Dangers of Buying a Car with a Student Loan
Six years ago, right in the middle of my junior year at Rollins College, the engine in my 1995 Volvo went kaput.
I was a full-time student at the time, working 30 hours a week as a barista at Starbucks and supporting myself. I was already pushing the limits of my finances when I was forced to face the burden of purchasing another car.
The Volvo was a cash purchase, and I didn’t have that luxury this time. I needed to make a decision quickly. Panic set in and, in my haste, I took out a $5,000 Direct Student Loan to purchase a 1999 Toyota Corolla with 80,000 miles from my friend’s mechanic.
My 1999 Toyota Corolla that I affectionately named Keyooko.
Today, I’m still making car payments to the Department of Education.
Rushing into anything without a clear plan of action is a recipe for disaster, especially for young consumers, like myself, who sometimes only see the end goal because of a lack of experience. It’s important to understand how student loans are not the solution to buying a car and how keeping track of your credit score is a skill that will serve you well in your future financial decisions.
Your Credit Score is a Powerful Bargaining Tool
Not checking my credit score was the first mistake I made when rushing to buy a car.
Credit scores are indicators that lenders use to determine how much money they will lend you and at what rate. Consumers with higher credit scores like 650 and above are considered a good investment. While a consumer with a score of 549 or below, would be given a higher interest rate and possibly less money.
At the time, I had applied for an apartment and was told my credit score was good, but I didn’t put that knowledge to good use during my car hunt. Here’s what I should have done:
- Requested a free credit report from TransUnion, Experian or Equifax.
- Paid one of the credit bureaus for my actual credit score.
- Walked into the dealership with a copy of that credit report and score.
- Used my official credit score as leverage for a low interest rate auto loan.
I could have left the dealership with a better deal and the experience to tackle other financial decisions with the confidence of knowing where I stand as a borrower.
Never Use Student Loans for Buying a Car
Getting the student loan was easy because it was a familiar process for me. I had stood by as my parents completed the paperwork for my first few student loans and the process did not seem that complicated. I did some searching online, had a chat with my school’s financial aid office and one signed promissory note later I had another student loan—except this one was for a car and not tuition.
Interest rates, terms and the devaluation of your auto are important factors that make all the difference between student loans and car loans.
Let’s assume my credit score was good. A car dealer would see that score during a credit check and offer me a lower interest rate than the 6.8 percent on that student loan I took out. Plus, car dealerships usually advertise special financing deals with rates as low as 3 percent.
As you compare financing options from dealerships and pre-approved loans from banks or credit unions, consider the total cost with monthly payments, length of term and your down payment. At first glance, one financing option may look like your best choice, but calculating all costs may reveal that you would be paying for more months implying you pay more over time.
Another important factor is the term of a car loan. The repayment period on most car loans is five years or less, while the Standard Repayment Plan on a Direct Student Loan is 10 years. If I had taken out a $5,000 car loan at 3 percent interest for a period of five years, my total repayment would be $5, 390.40. Now I’ll be paying $6,904.80 under the Standard Plan for my student loan. That’s a difference of $1,514.40.
There’s a reason car loan terms are less than 10 years: A car loses value over time. My vehicle, unlike the student loan, would be losing value while my interest continued accruing. At the same time, I would be paying for maintenance and repairs, ultimately adding to the overall investment in the car.
Beware of easy approval lenders offering loan terms longer than five years. Even though longer leases lower payments, protecting you from jumping right into debt, the long lease means years of paying interest and possibly a barrier in becoming debt-free later on.
While a student loan equips you for a lifetime, a car provides transportation for only a limited amount of time.
Think It Over, Don’t Rush into Buying a Car
In retrospect, rushing into the purchase was the biggest mistake.
My job at Starbucks required me to be there by 4:30 a.m. Public transportation in my neighborhood wasn’t an option at that hour. I couldn’t afford renting a car, even for a short period of time. The necessity to keep my job and get to school motivated my quick decision.
My friends might have provided me with a ride to and from work while I saved money for a down payment. Although a temporary inconvenience to all parties, I could have used the time to build my credit by using a secured credit card (which requires a deposit), paid off credit card debt, consolidated outstanding loans and saved some money for a down payment. All of these actions would have improved my chances of being approved for a lower interest loan down the line.
Buying a car using student loans was a means to an end. I quickly regained mobility and got to work and school without searching for rides.
As my 14-year-old Toyota Corolla quickly loses value, I’m confident that my next car will either be paid in cash or with borrowed money not owed to the Department of Education.