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Related topics: savings, cars, used cars, car loans, Liz Weston

If you're constantly broke and can't figure out why, the answer may be sitting in your driveway.

Americans are spending more on their vehicles than ever before -- about $8,600 a year on average -- and it's driving some to the breaking point.

Credit counselor Bill Thompson of Jacksonville, Fla., estimates that one out of every four clients his agency sees has overspent -- sometimes dramatically -- on a car.

"They may be spending 15% to 20% of their (take-home) pay on just the car payment," said Thompson, who supervises credit counseling for the nonprofit Family Foundations, "and that doesn't include insurance, gas, maintenance and all the other costs of owning a vehicle."

And sometimes there's more than one whopping payment. Sandra McGeary, a counselor at Consumer Credit Counseling Services of Western Pennsylvania, says she regularly sees middle-class families struggling with two payments in the $400-to-$500 range. The burdens are so big that it doesn't take a major disaster, like a job loss, to send them over the edge.

Liz Weston

Liz Weston

With most other areas of the budget, you can find ways to trim. You can eat out less and shop more carefully to reduce your food bill. You can lower utility bills by adjusting the thermostat. You can cut your entertainment budget by canceling your cable service and borrowing movies from a library. You can even reduce your shelter costs by taking in a roommate or moving to cheaper digs.

Once you've committed to a car payment, though, your options are few, particularly if you owe more than the vehicle is worth. Whether you drive it or not, you've got to make the payments, and you've got to insure it.

What we spend on transportation:

 
Annual incomeAverage 2008 spending
$19,064 or less$3,430
$19,065 to $36,270$5,657
$36,271 to $59,086$7,834
$59,087 to $93,357$10,469
$93,358 or more$15,614
All households$8,604
Sources: Bureau of Labor Statistics and Census Bureau. Average transportation expenses include vehicle purchases, finance charges, insurance, fuel, maintenance and repairs, public transportation and other out-of-pocket expenses but not vehicle depreciation.

We're prolonging the agony

The signs of vehicular overspending are everywhere:

  • Nearly 90% of new-car loans and 81% of used-car loans are for terms longer than four years (which, a couple of decades ago, was considered a long loan), according to vehicle research site Edmunds.com. The average new-car loan term has grown from just under four years and seven months in 1990 to five years and three months. Longer loan terms mean that people build equity in their car more slowly, which in turn means that borrowers will be "upside down" in their vehicles -- owing more than they're worth -- for three years or more on the typical purchase.
  • One-fifth of cars that are financed include debt rolled over from a previous vehicle, according to Edmunds.com. As of March 2010, the average amount of negative equity in these deals was nearly $4,000.
  • Rolling debt from one car to another is, in case you didn't know, a terrible idea. You'll pay higher interest rates because so much of what you owe isn't secured by the car itself.

And being upside down can really leave you up a creek if the car is totaled or stolen. You can protect yourself somewhat with gap insurance, which covers the difference between what you owe and what you get from your insurer, but that's another hit in the wallet.

What's going wrong

So why are so many people messing up so badly on such a basic purchase? There are plenty of reasons, including:

Viewing cars as a need rather than a want. Transportation is, indeed, a real need. We have to get to the grocery store and to work. But many of us have plenty of options, from our own feet to public transportation to carpools to shared car arrangements such as Zipcar.

Owning a car does get pretty close to a need in rural areas without public transportation or when your job doesn't allow for carpooling. But you never "need" a new car. That's a luxury, not a need. There are plenty of safe, reliable, gently used cars on the market.

There's also no requirement that you get rid of your current car once it's hit a certain mileage milestone. Today's cars are better built and more dependable than ever, which means that unless you've got a real lemon you could keep driving it past 200,000 or even 300,000 miles.

Treating cars as a status symbol. You can't watch television for long without being bombarded by car commercials, and many of us have absorbed the idea that we are what we drive. It's complete BS, of course, but some people have been so brainwashed that they literally drive themselves into bankruptcy.

Failing to consider the overall costs. When buying or leasing a car, many people consider nothing more than the monthly payment. They're not seeing the whole picture -- far from it.

Once you factor in insurance, gas, maintenance, repairs, taxes, depreciation and other costs, most cars will set you back at least twice the initial purchase price over five years.

(Depreciation, by the way, is just a fancy word for the steady, day-by-day drop in the value of your car. You don't pay for it as it happens, but you do pay eventually, when you go to trade in your car for another.)

If your vehicle is 5 years old or newer, you can check out Edmunds.com's "True Cost to Own" feature for the breakdown on your particular vehicle. Or you can use AAA's estimate.

The auto association estimates the typical medium-sized sedan costs 56.2 cents a mile to operate, or $8,430 a year assuming 15,000 miles driven annually. The estimate is based on fuel prices of $2.603 a gallon and finance charges of $803 a year, based on a five-year loan at 6%. Your costs may well be higher; for example, bad credit can send your finance costs soaring.

Assuming they can afford a payment simply because a lender approved it. Lending standards are much tighter than they were before the credit crunch, but it's still possible to get in over your head, particularly if you have good credit scores and a steady income.

Acting like a lamb before the slaughter in car dealerships. If ever a transaction were designed to soak the consumer, it's the typical car purchase. Car dealerships are experts at getting people to pay too much for cars or financing, and often both. The savvy consumer does plenty of research, gets detailed car price reports from Consumer Reports, MSN Autos or other sources, knows her credit scores and arranges financing in advance -- in other words, not at the dealership. She also knows the tricks of the car sales trade and how to negotiate a good bargain. As any car salesperson will tell you, this describes a pretty small slice of the folks who actually buy cars. Many people wander onto the lot with little information, fall for the salesperson's assurances that they're about to miss out on a great deal, have no idea what interest rates they should qualify for and accept whatever payment the dealership gives them.

What to do now

If you're struggling to afford your car, you've got a few options:

You may be able to sell your car if you have some equity in it or can come up with cash to pay off the loan -- or if you can persuade the lender to let you pay off the remaining debt over time.

You may be able to refinance if you bought the car new, made payments for a few years and have a lender who is willing to extend your loan term. For used cars, you'll need to have some equity in order to refinance.

You can let the lender repossess the car. This option should be avoided if at all possible because repossession, voluntary or otherwise, trashes your credit and usually leaves you with substantial debt besides. You'd still owe the difference between your loan balance and whatever the car brought at auction, plus substantial repossession and auction fees.

You can drive out of the loan. This is usually the best solution for a too-expensive, upside-down car. Trim other areas of your budget so you can make the payments and keep the car until it's paid off . . . then keep driving it until you've saved up enough to buy another car or at least make a substantial down payment.

You also can try to reduce your transportation costs by driving less, raising your insurance deductibles and maintaining your car properly to avoid big repair bills.

Next time, be smart

Use a bad car ownership experience as motivation for change. The next time you're in the market for a car:

Rethink the whole thing. Isn't there something else on which you'd rather spend nearly $9,000 a year? With that as your motivator, you may be able to find a way to live without a car, or with one less car if yours is a multiple-vehicle family, or to keep the car you have going for a little longer. Maybe not, but it's worth thinking about the options before you commit yourself to another payment.

Figure out what you can actually afford. Thompson, the Jacksonville credit counselor, says total car costs -- including car payments, fuel, insurance and maintenance -- shouldn't top 20% of net (after-tax) income. McGeary's Pennsylvania agency uses a slightly different rule of thumb: Total car costs shouldn't exceed 19% of gross (pretax) income.

These are only guidelines. If you don't have other large expenses, you might get away with higher car costs. If you've got a big mortgage or child care bills to pay, you might need to spend less.

I like the overall budget guidelines in Elizabeth Warren's book "All Your Worth." The Harvard University professor and bankruptcy researcher recommends that all your basic expenses -- shelter, food, insurance, child care, transportation and minimum loan payments -- total no more than 50% of your after-tax income. That ensures you'll have enough left over for variable expenses such as clothing and vacations (30% of after-tax pay) as well as giving you room (20%) to pay off debt and save adequately for retirement.

You might not be anywhere close to these guidelines, but they're something to shoot for as you get your finances in order. In the meantime, you can simply double your projected car payment and see how well that fits into your budget. If it doesn't, look for a cheaper car.

If you must borrow, stick to loans of 48 months or less. If the only way you can afford a car is with a longer loan -- or worse yet, by leasing -- then you really can't afford the car at all. A loan of four years or less will help keep you from overspending and allow you to build equity in the vehicle faster.

Own your cars longer. This one move can save you literally hundreds of thousands of dollars over your lifetime. Keep your cars for at least a year or two, if not longer, after you've paid them off. Set up an automatic savings plan so that the money that used to go for payments goes instead into a high-interest-rate savings account (ING Direct and EmigrantDirect.com are two options). Use the money to help pay for your next car. The longer you save, the less you'll have to finance.

Try to pay cash for your vehicles. In general, you don't want to borrow money to pay for assets, such as cars, that lose value, if you can possibly avoid it. You might not be able to pay cash for your next vehicle, but you certainly could for the one after that. Finance it for four years or less, keep it for an additional four years after you've paid it off, bank the payments and voilà: You have cash for your next car.

Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.