Is a car loan good debt or bad debt?

Neither label survives the arithmetic. A $28,000 car at 9.5% over 72 months costs $6,395 of interest in its first three years. In the same three years the car loses $11,816 of value, nearly twice the interest, and it loses that whether the money was borrowed or not. The loan is not what makes a car expensive. The car is.

The example

Three ways to buy a car at the same 9.5% rate. Depreciation is 20% in the first year and 15% a year after that, an ordinary curve for an ordinary car.

What three years actually cost

Read that table twice

The good-debt story says a car loan is bad because a car loses value. True, and it is the wrong lesson. The car loses $11,816 in three years in every column; paying cash loses the same $11,816. The loan adds $6,395 on top. Depreciation is the bigger cost, and it is the one no financing decision touches.

What the loan term changes is the other row. After three years the 72-month loan still owes $15,974 on a car worth $16,184; the 48-month loan owes $8,023, with $8,161 of equity. Same car, same rate, $191 a month more, and that is what it buys. Whether that is a good trade is a question about the $191, not about “debt”.

The used column is the one that moves both numbers. $16,000 instead of $28,000: interest over three years $3,416 instead of $6,395, depreciation $6,174 instead of $11,816. Roughly $8,621 less spent in three years, and all of it from the price.

The honest recommendation

1. Judge the car, then the term, then the debt, in that order. Price sets the depreciation, which is the biggest number on the page. Term sets how long you owe more than the car is worth. The label “bad debt” sets nothing.
2. A car loan is fine debt when the payment fits and the term is short enough to stay ahead of the value. The 48-month column is $191 a month more and is ahead of the car’s value at three years by $8,161. That is what fine looks like.
3. It is bad debt when the term is the only way the payment fits. Owing $15,974 on a $16,184 car at year three means an accident or a job change is a cheque you write to get out. That risk is the cost, more than the interest.
4. Do not pay cash to avoid “bad debt” and empty the emergency fund doing it. The $11,816 is lost either way. An emptied cushion plus a depreciating car is worse than a short loan plus a cushion.

Where these numbers came from

Payments use the standard amortisation formula at APR ÷ 12. Interest over the first 36 months is summed from the amortisation schedule; the balance still owed is read from it at month 36. Depreciation applies 20% in year one and 15% in each later year to the purchase price. Rounded to the nearest dollar. Your rate and your car’s resale curve will differ; the ordering of the two costs rarely does.