If your current vehicle is on its last leg, or if you’re simply ready for something different, it might be time to bite the bullet and purchase a new car. That said, buying a new car isn’t some small, insignificant purchase.
There are many costs that inflate a car’s expense beyond the simple ticket price. You want to make sure the car you buy is one you can actually afford, so before you sign and drive, make sure you fully understand the costs of buying a car.
Factors Affecting Car Affordability
1. Monthly Car Payment
If you’re like the vast majority of car buyers, you’ll probably secure a loan before heading to the dealership. But just because you’re planning to pay for a car in installments, it doesn’t necessarily mean you can afford the purchase. While paying $400 a month sounds a lot better than paying $20,000 up front, you must remember that’s $400 every month for the next 36, 48, or 60 months – if not longer.
Look closely at your budget to make sure you can afford a car payment. Determine how much disposable income you have after paying all of your living expenses, such as mortgage or rent, food, insurance, entertainment, gas, travel, utilities, and debt payments. It helps to monitor your spending for several months to see where your money goes, and to determine whether there’s wiggle room in the budget.
As a rule, your monthly transportation costs – which includes car payments, auto insurance, and gas – should not exceed 20% of your monthly gross income. To illustrate, if you earn $2,000 a month, your total car expenses should be no more than $400 a month. A reasonable monthly breakdown might include $200 for your car payment, $100 for gasoline, and $100 for auto insurance.
The price of the car isn’t the only thing that affects the total cost of the vehicle. Unless you qualify for 0% financing – which typically requires a minimum credit score in the high 700s – you’re going to pay interest on your car loan. Interest may seem like a small piece of the puzzle, but your rate affects your monthly payments, which can impact the type of car you can afford.
For example, after taking a look at your income and debt, the bank may decide you can spend $370 a month on your car payment. Based on a 60-month term with an interest rate of 4.25%, you can purchase a car with a price tag of $21,000 – not a bad amount. But if you have credit problems and end up with an interest rate of 8%, your purchasing power is affected. Since the maximum amount you can spend on your monthly car payment is $370, the higher interest rate reduces your purchasing power to $18,000.
Don’t get caught off guard by a bad credit score. Order a free copy of your credit report before applying for vehicle loans. This way, you can dispute errors that might lower your score, such as late payments reported erroneously by creditors. Also, if you catch a bad score early, you can delay your purchase and take steps to improve your credit score.
3. Negative Equity From a Previous Vehicle
If you’re financing a car that you want to trade in for a new purchase, you might end up with negative equity. Here’s how negative equity works: When you go to trade in your car, the dealership appraises it and offers you a specified dollar amount as its trade-in value. Unfortunately, this amount might be less than what you owe on the car. This doesn’t mean you can’t trade in the car and purchase a new one, but it does mean that the difference between what you owe on the car and its trade-in value impacts how much you pay for your new car.
For example, if you owe $8,000 on a car you’re trading in, but the dealership offers you $5,000, that’s a difference of $3,000. The dealership then tacks this difference onto the price of your new car. This increases the cost of your new car, as well as your monthly payments. Depending on how much your monthly payment ends up increasing, negative equity can put a new car out of reach.
To avoid negative equity, you’re better off selling your current car as a private party, as the private party value of a car is typically more than its trade-in value. You can sell the car yourself, pay off your car loan, then shop for a new vehicle.
If you decide to go ahead and trade in your car, be sure to give the dealership a down payment that compensates for any negative equity. This prevents you from financing negative equity with your new loan.
4. Auto Insurance Premiums
There’s no such thing as one-price auto insurance. The truth is, what you pay for coverage is based on many factors, including your age, driving record, the make and age of your vehicle, and your coverage type. If you’re currently driving an older car, you’re probably paying a low insurance premium – a rate you’re likely to kiss goodbye when purchasing a newer car.
Back in 2010, I upgraded my 1998 Toyota Camry to a 2010 Toyota Camry. As a result, my monthly auto insurance premium jumped by $65 a month. I expected to pay more, but I didn’t anticipate the size of the price hike.
To avoid getting hit with an unexpected insurance premium, call your insurance company to request a free quote before making a purchase. Insurance companies can provide a fairly accurate estimate of your new premium based on the make and model of the car you’re considering, and you may even want to ask if there are certain makes and models with lower rates. Finally, call around and compare prices – there’s no reason you have to stay with your current insurance provider.
There’s nothing like a new set of wheels, but don’t let emotions cloud your judgment. Take a long, hard look at your finances to decide whether now’s the right time to buy. Even if your current car is starting to need repairs, they’re probably less expensive than committing to five years of monthly car payments. Give yourself time to make a decision and thoroughly research your purchase.
What other costs go into buying a new car?