Sorry, but most of the arguments made by the author have no validity and can easily be counteracted by simply making a second principle payment as often as possible on top of your regular car payment, then have the bank recalculate your monthly payment. This means you can go with a no-money down 6 year loan and still pay less interest over the long run and pay it off in less than 6 years, AND you'll have the flexibility of having a low required monthly payment to juggle around during times of economic crisis.
Cars Are Great, But They Can Erode Your Wealth
For many of us, a car is a necessity. With our sprawling cities and an often lacking mass-transit system, unless you live in the heart of a relatively large city, you need a vehicle. While important, a vehicle is also one of the biggest wealth destroyers out there today. Just look around. What are people driving, and how much are they spending? It isn’t uncommon to see multi-car households with over $100,000 worth of vehicles parked in their garage. And they are rapidly depreciating assets on top of that!
So, even though vehicles play an important role in many of our lives, and we need something comfortable and reliable, there are a few major mistakes you need to avoid when you’re buying a car. Just one relatively minor mistake can cost you thousands and put your other financial goals in jeopardy.
1. Overestimating How Much Car You Can Afford
Just like when buying a house, you can pick who to blame when people get in over their head. It is the buyer’s fault for stretching beyond their budget, or is it the dealer and lender’s fault for extending the credit to you even if you can’t realistically afford it? In either case, it’s up to you to understand how much you can really afford. If $300 a month is your limit, don’t budget on it when you get to the car dealer. They would love to convince you that you can afford a few extra features or a fancier model. Know what you can afford going in and stick to it.
And it isn’t always the upsell that gets you. Thanks to heavy advertising and a culture that promotes vehicles as status symbols, make sure you don’t fall into the trap in thinking you need more car than is necessary. You’re going to pay a premium for the badge that gets stamped on the hood, you’ll pay thousands more for a few more horsepower, and while your fingers may enjoy a heated steering wheel, a pair of 10 dollar gloves could save you a thousand dollars. Be aware of what features you actually need for your type of driving. That doesn’t mean you have to stick to a base model or sacrifice features you might need, but make sure you’re getting what you need, and not just what commercials say you need.
2. Buying New Instead of Used Just for the Sake of a Warranty
Years ago, if you wanted a warranty, you had to buy new. A used car purchase was like the roll of the dice. Today, you can often get used cars that transfer original warranties, and can even buy certified pre-owned vehicles that have not only the original warranty, but have undergone inspection and had any needed repairs done before being placed back on the lot. In some cases, you may even decide to opt for an extended warranty or service contract that could provide the piece of mind you’d get with a new car. Get an extended warranty quote to see if it makes sense for your car.
One of the big misconceptions is that a used car is going to be beat up by the previous owner and prone to problems. While it’s true you can’t be sure how the previous owner took care of the car, you have to look at the savings. When you consider that most new cars depreciate between 20-40% in the first few years of ownership, the savings can be tremendous. If you are considering a model that’s $30,000 new, you might be able to pick up a two year old used model for $18,000 – $24,000. Even better, it may still be covered under the existing warranty for a few years or another 50,000 miles.
Just look at your investment accounts. How do you feel when you use 20% or more in value in a year on your investments? Not good, right? Well, why take that kind of loss on a new car? Let someone else take the initial loss in value. Sure, you’re still buying a depreciating asset, but if you already buy it at a substantial discount from new, you’ll lose thousands less in value over the life of the car.
3. Choosing a Longer Term Loan to Make Monthly Payments Affordable
This is a big mistake. Remember, cars continue to become worth less and less as time goes on and miles are put on. Unlike a house which has the likelihood of increasing in value over a number of years, your car has virtually zero chance of becoming worth more money. This means you’re paying interest on something that’s never going to have the chance to make your money back. And let’s not forget the fact you’re not deducting the interest on your taxes. Buying a car and then selling it at some point in the future is almost always a loss.
So, the longer the loan, the more interest you’ll pay, and the bigger the loss you’ll end up realizing. Even worse, if you choose a long-term loan and decide to sell or trade in before the loan is paid off, you could easily find yourself upside down and actually owe money. It wasn’t long ago and a 36 month term was the standard for an auto loan. But this has been stretched out a bit, and now it’s fairly common to find 4, 5, and even 6 year loans. While a six year loan may decrease your monthly payment, you’ll pay for it in terms of interest.
Let’s look at a simple example. We’re going to finance $20,000 at 7%, which is a typical auto loan rate as of this writing. If you were to finance this with a 36 month loan, your monthly payment would come out to about $617. Even over these three short years, you’ll pay roughly $2,200 in interest over the life of the loan. So, let’s say you do what a lot of people do, and opt for a longer term loan so you can keep that monthly payment down. So, financing the same amount at the same rate but over 72 months, you bring your monthly payment down to about $341. That’s certainly an improvement, but at what cost? Well, with this loan you’d actually pay $4,550 in interest.
With six year loan, you’d be paying almost 23% of the original loan amount in interest. Even worse, since you’re dragging the payment out even longer while the vehicle continues to depreciate in value, if it comes time to sell or trade in the car early, you’re far more likely to be in a situation where you’re upside down. This is especially true if you put very little or nothing down up front.
4. Putting Little or No Money Down
Want to buy a car but have little or no savings in the bank for a down payment? No problem. Car companies are notorious for having zero-down promotions, and even if a down payment is required, you can often get by with just a few hundred dollars. While this isn’t quite as common these days since credit is a little harder to come by, it’s still a big mistake.
Again, we’re talking about a depreciating asset. If you put nothing down on a car and it drops in value virtually the moment you drive it off the lot, you’re immediately upside down. This is such a huge deal when homeowners find themselves upside down that some will just walk away from their home, yet when it happens to a vehicle, it’s just to be expected. While it might be the nature of the beast, that doesn’t mean you should make a purchase like that.
First, you have to look at how sales tax can compound this problem. If you live in a state that has sales tax, you’re going to be paying hundreds or even thousands of dollars in sales tax. Consider a $20,000 car with a 6% sales tax rate. That’s $1,200 in tax. So, what happens if you don’t put any money down? The tax gets rolled into the loan, and you’re financing another $1,200. Even if the car were to keep it’s full value when you take ownership of it, since you finance the sales tax, you’re already upside down. On top of that, you’re going to be paying interest on that tax, which just increases your total ownership costs.
Even if you aren’t required to put anything down, at the very least you want to put enough down to cover the taxes and fees that aren’t the cost of the vehicle. There’s no need to pay interest on these items as well. So, come to the table with enough to pay the taxes and any other fees at the bare minimum. Obviously, you’d like to put even more down so that you can finance even less and have some “equity” right out of the gate, but don’t get trapped into financing taxes and extras.
5. Not Factoring In Total Ownership Costs
While the monthly payment is one of the largest components of owning a car, you really have to factor in all the other costs. When you own a home, you have a number of costs that aren’t tied into the mortgage. You have utility bills, insurance, and maintenance, which can vary significantly depending on the size and type of your house. A vehicle is no different.
First, you have insurance. Obviously, not all vehicles have the same insurance premiums. How much you pay for insurance will depend on a number of factors, namely the value and make/model. Generally speakking, the more the vehicle is worth, the more it will cost to insure. In addition, if you have a make of vehicle that has a greater chance in having a claim, the premiums will be higher. While you might be able to get a good deal on that SUV right now, how much of that deal is going to be offset by higher insurance premiums? Premiums can vary greatly, and you could find yourself paying a few hundred or even a few thousand more each year on insurance just by choosing a vehicle that’s more costly to insure.
And if higher insurance premiums aren’t enough, you have the cost of gasoline and regular maintenance. Don’t underestimate the impact that gas mileage can have on your total costs. Just a 5 mpg difference could save hundreds of dollars annually depending on the prevailing gas prices and how many miles you drive. And if you buy a vehicle that has specialty equipment, high performance parts, and you aren’t equipped to service these yourself, expect to pay more money to have someone else service them for you.
Consider the Long-Term Effects
Sure, it may not seem like a few hundred dollars a year here, or a thousand dollars over the life of a loan there is going to have much of an impact, but it can really hold you back financially, especially if these costs could be completely avoided or minimized with making a smart purchasing decision. But if you find yourself buying a new vehicle every five years or so, the amount you could save over your lifetime could be substantial.
If you could save an average of $2,000 each year on total vehicle ownership costs, that could be an additional $60,000 over thirty years. And if you put that savings to work and paid off high-interest debt or tucked it away in an IRA, the total savings could be well into the six-figures. And saving $2,000 a year isn’t a stretch by any means. Buy used instead of new, finance with a short-term loan, put some money down, find a car that’s relatively cheap to insure, and get a few extra mpg and you’re well on your way to a larger nest egg in your later years.
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Filed Under: Personal Finance
About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.
ALso i own a chevy cavalier and if you take care of it, its a GREAT car. run it into the ground then that's another story
This is great info! Glad I read it considering we are very close to purchasing a new used car with a bank loan. Sadly our situation doesn't allow for us to avoid a couple of the named mistakes....but we do everything we can with what we have.
On July 4, 1996, in my early 20's, I got the deal of a lifetime. I bought a 1987 Nissan Pickup for $100 (one hundred) dollars from a lady who wanted to "get rid of" her Nissan in order to purchase a Toyota. The pickup was in very good condition and had about 140,000 miles on the odometer. Today, it is still my daily driver. I haven't had to replace anything other than a battery and a fan belt. I pay $13/month for liability. AND have over $300,000 saved on a teacher's salary! My father told me that that purchase was better than any stock or mutual fund ever. I love my Nissan Pickup! **I own 3 other cars (all paid off) a showroom quality '95 Ford Mustang GT, a '95 Chrysler Cirrus LXi & a 2003 Cadillac CTS.
Well some people can not afford to pay cash. I have saved every penny I could for 2 years working full time and I only have 2,000 dollars.
Be smart when buying a car. This is my own experience.
my chevy cavalier broke down constantly. even after getting it repaired it would break down again. finally enough was enough. I had my vehicle towed to a used car dealership here in chicago. i was the first customer, and i spoke to the general sales manager. I was directed to a white 2004 Honda Civic sedan. Nice reliable car. i paid just $6,000.00 (six-thousand) dollars for this vehicle, including title and registration transfer. I paid the vehicle cash, just wrote them a check (it pays off to pay yourself first) I have no car payments, because im smart.
And we all know honda's are awesome cars. They last forever. So i have a great asset that i own. I am not enslaved to a bank, or dealership that screws people on the interest alone. oh, yes, my car insurance is only $38.00 dollars per month. (i have liability). but how often is it that one gets into a car accident. (I have not had a car accident for my entire driving life. So it makes financial sense to have liability insurance. the best thing, is having the peace of mind of not having to throw a way my money every month on a depreciating asset. Cars depreciate quickly, especially a used vehicle. Anybody who finances a new car, let alone a used car in my book is an idiot. BE SMART, and dont let a car dealership screw you. They only want your money.
First off, I wanna say this is an awesome post you have here. I think the big problem people have is putting the money down for a vehicle which prompts the mistake of showing up at a dealer when you don't have money to put down. Most of the time they are lead to visit the dealer by false advertisements at times too, especially 0 down deals.
I find these tips and options interesting. I'm an 18 yr old senior on my way to college in California and was just woundering if any of you had tips as to what I should do when I get a new car? Should I buy used, new, lease or what? What things should I consider and take under consideration.
This is probably the most informative, insightful, and true article on car buying for our generation. I am just curious, are there any scenarios where you get published in printed news with this information. I know that it would be a great read in our school newspaper here at the University of Tennessee Knoxville.
I am researching buying a vehicle for me and my fiancee at the end of next year when I graduate, and I am very glad to have found this read. I had previously decided on short term loan, and used. But some of the information I think is just not readily available to others our age.
This is a VERY good post. There are way too many people who jump into the decision to purchase a car and make terrible financing decisions. The same thing happens in real estate, etc. This post is a great wake up call for those considering making a large purchase -- especially in this economy.
This is a fabolous post.. I think the most important thing to keep in mind is that one should never overstretch while making any asset purchase because as is explained in RICH DAD POOR DAD assets like car etc are infact a liability and hence the lesser is the outgo in it the better it is .
I had the same problem as Matt: I bought a new car last year because I couldn't find an used one that met my requirements. I wanted to downsize from my SUV because it was costing me a fortune to drive to work (I have a very long commute). My husband and I spent weeks comparing prices and gas milage, and we had our hearts set on a Toyota Corolla '06/'07. But we couldn't find one used around our area for under 17K (which was above the price we had budgeted). We finally bought a 2008 Toyota Yaris for 13K. We checked with Consumers Report, and they gave it a good rating. Our intention is to drive it until it falls apart. I guess our son will end up inheriting it ;-)
I agree with Matt that sometimes a new car makes more sense to purchase. I purchased a new car (Honda Civic) just under 2 years ago and it has only depreciated about $1,000 - $1,500 from the amount I paid - I'm a pretty good negotiator (this is according to Kelley Blue Book and taking into account mileage etc). Some cars don't depreciate as much as others do so you need to do your research. It also has a low cost of ownership.
I also keep my cars until they are almost embarassing to sell 10+ years so I get the good years with the warantee as well as the rest of the more unpredictable years.
Cars purchases can so often be hugely influenced by ego. I personally believe that spending all your cash on something that could well prove to be unaffordable later on is financial suicide. Not only will the bank repossess it, you'll also be blacklisted and unable to get credit again.
I am now 10 payments away from owning my car outright. I absolutely don't regret getting the car. I stuck to my payment limit, put 20% down, budgeted for gas and insurance as well as incidentals and I made a great decision for me.
I remember how the dealers all wanted to push me into a lease. That is about the dumbest idea I have ever heard. Now I intend to take good care of my car and drive it until the wheels fall off. Trust me...and I work for a major manufacturer where I get a deal. You will NEVER catch me leasing - even with a discount.
For those looking to buy a used car, there's a new online database where prospective buyers can key in the car's VIN number and find out if the car's ever been involved in an accident and other details. Best of all, the federal database, which provides the same info as paid services such as Car Fax and Auto Check, is absolutely free.
You can find the link for it here...
I made the mistake of financing a 15k car when I was making 400 per week! Of course I know better now, but you just have to be careful.
Great post, though I disagree with one point: calling cars an asset. They are liabilities, plain and simple. :)
Great informative post. Another reason (related to your first point) is in thinking you need too much car. I cited a study in a recent blog entry that the 'big car' maybe too ingrained in the American psyche to give up. But I'm not sure that's as much an issue with gen x.
I agree with the previous commentor. One thing that dealers always try to do is make it seem like they can't negotiate for a better price. They are always marking the price up on cars to try making a higher profit on it. Even when buying a used car, there is always wiggle room and you should never pay sticker price for a car.
Here is a tip... for when you go and get a car at a dealership, don't give away too much information about yourself. The dealors are trying to squeeze information out of you so that they know what kind of person they are targeting. Example.. imagine if you told them that you are a doctor and that you are single. This raises an alarm to them, saying that Oh Hey this guys got alot of money to spend, and I can probably get away with pushing something expensive. At the same time... if they know that you are looking for just one specific car, they know that they dont have to price bargain as much, since the person really wants that car.
I grew up on a farm and love driving pic up trucks, but they are costly especially today since they are dresses up like cars. There is no way that I can justify owning one.
We own two vehicles both cars bought used, my 96 Pontiac Bonneville still runs well so I am hoping to get another year or two out of it. The car cost $6,000 plus about $3,000 in tires, repairs, and such. I have owned the car for 7 years, so its cost to me has been about $1,300/yr if I had bough the car new the value loss would have been more then $2,000/yr then add the tires and repairs. New cars are pretty but hey cost you dearly
Remember cars can only gt you from A to B and or most of us we barely need them. When you occasionally need a larger or fancier car rent it, it costs you less in the long-run.
All the best and educate yourself budgetingsense.com constant message.
@Chris - Your "crap" comment cracked me up! I couldn't agree more. I haven't owned a car in over ten years - and my savings over those years is considerable.
I'm saving up to buy a car rt now. Thinking about getting the Nissan Altima, need to save up a little bit more so I can put a big down payment. Thanks for the tips. It's going to be my first big purchase (first car) :)
One of the single largest personal finance mistakes people make (myself included). Vehicles are depreciating, money sucking pieces of crap. Only buy a nice car when you can afford to pay cash for it. Excellent and timely post!
I totally agree with all of your tips. But I have another tip for negotiating with the dealer. Even though you have a down payment, you don't want to tell them this up front. They'll try to use it to their advantage. Say if you're paying 2,000 down, the cost of the car may be 10,000, but they'll say you're only financing $8,000. They'll try to use that to get you to pay $2,000 more than you planned on paying. I learned this from my brother-in-law who used to work for a Ford dealership.
Let's face it, people making 50K or more, who have a mortgage or suck at managing their monthly expenses, are shooting themselves in the foot by buying a 30K car.
I have a friend, shes 22, she works in a bank, making probably just over 30K, and just bought a brand new corolla, which probably came to around 25K.
And I ask myself what was the point? Is she just doing that because everyone else is?
What happens when she looses that job?
Its not enough to just look at your monthly budget and see if you can make it, you need a long term view.
I bought a new car last year and paid it off in December. The funny thing about today's environment is you can get a better price on a new car. This is because the factory offers incentives to dump their inventory.
You should also really look into the financing offered through the dealers. I got a better deal through the dealer than I ever got at my bank (and I work at the bank!).
Last tip, NEGOTIATE ONLINE. Use email and NEGOTIATE. Including taxes and fees, I saved about 15% off sticker price.
Great post! If I may, I'd add two more tips to this.
1. Do your homework and know what the vehicle you want to buy is worth. This gives you more leverage when making the deal.
2. Don't give the salesman too much info up front. Selling cars is a game in psychology. They latch on to something you say and spin the deal around that. For example, you may tell them that you can only afford $300 a month for a car...well, they can usually find a way to make that happen, but it may not be in your best interests! They may extend the term out to 84 months (just saw this the other day with one of my clients) or they could find other equally ridiculous ways to stretch out your financing because it's more money for them.
If you walk in with the knowledge of what you want, how much it is, and what financing options you have, you can pretty much play the game on their level and get them talking real numbers. And this will save you thousands of dollars!
Oh! One more thing. DO NOT buy Gap insurance or extended warranties from the dealership unless they are offering you a fantastic deal. Check with your insurance company or local credit union/bank first. The dealerships where I live tend to charge about $2k for GAP insurance. My credit union sells it for $300.
Excellent list of new car no-no's. Don't forget about all of the over=priced dealer add-ons that tend to show up on the sales contract. Make sure you scratch those off.
I was (and still am) an advocate to always purchase a used vehicle. However, I admit I am guilty of purchasing a new vehicle a few years ago.
There are many factors (including forces of nature destroying my car) that weighed in on my decision to purchase a new car.
- I needed a car immediately
- My insurance gave me well above book value for my previous car
- 20% off MSRP and $1,500 under invoice (unheard of at that time)
- newest model year (i.e. they had both 2006/2007 versions on the lot, got the 2007)
- no used inventory in the region at the time
I did a lot of research before my purchase and concluded that if I were to keep the car for 10+ years, it would work out.
Because I chose a reliable car with a storied history, it was near impossible to find a 'used' version I was looking for.
I still wholeheartedly agree on buying used, but I ran so many numbers I went against my better judgment. We'll see how it works out in the end. I don't anticipate ever purchasing a new car again...I think.
Oh...and if you are curious, it is a 2007 Toyota Camry.
When I drive around and see the luxury vehicles cruising the highways, I always wonder to myself...
Are they driving something they can't afford to impress people they don't know?
Grant, that's the reason I wrote this, because I'm amazed on a daily basis how people destroy any chance at having a comfortable retirement just because they waste money on their vehicles.
Most of the people I work with are your typical middle class families, and most will say they are doing just enough to get by, basically living paycheck to paycheck. Of course, 9 times out of 10, as we begin to dig into their finances, I'll find they are paying more each month on automotive expenses than their mortgage.
It's just so common to sit down with people who have two $400+/month car payments, $250/month or more on auto insurance, and spend around $200/month on gas, while at the same time can't seem to find money to put into a 401(k) or even create an emergency fund.
Having one or more vehicles might certainly be necessary to get to your job, but if you put things into perspective and realize you're paying $1,200/month or more primarily for the transportation to and from your place of employment, it's no wonder money is tight.
The people I really feel bad for are those who get into the never ending cycle of financing what you still owe on your car when trading in or buying a new one. People often find they want out of a car before it's paid off and if they are upside down, they roll that into their new loan, and repeat every three or four years. It's a dangerous cycle to get into.
But that's just what I see a lot of around here. Vehicles are an important part of people's lives and they spend a lot of time in them, but they often don't realize the long-term impact that having more vehicle than you need can have.
As my husband and I venture out into the car market, this is a great and timely reminder to be wise with our car buying decisions. Thanks for this great post.
Great thoughts Jeremy! When planning to purchase a car, it's so easy to bite off more than you can chew and leave the lot with buyer's remorse.
The best piece of advice I've been given when buying a car: Pay Cash!