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Drowning in expensive car debt

With new and used car prices locked in a painfully high gear, financing has become indispensable for a growing number of Americans.

But even after spreading the financial load over several years — the most common auto loan terms are 60, 72 and 84 months — many car owners still struggle to make their monthly payments.

Bloomberg recently reported that Americans are falling [behind on their car payments at the highest rate in nearly three decades — with the percentage of subprime auto borrowers at least 60 days past due on their loans rising to 6.11% in September, beating a previous high of 5.95% in January.

This is partly due to the fact that it costs so much to borrow money today — thanks to the Federal Reserve’s aggressive interest rate hikes to try and tame inflation over the last couple years.

The average APR for new and used vehicles in September was 7.4% and 11.4%, respectively, according to data from Edmunds.

That shows just how much of a bind young Rivera was in with his 13.06% and 24.39% loans, which Hammer described as being “absolute death” to his financial health.

The 22-year-old said he does plan to refinance his auto loans to get a lower interest rate. But that’s only possible if he can keep up with his minimum monthly payments and avoid defaulting on his loan — a hard feat after they worked out that over 80% of his $52,000 annual income is going towards his debts and vital living expenses.

Of course, lenders don’t just hand out 20+% interest rates willy-nilly, though it may feel like it these days. Rivera had racked up credit card debt, student loans and he’d borrowed money to buy tools for work. He also had debt collectors chasing him for an unpaid medical bill, which would have damaged his credit score.

It’s important to note that Rivera wasn’t seeking help because he’d missed payments; the concern was more about the sheer amount of high-interest debt.

But as Hammer pointed out during the episode, the 22-year-old had hardly any savings and no emergency fund, so if he found himself in a situation where he had to drop $2,000 in cash, he could easily fall delinquent and potentially default on his loans.

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Crunching the numbers

The average listing price of a new vehicle in September was $47,397, according to Cox Automotive, while the average used-vehicle price was $26,717.

And that’s just getting the wheels. Then you need to pay for your vehicle registration, car insurance, gas, repairs and more. So, if you don’t have thousands of spare dollars stashed in your savings account, you’re likely going to have to borrow money to buy a car.

Hammer advised Rivera to consider the Money Guy 20/3/8 car buying rule. To follow this rule, car buyers need to pay 20% of the total cost upfront and have the ability to pay off the car in three years or less, with the monthly car payment being no more than 8% of your income.

“If you can’t do that then you can’t afford a car,” said Hammer. He also said “you have to shop around for a car that fits that criteria by looking in more than one lot” — jabbing at Rivera, who didn’t shop around due to his “tight schedule” at work.

He also balked at Rivera’s latest plan to buy a third car — none other than a Tesla (TSLA), with a starting price of $47,490 — which will see the car technician drive himself further into debt simply to “save on gas.”

Paying off your car loan in the shortest time possible will benefit your finances in the long run. Remember, the longer the loan term, the lower the monthly payments but the more interest you will end up paying.

There are other setbacks to having a long loan term, like Rivera’s 72-months. The older your car, the more likely you’ll have to spend money on repairs and maintenance in addition to your monthly loan payments. You also risk falling into negative equity, where you owe more on your auto loan than your vehicle is worth.

If you fall behind on your payments, it’s worth reaching out to your lender to see if you can get an extension or even refinance your loan with more favorable terms.

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Bethan Moorcraft is a reporter for Moneywise with experience in news editing and business reporting across international markets.

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