Aside from a home mortgage and perhaps a college education, vehicles are the most significant purchase most of us will make. Owning a vehicle is necessary for nearly all of us, but the decision to drop a lot of money on a purchase like this can feel overwhelming.
When it comes time to make this sizable purchase, here are a few things you can do to make sure you know what you’re getting into before walking into the dealership.
Save up ahead of time
Unless buying a new vehicle is an emergency (meaning your old one is wrecked or otherwise undrivable), hopefully you have some time to save up money for a down payment on a vehicle. If you’ve been making extra payments to pay down debt, now is the time to pay your minimum payments and put that extra cash into your savings account.
When you’re ready to pull the trigger on a new car, cash gives you some bargaining room and will help you lower your monthly car payment.
How much can you afford?
Before heading into the dealership, figure out what you’re comfortable paying each month. A good rule of thumb is that your total vehicle costs are about 15 to 20% of your monthly budget. This number includes expenses such as gas, vehicle taxes and registration, maintenance, and insurance.
It’s hard to determine these costs if you’re not sure what kind of vehicle you’ll be purchasing. You can estimate the costs by looking at what you’re spending for gas, taxes, and insurance on your current car.
Here’s a quick example. Let’s say you bring home $3,500 per month. Fifteen percent of $3,500 is $525. If you budget $75 per month for maintenance, $50 per month for gas, $12 per month for registration, and $50 per month for insurance, that leaves you with $338 per month to spend on a car payment.
Knowing what you can afford before you start looking will help keep you in your budget and keep you from making a decision you might regret later.
Making the right choice on a car loan
Before you sign on that dotted line to buy your new car, take a look at how long the loan lasts as well as the interest rate. Car loans vary wildly in their length, and interest rates are determined by factors such as your credit score and the length of your loan. How much will you be paying in interest over the life of this loan? Additionally, check to see if there are penalties for paying off the loan early.
Avoiding depreciation
Unlike a house, which will usually go up in value over time, a car will only go down in value. The first year of owning a new car sees a drop in value of nearly 20%, and by the time a car is four years old, it will be worth about half of what it cost at the dealership.
Many vehicle owners have been shocked to find out they owe more on their car than it’s worth, simply because it has depreciated over the time they’ve owned it. This can be problematic if you are in an accident which totals your vehicle. Your insurance company pays to replace the value of the car, but it might not be enough money to pay off the car loan. You’re left owing money on a car loan without the benefit of owning a car.
One of the best ways to reduce the cost of depreciation is to buy a used vehicle. Purchasing a vehicle that is at least one year old can save you thousands of dollars and still leave you with a reliable, trustworthy vehicle without eating those first-year costs.
Consider cash
Many consumers treat car loans as a fact of life, something that will always be a part of their monthly budget. But it doesn’t have to be that way! If you don’t have a car payment now, before adding another payment to your list of bills, try to save the amount you’d spend on a car payment each month.
There are two benefits to saving the amount of your would-be car payment each month. First, you can be sure the amount you have budgeted for a car is affordable for you, without taking the risk of the loan. If for some reason you find it’s too difficult to save that amount each month, you’ll know before you’ve committed to making those payments. Second, when it comes time to purchase your car you may already be able to pay cash, or at the very least make a nice-sized down payment on your vehicle with the money you’ve saved yourself.
A car is a tool to get you from point A to point B, but can become a catalyst for regret if you overspend on your purchase. By budgeting, saving up a down payment, choosing your loan carefully, and avoiding depreciation, you can make a purchase you’ll feel good about for years to come.