Financial writers often suggest you determine how much house you can afford before you go shopping. But instead of setting a price goal, people often shop for cars by finding what they want and then figuring out how they will pay for it. With car prices at all-time highs, it’s important you don’t fall in love before you’ve determined what you are able to spend.
Do you need a car NOW?
New cars have increased 14% year over year, while the average used car is up 24%. In this time of crazy prices, the first thing you should consider is if you really need a car now? Prices are high, selection is low, and your chances of making a deal (anything below MSRP) is doubtful on the most popular models. Money from the US Economic Impact Payments might be burning a hole in your pocket, but – if you can – consider holding out until supply has caught up with demand.
Why do you want/need a car?
Are you replacing a car for one with better gas mileage due to a new job across town? Are you trading in the Mini for a minivan for your growing family? Before you head out, think about what you need from your next car. If your family is growing or will be soon, buying a car now that can handle the increased size might make sense. Recently I have considered buying an electric car to replace my older Honda Pilot. It would make more sense with my day-to-day drive and save me money in the long run.
How do you plan to pay for it?
The vast majority of Americans finance their new car purchases. Even some who can afford to just write a check may make the decision to finance, especially if the car manufacturer is running a 0.9% or less special for the model they’re purchasing. Others will only pay cash, and this is even more true when taking into account the used car market.
Cash. Living without a car payment can free up your budget for other necessities. That is, if you don’t put yourself in an awkward position financially to get there. For instance, if you’re the parent expecting twins, being cash poor around the time they will be born may not be the best option. However, if the job across town came with a sweet raise and you can afford it, not having a car payment means you could use that money elsewhere (maybe upping your 401k contribution at the new job).
Finance. Often financing involves two decisions – how much will you put down on the car and how much can you afford to pay monthly. While there are zero down-payment loans available, using these instantly makes you upside-down on the car loan – you owe more than it’s worth. Most experts agree you should pay down a comfortable amount, perhaps 20% or more. This will also help to reduce your monthly payments. And while we’re on the topic of financial advice, most pundits recommend you avoid anything over a four-year loan term.
Financing isn’t just for people who can’t pay cash though. Car manufacturers often advertise special financing – often zero percent or 0.9% – to move slow cars off the lots. If you can make more money by investing, it makes sense to consider these rates if they are available on your car of choice. Just make sure you actually invest the cash and don’t end up spending the extra.
Is your house is in order?
Whether paying cash or financing, make sure you have an emergency fund available, especially if your car payment is going to push you closer to the edge financially. Also, look not only at what you’re spending now, but what’s coming down the pike. Are you planning any big-dollar expenditures (like a new house or braces for the kids)?
Don’t forget the extras
A newer car often means higher insurance rates, especially if you’re going from a car where you didn’t have comprehensive coverage to one where it’s required. A call to your insurance broker might be warranted once you’ve made a decision on the car you want.
What should be my maximum debt for a car?
Most experts recommend you keep your car payment at no more than 10% to 15% of your monthly take-home pay. This may seem low but remember that the payment is only part of your car expenses each month. You will need to budget for gas, insurance, and maintenance too. These estimates assume you don’t have outstanding credit card debt and aren’t under a huge debt-burden on your home.
How much car can I afford?
Once you’ve examined your budget, figured your down payment, and looked at your monthly spending, use online calculators to back into the total amount you could spend on a new car. For example, if you can afford to make a $7,000 down payment and can pay $450 monthly for a car, your sticker price range would be from around $23,000 to over $25,000 (taking into account state taxes) or $27,800 if you don’t include taxes in the equation. This assumes a 1.9% interest rate and 48-month term.
Remember though – when you start reviewing dealer websites, the advertised list price doesn’t include state taxes and may not include dealer fees and other hidden expenses. Make sure you have some wiggle room in your budgeting.
Will you be shopping for used or new?
Now that you have that number, can you afford what you were hoping to purchase? Or will you be considering newer used cars? It’s fun to play with the numbers on the online calculators to see what would happen if you could afford a $500 monthly payment or maybe found a car that had a special zero percent interest rate. Try not to extend the loan term, especially if you are someone who quickly grows bored with their car.
Shopping for a car recently has turned into a whole new game. Playing dealer vs. dealer may not work as well as it has in the past (or may again in the future). If you absolutely need a car, you can still get a fair deal by doing your homework and deciding what you can afford upfront.
Photo by Jim Witkowski