By Jason Alderman
When I was growing up, car manufacturers made a big deal each fall about unveiling next year’s models, literally shrouding them in secrecy under tarps in print and TV ads until the launch date. Car-crazy dads would then rush down to the dealer for a test drive.
New models now roll out year round – and financing methods have gotten more flexible as well. Back then, many people saved for years in order to pay cash for a new car; today, most people I know take out car loans. In fact, many saddle themselves with debt that might take five or more years to pay off – money they could be saving to buy a home or pay for retirement.
Although a longer-term loan may lower monthly payment amounts or enable you to buy a more expensive car than you could otherwise afford, it can also have unexpected, costly consequences:
The longer your loan term, the more interest you ultimately pay. For example, on a six-year, $25,000 loan at 6 percent interest, you would pay $1,659 more in total interest than for a comparable four-year loan. When calculating how much car they can afford, many people forget to factor in such expenses as a down payment, insurance, sales tax, registration and emission fees, maintenance and repairs, which can add thousands of dollars to the overall cost. New cars typically lose 20 percent or more in value the minute you drive them off the lot. Thus, if you put 10 percent down on a $25,000 car and borrowed the rest, you’d automatically owe $22,500 on a car that might only be worth $20,000. If you suddenly had to sell it, would you have $2,500 to pay off the loan? (Not to mention having to come up with the cash to buy another car.) Worse yet, if the car were stolen or totaled in an accident, depending on your insurance coverage you could owe much more.
Before you sign on for a new car payment you can’t afford, consider these points:
Today’s cars are much better constructed and more reliable than in the past. With proper maintenance, you might be able to get 150,000 or more miles out of your current car before repair costs become prohibitive. Check your car’s service manual for maintenance guidelines. If you can’t find it, go to your car manufacturer’s website. A good used car could save you thousands of dollars, both in price and insurance costs. To find a reliable used car, look for a certified pre-owned (CPO) vehicle backed by a manufacturer’s warranty. Kelley Blue Book (www.kbb.com) and Cars.com (www.cars.com) both have good discussions on CPOs. Also, ask friends or reputable mechanics for reliable referrals. Before purchasing a used car, look into obtaining a Vehicle History Report, available from www.carfax.com and other sites for a small fee. These reports will trace the car’s history by vehicle identification number on a nationwide database to make sure it’s not a lemon or has title problems.
For more tips on budgeting for and buying a car, visit Practical Money Skills for Life, Visa Inc.’ s free personal financial management program.
This article is intended to provide general information and should not be considered tax or financial advice. It’s always a good idea to consult a tax or financial advisor for specific information on how tax laws apply to you and about your individual financial situation. You should also consult a lawyer to determine how estate, probate and/or other laws may apply to your specific circumstances.
Jason Alderman directs Visa’s financial education programs.