5 Mistakes You Can’t Afford to Make When Buying a Car

5 Mistakes You Can’t Afford to Make When Buying a Car

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, cars carry a lot of expenses. 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! Cars can quickly eat away at your hard earned money and keep you from your goals of retirement or becoming a millionaire.

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.
5 Mistakes

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, being broke sucks. 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.

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. The car salesmen will tell you whatever they need to help you get into a car, so be cautious in dealing with them.

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. There could also be errors on your clue report, check out how to get your free clue report here. Generally speaking, 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, this could really help you in saving up some money fast for other things. 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.

Here are some other posts to keep in mind as you are buying a car

things you should know before buying your next car

repair or replace your old car?

is buying a new car cheaper than a used car?

don’t waste your money financing your car to long

how to buy a new car

is it better to buy or lease a car


Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

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