Getting a brand new car is a complicated emotional and economic issue for most people. Often shoppers find a car model and color they really want to own and no matter how bad the safety, repair or customer service records, or how high the price, they stand by their choice. While it is certainly a good idea to buy the car of your dreams — a car that brings enjoyment is generally cared for properly, retaining more of its resale value, a car payment that outstrips your budget can lead to serious financial problems.
The cost of a new car includes many expenses along with the price. These additional costs include the interest on the loan or lease payments, loan and lease fees, tax on the purchase, the license fee, insurance coverage, enhancements (like a better stereo or a sunroof), maintenance, repairs, depreciation and, of course, gas. These expenses, as well as the price of the vehicle, need to be taken into consideration when determining what you can afford to spend for a new car.
In 1923 Henry Ford shocked the business world by paying his workers the incredible sum of $5 a day, then allowing Americans making that wage to buy a $265 Model T on the “layaway” plan. The customer was given a coupon book to pay the dealer $5 a week until the car was paid off. Once paid for, the customer took delivery. That was the informal beginning of payment plans for cars.
In today’s “get-it-now, pay-later” world a vehicle buyer no longer pays up-front before taking delivery. We pay for the car while we use it. Unfortunately, buying a car on credit can allow one to buy more car than one can afford. We can choose a Toyota Camry, for example, when we should be considering the price-and-feature-comparable Toyota Corolla or Echo. All we have to do is take out a longer loan.
All of this “emotional” buying is made more poignant because we’re bombarded with advertising that sells us features we think we need, but perhaps do not.
For example, how often do we see men buy cars they think will turn women’s heads? Or a woman who covets a Mercedes because it fits her image. Madison Avenue has learned to appeal to our emotions, circumventing our sensibilities. Those images are deeply and deliberately associated with all products today. Many automakers have successfully equated their make with a specific concept. For example, Volvo is safety, Mercedes is elegance, Lamborghini is decadence, Volkswagen is fun and young, Pontiac is excitement, GMC is comfortably in control, and Saab is independence. All of us are influenced by advertising. It is important to buy the product that best meets your needs and budget.
The Cost of Ownership
First consider the price of the vehicle. The average new car price hovers in the $23,000 range. There are some excellent products costing less and many that cost much more. Price is an important issue because the lower the negotiated price, the lower the lease or loan payment and the less taxes and interest will accrue.
In order to bring a monthly payment in line with your budget, more than likely a down payment will be needed on the loan. This reduces the amount owed and the payment will be lower. The same is true for a lease. Pay a “cap reduction” (money used to lower the amount of “capital” being financed) and the lease payment will be less.
The next factor to consider is interest. When borrowing money (even it is from Mom), it must be worthwhile for the lenders to part with their cash. The more likely the money is to be paid back quickly and hassle-free, the more motivation the lender has to provide a loan. So a person with a good track record of repayment — a “good credit risk” — will pay a lower rate. Interest rates are affected by many elements — what’s happening on the stock market, how much money is currently being loaned, the state of crops, the inventory in warehouses and even the weather. Suffice it to say that you’ll pay some money to borrow money and this amount contributes to the overall cost of the purchase, increasing the price of the car by as much as 30 percent.
After the details of price and interest, there are miscellaneous fees involved in the sale of a car. They include the loan or lease fees for processing the paperwork, tax on the purchase, possibly a “gas guzzler tax,” the cost of a license and registration, and the delivery charge. Some dealers will try to charge you for their advertising expense; just refuse to pay it.
Tax and license fees in most of the U.S. are between 8-11 percent of the total price of the vehicle. The registration needs to be renewed annually or every few years and can be expensive. For example, in California the cost to register and get stickers for a two-year-old Honda Civic is around $300 a year. This expense is an easy one to forget in the excitement of buying a new car.
In most states, insurance coverage is required to drive a new car off of the dealer’s lot. The budget for insurance can be anywhere from $50 a month for a passenger car with minimal coverage to $1,500 or more a month for an expensive sports car with full coverage. All of this is affected by where you live, age of driver, marital status, age of the car, gender, driving history, number of people driving the car and their driving histories, the cost of the car to replace or repair, how likely it is to be stolen, whether you smoke or not, and even if you are a good student! In some states rates can also be lowered by installing antitheft devices and whether you took a driver training
Once a decision has been made about which cars are part of the consideration set, check with your insurance company to find out what each car will cost to insure. Then start shopping. Compare the rates from your current insurance company to other company’s rates. Explore several different companies from local to mail order to Internet.
If plans are in the offing to add some nice enhancements to your new car, such as a CD changer, a DVD entertainment system, an alarm system, a phone, or a better stereo, be sure to include these costs in your proposed budget. These additions can be expensive and need to be considered when looking at the overall picture.
Then there are maintenance and repairs to consider. These are two separate budgetary items. Maintenance is the stuff you do all the time to keep the car in good shape, like change the oil, the spark plugs, put on new tires, batteries and brakes. Repair costs, on the other hand, are expenditures for fixing things that break.
Good maintenance can add $1,000 or more to the car’s value at resale time. Make it part of your routine. Car ownership is a responsibility. A well-maintained vehicle is a more reliable and safer vehicle.
New cars come with a comprehensive warranty that covers most problems. Be cautious about offers to buy extended warranties. They often provide limited and unnecessary coverage. If possible have a person who is well versed in auto repairs review the warranties. It may be that some of the most important repairs, car parts, components and common types of breakdowns are not included.
We are in the age of the “rapidly evolving warranty.” A Toyota Matrix and a Pontiac Vibe are nearly identical cars, one built in Canada and the other in California. Yet the Matrix has a better warranty, but the Vibe includes three years of 24-hour roadside assistance. Be sure to look for roadside assistance when comparing warranties.
When you have narrowed your vehicle choices to two or three, it is time to study maintenance, warranties and other ownership costs in depth. One of the easiest ways to compare is to visit the pricing section of the site to acquire new vehicle purchasing reports for the autos under consideration. All this information is available to you free of charge and much of it exists within the car reviews as well.
Depreciation, even though it is not something paid for in cash, is still an expense. It is the amount of value a vehicle loses as it ages. Check how your vehicle is devaluating through a leasing company’s “lease guide.” There you will find the estimated percentage “rate of devaluation” for your car. Or you can get an estimated calculation at financecenter.com.
And, last but not least, you will want to clean your car and put gas in it. Most people drive about 15,000 miles a year. You may drive more or less, but if you figure $1.75 a gallon (the average over ownership) for a car getting 20 miles to the gallon, you can expect a yearly fuel bill of over $1,300. Fuel costs are included in the Fuel Economy Guide.
How Much Can I Afford to Spend Or Borrow?
An excellent way to judge what you can afford to spend on a new car, assuming you will either lease it or borrow money, is to prepare a budget. This is a task few people are willing to do, even though it is the ultimate tool for managing money and guaranteeing financial health. Whether your credit is perfect or poor, do a budget before (even a brief one) buying a new car. If you want help, call Consumer Credit Counselors (CCC), the nonprofit organization offering free services to the public. They can help you get out of debt or simply send you a brochure on how to do a budget. More about budgets later in this article.
The idea of the budget is to determine how much money you can spend on a car payment without being overextended. First determine exactly how much money you make — do you have a bonus on the horizon, or perhaps a raise? Next, make a list of your expenses. Then compare what’s left over after subtracting your “obligations” from your “income.” This exercise may expose that you don’t have enough free capital each month to buy the car you want and pay for the insurance, gas and maintenance.
But there are lots of alternatives. Consider a part-time job to save money for a down payment. Can you trim spending habits to free up some capital? If you plan to buy a car, start saving for a down payment immediately — $350 tucked away each month for 6 months will give you a good start. Take a look at your priorities and make a list of what’s most important to you right now.
If you’ve been receiving a sizable tax return each year, consider adjusting your withholding so that you see more of your money each month. This can help pay the car loan. Make sure you review your withholding status each year, particularly if you’ve received a raise, to make sure you won’t unexpectedly end up paying more taxes at tax time.
Homeowners can use an equity loan to finance a car. There is a risk involved, but the interest paid is deductible and the rate is usually lower than “market rate” car loans! Unlike the interest paid on a consumer loan, home equity loan interest is tax deductible. If you are considering either option, a conversation with a tax preparer or accountant is worthwhile.
Most financial institutions base your ability to borrow money on your “debt to income ratio.” That is the relationship between gross monthly income and what you have to pay out each month in expenses. Banks aim to give loans to people whose debt is between 35 and 38 % of their income, including rent and the estimated new car payment. If, after you pay all your credit obligations each month including the proposed new car payment and your rent or mortgage, you have 60 to 65% of you paycheck left to pay for food, utilities, insurance, fun etc. you’ll look good to the lending institution. However, this is not a hard and fast rule and lots of loans and leases are given to people with less than 65% of their paycheck left over. So, for example, if you earn $25,000 a year and your rent, plus credit card obligations, plus your new car payment equals $792 per month, that’s exactly 38% of your gross income. You would easily fit into the bank’s equation.
The bank will ask for a five-year history of your finances. They will evaluate not only your income and expenses, but other financial strengths including a strong credit history, living at the same address for 2 or more years (5 is preferable), working for the same employer for 2 or more years (5 is preferable here as well), and an exceptional history of on-time bill paying. If you are off a little on the “debt to income ratio,” a bank or finance company will fudge a little if your other ducks are in a row, especially if you are female. Women are considered better credit risks than men, even if they don’t make as much money. Women file far fewer bankruptcies in the U.S. and they are also more inclined to pay all the money owed on a loan and never default.
Take a look the following worksheet. Write in your own answers and see what you can afford. The more conservative 36% figure is used in this worksheet. You can certainly plug in another number.
If the car payment you can afford is less than the one for the car you want, try a larger down payment, less car or getting help from a family member — but that option can have pitfalls of its own.
Let’s look at the form for addressing all these financial issues on the next page.
What can I Afford to Spend on a New Car? – Worksheet
Gross Monthly Income = _____________
Gross Monthly Income _____________ x .36 _____________ = Target Debt Maximum _____________
Monthly Debt (add together):
Rent or Mortgage _____________ +
Credit cards _____________ +
Store cards _____________ +
Total Debt = _____________
Target Debt Maximum _____________ – Amount of an affordable Car Payment _____________
Getting Help from Your Family when Buying a New Car
Whether you loan or lease, you will probably need a down payment ranging from a few thousand to several thousand dollars. If you need help getting into a new car, think who may be able to lend a hand. Often parents, grandparents, aunts or uncles may be able to loan you enough money for a down payment or “cap reduction.” They may even lend it to you at a “low-” or “no-interest” rate. This is often the case if you need a car to help get a better job, keep the one you have, or go to school.
Family and friends can help in a way other than loaning money. A helper can lend their signature as co-signer on your loan. What they are doing is “loaning” you their credit history. A co-signer can make the difference between getting a loan or not. And it can certainly affect how much money the financial institution may be willing to give you.
Ultimately, the co-signer is responsible for the repayment of the entire loan if you default. So make sure that you can afford to repay it without defaulting or you may harm their credit rating as well as stick them with the payments and ruin an important relationship.
By the same token, if you make the payments regularly and on time, you will be building the credit rating of your co-signer rather than your own. The only way to get credit for having paid a loan or a lease that had a co-signer, is to have the co-signer send a letter to the finance company stating that you made the payments and deserve the credit for the completed loan or lease. This is essential if you plan to use the purchase or lease of your new car to build your personal credit worthiness. Paying with your own checks is not good enough.
Borrowing money from family can be a dicey situation that can potentially create a lot of pressure and hard feelings. But if you keep that kind of borrowing to a minimum and pay your obligations promptly, a family loan can put you in a good car that will get you to work or school reliably for years to come. The family member will be helping you to success.
Don’t be too shy to ask for help. At some point everyone needs a helping hand and it is very common for families to help one another in this manner.
If you get help, keep up your end of the bargain. Make the payments and be sure your name is on the lease or loan contract as well as the car title to develop credit of your own.
Read more about leases and loans in “Lease or Buy – Deciding on Financing Options.”
Help Establishing Credit
Every person is in a different situation when it comes to the ability to borrow money. Some people have great credit ratings because they have regular jobs that they have been at for a long time and everyone wants to lend them money. Conversely, many people have no credit or have been in a pinch and had problems that have damaged it.
If you have credit problems, it is still possible to get a car loan. You’ll just pay a higher interest rate. You may decide that you’d like a little help with all the “budgeting stuff.” If so, there are resources available. First, you can call Consumer Credit Counselors (CCC). They are a nonprofit organization with branches in every major city and many small ones. Their services are free and can help with everything from budgeting and personal finance, negotiating lower payments on your debt till you can get out from under it, or helping you repair a bad credit history. Their services are very reasonable. and most are free of charge.
Sharon Morse, the Director of Counseling for Consumer Credit Counseling Services of Ventura County, California, made these recommendations about new car buying. “One of the most important things to concern yourself with when shopping for a new car is to keep the auto dealers from checking your credit until you are ready to buy a specific car. This is important because every review of your records is recorded. Anyone with access to your credit report will see that you’ve been shopping and looking for money and it will appear as if you have been turned down for a loan. It can reflect badly on you.
It is easy to get fooled into signing a document that allows a dealer to check your credit. This usually occurs when you first enter the dealership and they are filling out a form with information about your car needs. If they ask you to sign it, read the fine print. You’ll see that it says they have permission to check your credit. Tell them it is premature to be signing anything. Wait until you know the bottom line and are ready to buy a car. What they are really doing is trying to see if it is worthwhile to spend time with you.
“It is also important to know that the “3-day right to rescind laws” that apply to consumer product contracts do not apply to cars (in most states). We are constantly being asked if there is such a thing as a “buyer’s remorse” law, and as far as we know, there isn’t. Once you sign the paperwork, that car is yours. Other than that, thorough research, knowing the hidden costs and what you can really afford are the best ways to protect yourself and your financial security.”
There are two options for checking credit — doing it yourself, or hiring someone to do it for you.
If you want to see what your credit rating looks like, here are the links and phone numbers to the major credit reporting companies:
- Equifax, 1 (800) 685-1111.
- TRW is now Experian, 1 (800) 422-4879.
- Trans Union, 1 (800) 916-8800.
If you need assistance reading your credit reports, Debt Counselors of America has a Web Site with lots of useful information. In particular, you can download pamphlets and articles (in the Adobe Acrobat Reader format called a .pdf) like “reading your credit report” or “want to know your credit reporting rights?”
As with everything in life that’s worth having, research and information are the most significant tools you have in attaining your personal automotive goals. Read your loan and lease contracts carefully as well as your warranties and don’t ever let anyone force you or talk you into doing something that you don’t want to do or don’t feel good about. Time is on your side when buying a new car. Armed with the knowledge of how much you can afford to spend, take a look at the articles on “Lease or Buy – Deciding on Financing Options” and “Which New Car Model is Right for Me?”
Above all, enjoy your new car!