The average new car payment in America recently exceeded $500 per month according to Forbes Magazine

Depending on your income level, that may seem doable.  It’s just 500 bucks right?

However, not all $500 payments are created equal.

Most of us have heard the term “good debt” and “bad debt,” but how do you know what makes one debt payment so good and the other so bad.

I ran out two scenarios that show the massive difference in results on one’s finances between:

Choice A: Buying an average new car with an average monthly payment of $500

Choice B: Buying an average rental house with a $500 per month payment

Choice A – $500 per month car payment

Car payments typically fall within the “bad debt” category because the owner is paying for an item that is losing value with each day of ownership (a liability), as well as the fact that the owner is paying the payment each month out of her hard earned money, as opposed to other financed items, where a renter is making the payment (and then some) by leasing the item.

$500 by itself isn’t a lot of money these days, which is why it is easy for millions of Americans living paycheck to paycheck to justify this payment on a car.

However, it’s the effect this payment has, day in and day out, over the course of ownership, that can be so detrimental to the owner’s finances.

Let’s take a look at the total payments compared to the value of a vehicle over a 5 year period

Over the course of 5 years, a typical borrower will have paid $30,000 of their after tax dollars for a vehicle that has around $5,000-$10,000 of value left in it.  Thereby losing $20,000-$25,000, plus the cost of maintaining and insuring the vehicle.

That’s pretty painful.

Choice B – $500 per month rental house payment

The financing on a rental property is often considered “good debt” for the exact opposite reasons of a car payment.

Homes on average have appreciated around 5% over the past 60 years or so nationwide.  So the payments being made are on an item that, in contrast, is going up in value (an asset).

The other, more compelling factor, to why this is so often labeled good debt, is because the tenant, NOT THE OWNER, is paying the $500 per month payment and usually quite a bit more as well.

Let’s look the graph for a typical $500 per month payment on an average rental home.

The total payments are exactly the same after 5 years ($30,000), but remember, the tenants paid that payment the whole time, so it was $0 out of the owner’s pocket as opposed to $500 per month for the car.

The value of the house at an average 5% appreciation is now worth $127,628.

That’s a difference of about $40,000 in value between the car and the house after a 5 year period.

On top of this, in many areas, a $100,000 house will rent for $1,000 per month.  This leaves about $200 per month extra after the monthly house payment and other expenses such as taxes, and insurance.

That means that not only have you accumulated an extra $27,628 in value on the house, but also an extra $12,000 of cashflow ($200 per month) that has accumulated over a 5 year period, all while the loan balance is being paid down and the IRS is providing additional tax benefits for owning and financing a rental property.

Of course there are other aspects that play into each scenario above like the fact that most people need a vehicle of some sort to get around, so it’s not a cost that can often be completely avoided typically.

However, when you start to consider all the long-term financial benefits that $500 per month on a rental home can bring, compared to the long term costs of $500 per month on an average new car, your mind automatically starts to think through scenarios to minimize vehicle costs, while scaling the rental portfolio.

After all, if this is the value that can be gained by owning one rental home over a 5 year period, imagine what the numbers look like if you accumulate 10 and hold them over the next 20-30 years.  This slow and steady journey is how wealth and financial freedom are created, enjoy the ride!

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