When to Cut Your Losses

Americans hate to quit or give up at anything. I think it is something that is a part of our culture. To quit is to admit failure, to admit we didn't achieve our goal, and that we have lost something. We are taught that quitters never win and winners never quit. What this way of thinking doesn't take into account is that there are times when it is smart to quit.

While quitting is rarely the best possible outcome for a situation, when it comes to personal finances there are times when quitting will prevent you from losing more money and help set you on a better financial path.

My oldest son learned this lesson recently. He bought a car that I would have wanted when I was in high school: a red Camero. He didn't have any credit and I was not about to become a co-signer. I had urged him to work at his job for awhile and save enough money to buy the car in cash. Instead, he decided to purchase it from one of those "buy here, pay here" places.

The auto dealership did nothing wrong. In this situation, my son purchased a car before he had a driver's license, which he still doesn't have. As a result, he was making $300 per month car payments and $100 per month insurance payments on a car that sat in our driveway all day. After he moved out of the house, my son decided that this was too much money to pay for a car he could not drive.

He asked me what I thought he should do. "Take it back to the dealership," I said.

He protested, saying he would feel bad because he is putting the dealership in a bad spot, and because he failed at purchasing his own first car. I pointed out that this was the wrong way to look at it. There is no doubt he learned a costly lesson (mainly because he didn't listen to my advice. Go figure.) I told him he had the following choices:

A. Keep the car. Continue to make payments and pay car insurance, which was costing him $400 per month, or $4,800 per year....for a car he could not, and would not, drive.

B. Give the car back. The dealership has already received a $750 down payment, and $2,600 in car payments. The car wasn't driven anywhere, so it has almost no more miles than when the car was purchased, and it was purchased used. It hasn't depreciated anymore than when he bought the car a few months ago. The dealership gets the car back, they will be able to resell it (more people are buying used, not new, these days) and they made almost $3,500 for their trouble.

Basically, my son learned a $3,500 lesson. If he had stayed the course he would have cost himself more money, with no benefit to himself. By giving the car back, he was cutting his losses. It wasn't the best possible outcome for either party, but it was the next best move. The dealership said after my son gets his license he can always come back and purchase another car, and they will apply the $750 down payment he already made to a different vehicle.

Some people may have stubbornly held on to that car, determined they could make the situation work...while depleting their bank account and not driving the car. I'm not saying everyone should shirk their responsibilities and start returning their cars. However, if you have a choice between making rent payments or making payments on a car you can't afford (and this does happen), you need to be able to determine what your real priorities are, and know when to cut your losses.

This post was featured in this week's Carnival of Personal Finance. Check out this week's carnival for other great articles!