our next car is to pay for it in cash and not compromise our financial stability to do so. But, back in 2008…
I knew that when I moved from Rockville, MD to Durham, NC for grad school I would need to buy a car. I researched Durham and assessed that by choosing to live in a safer part of town I would have to give up the car-free lifestyle I had enjoyed in the DC area. I did some light research into the best used car models available and decided that my first choice of vehicle would be a Toyota Echo. In the summer months I started searching for Echos in used car dealerships and from private sellers all over the East Coast. It turns out there weren’t a lot available! So I waited. While I waited, I moved to Durham and borrowed one of my parents’ cars for the interim.
not my actual car but similar
Finally, the perfect Echo appeared on Craigslist from a seller in VA. It was a 2002 with relatively low mileage and the seller had listed it for below its value because of some cosmetic damage. Through some email exchanges, I negotiated a price for the car ($4,500) and arranged that my mother would go check out the car and buy it for me, since the seller lived close to my parents. I just had to secure the financing.
I researched interest rates for auto loans and went to the local bank that offered the best ones. After getting quite far into the loan application process, we hit a snag: Because the car was being sold by a private party out of state, the bank would not be able to issue me the loan. There was nothing that bank could do for me.
I sought out the local bank with the next-lowest interest rates and told them up front the information that had prevented the previous bank from issuing me a loan. This bank didn’t have a problem giving me an unsecured loan to take across state lines to give the seller. However, they would not issue me a loan for $3,500 – the smallest loan they issued was $5,000! Given that I wanted the loan from that bank, I had no choice but to accept the larger amount. I made sure there was no penalty for paying the loan off ahead of schedule.
Everything worked out and my mother bought the car on my behalf. I transferred the $4,500 to her and the extra $1,500 sat in my checking account. I was itching to get rid of it. I hated thinking that I had such a large loan and was afraid that some crazy error would cause me to lose it. I had to wait a few weeks for my account with the lender to be set up to accept payments, and I sent the extra $1,500 back with my first scheduled withdrawal. I ended up paying off the loan early and the car has been mine free and clear for years!
I guess the lesson I learned from this is truly that cash is king! I don’t want to have to jump through these hoops and meet silly requirements to have access to money – I’d rather just have my own.
Have you ever been faced with a weird situation involving a loan? Do you think there is something else I should have done?
photo from ansonchappell
Filed under: cars, debt · Tags: banks, car, craigslist, loan
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I think that it’s reasonable to do what you did. You paid that $1500 back right away, right? Sometimes it’s good to be covered, although of course it’s better to use money that isn’t loaned.
Yes, I gave it back as soon as I could. It took a little while on their end to be ready to accept the money, which caused me some anxiety.
I think what you did would be what I would’ve done also, especially since you paid it back.
It was so shocking to be put in that situation! I was like, “I don’t want the extra money! Can’t you just keep it??”
I think you handled the just fine, all things considered. With little to put down, and the desire for a better car than $1,000 can buy, I can see why you took that course of action.
I’m with you on the idea of trying to pay in cash. If that isn’t possible in full, at least paying as much as reasonably possible in cash while minimizing a loan could work as well.
I never even considered buying a $1,000 car. :/ I’m hoping for a while after we graduate we can live like we’re still students and save up fast to pay for our next car with cash.
Since you had no choice but to take the $5,000 loan, you did the right thing paying the extra $1,500 with your first payment! A lot of people would be tempted to spend that money on something else.
I didn’t really have a weird experience involving a loan, it was more of a stupid experience. I financed my entire $23k new car after college over 3 years. Needless to say, that was not a payment I looked forward to every month! But it is fully paid off now.
Yikes! Well, you learn what you can and move on. Or in your case, probably drive that car forever!
You handled it just fine Emily, I posted last week about my car buying mistakes, the important thing is you learn from them and are much better prepared for the next purchase.
ps- sorry about […], we’re […] fans 😉
We’re definitely going to strive for cash for next time!
I read the title of the post and said….’oh no!’ HAHA.
Fun post. You definitely caught me off guard a bit tho. I think you did it well. Other than paying cash there isn’t much you could have done (unless you got a loan from family/friends).
You also could have used an avenue like Prosper or LendingClub. Interest rate might have been higher though.
I definitely would rather borrow from a bank than a friend or family member, and at the time my parents were contending with the enormous parent loans they took out for my college so they weren’t in a position to help me any more than they did! I didn’t know about peer-to-peer lending back then and I thought a local bank was my only option.
I’m curious if a loan like this (small car loan) has positive (or negative?) effect on your credit score. When I bought my car (~$17k with cash) in 2009, I was considering taking out a loan for $1 or 2k and paying back on time (or earlier) and keep the extra $1 or 2k on hand for unexpected expenses as I moved across the country to start grad school. I talked to my credit union for some financial advice on this, and because I had student loans and was paying them back on time, they said having a small car loan wouldn’t have any demonstrative purpose as far as credit scores go. But maybe it would if I didn’t have student loans?
While the loan would not have been more than the car, it would have been a similar easy/pay-back-early loan. I’m glad I ended up just paying cash–since I, too, would have been itching to pay it back!
Awesome that you sought out advice at your credit union! I think a car loan helps credit differently than a credit card because it is installment credit rather than revolving credit, so if you hadn’t had the student loans it would have helped. I think the cash was your best choice. I wonder if the car loan made a difference in my credit score because my loans were deferred.
I think the only time I’ll care much about my credit score will be right before buying a house, but I’m not sure if I would actually take out more debt to increase the score. Such a weird system. I’m considering getting a report from Ecredable when we’re applying for a loan if our credit scores aren’t the awesomest to demonstrate our excellent bill-paying history (over debt-paying history).
The temptation to spend that ‘extra’ money would have been too great for many people; myself included. When I was in college, I borrowed way too much simply because I could. It never occurred to me to only borrow what I needed to pay for school and books.
Hopefully, I can pass this knowledge onto my kids as they grow.
I think I benefitted from the year+ of budgeting on a low income that I went through before I bought the car. When you are living on loans I think it can be hard to keep perspective. I knew I needed a car that my small salary could reasonably cover.
Emily,
I think did make the right decision considering the circumstances. We all make mistakes in life. Important thing to remember is to learn and live better. You are doing just that. Good job.
Thanks, Shilpan!
That’s really quite interesting. I think you did the right thing, given that you could pay extra penalty free. Usually if there is a minimum, there is usually some type of pre-payment penalty also. Other times it’s just the financing company that the car dealer works with, they just can’t get a return on their loan after risk to pay the admin costs on a smaller loan. Good job!
While I did make sure I could pay the loan down faster than the minimums, when I paid off the loan entirely less than a year after I took it out, the bank hit me with a fee. If I had waited until after the 1-year mark there would have been no penalty. It never occurred to me to ask about that when I took out the loan. So weird!
Hey Emily – I took out a car loan, myself, of similar magnitude. The loan itself wasn’t beyond my monthly expense, and I didn’t really have qualms about it at the time. But what I didn’t realize was that my credit union would require collision insurance with the car – which ended up being very high. On top of that, the insurance increased over 30% when I moved to DC’s infamous PG County! Eeeek! I held onto the car for way too long, and underwent a good deal of stress as a result of the tight budget I had to follow in order to stay ahead. Never again!!
That’s a good point about low-cost cars – you may not want to carry so much insurance but with a lein you don’t have a choice! That’s something that you probably wouldn’t think about when you take out a loan vs. save up in advance. Did you end up living car-free for a while in the DC area?
I’m also looking to pay cash for my next car. I’ve had my current car for a few years and I should have it paid off in the next few months. I think the best thing you did was to search for an inexpensive car. The fact that you had the patience to wait for the right one says a lot.
I also was very lucky that my parents had a spare car to lend me while I continued my search! Great goal to pay cash for your next car! Just continue saving the car payment amount and you’ll be there in no time.
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I recently got a loan for $5000 for a $3000 motorcycle because it was the lowest loan I could get. I plan on paying the extra money (minus registration fees, etc) the second I get the car all done and ready. My question is about how to record the lien on the bike. I paid the purchase price of $3000, but my lien would be $5000 for the bike which I feel will look really weird to the DMV when I’m trying to register my bike. How did your DMV experience go when you had to show the loan amount, and the actual price of the vehicle?
I didn’t have any problems with the DMV when I registered the car – I actually don’t think they looked at the loan amount. Maybe the procedure varies by state? I’m sorry I can’t be of more help!
It doesn’t make sense to live away from work/school in order to be in a “safer” neighborhood. You are much more likely to die in a car accident than the very small risk reduction you might get. hence, the SAFEST place to live is the one with no commute, even if the crime rate is higher than further out.
In that situation, I would simply move close to school while saving up the cash.
That’s a good point. We are disproportionately afraid of those rare but scary events like shark attacks and getting mugged. (Though in 2008 and 2009 there seemed to be a LOT of muggings near campus!) I wonder what the risk is of being hit by a car as a pedestrian or cyclist vs. similar injuries in a car?
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One reason to take out a loan for an amount greater than you need for the purchase is the return that you can potentially earn on the extra cash. In the current economic environment, interest rates are quite low and capital returns have been quite high. There are also fewer and fewer barriers to entry into capital markets. If your return beats the interest you paid on the loan, even over a brief period of time, you have profited from the extra amount. Obviously this entails some risk and implies a certain level of knowledge/experience with investing, but it is not too difficult to beat the low interest rates currently available (<3% APR from some lenders). Of course, given the unsure financial footing you were on at the time of purchase, this may not have been the best use of the cash. It's also not a bade safety net while you establish yourself in a new city. Not too much higher of a monthly payment, but a nice emergency cash reserve in case you find yourself in an unexpected financial conundrum.