Financing a new vehicle comes with extra costs and a long-term commitment that can leave us stranded on the side of the road if we are not careful. High interest rates, depreciating value, and a huge monthly payment can leave us feeling overwhelmed.
We highly recommend you check out our article about the benefits of paying for a car with cash as opposed to financing. We advocate for saving for your car purchase in advance instead of taking out a loan, but if you decide to finance anyway, consider the following tips before walking into a dealership.
Let’s say you finance a new vehicle at $30,000 with an interest rate of 5% for five years. That’s 60 months of paying $566 over the course of the loan. That figure doesn’t even include gas, insurance, and standard maintenance, which could easily push your cost of ownership over $800 a month. By the time you pay that loan off in five years, you will have thrown away nearly $4,000 in accrued interest too. Ouch.
If you’re going to finance a car, make sure you’re doing so out of necessity, not vanity. Know what you can afford, and commit to buying a car that fits within your budget. Remember, the benefit of a car is that it gets you from point A to point B. Resist the temptation to test-drive cars that are beyond your budget.
A good rule of thumb is that monthly car payments, including insurance, should be kept between 10% and 15% of your gross monthly income, and we recommend that you make at least a 20% down payment when financing.
Research Interest Rates
Before you even consider speaking to a dealer, do your homework. There are an untold number of lenders out there who will gladly offer you a preapproved rate on a car loan. More often than not, you can secure a lower interest rate by searching ahead of time before the dealer recommends its lender of choice. Taking a week to shop interest rates before visiting the car lot can save you hundreds—if not thousands—of dollars in the long run.
If you have outstanding credit, good for you! You can leverage that to secure low- to no-interest financing depending on the dealer, inventory, and market. Dealers sometimes need to liquidate old inventory to make room for the new stuff. That is an opportunity for you to take advantage of additional cost savings. When shopping for your car, be sure to ask your dealer if any such program is available. And don’t forget to bargain on dealership costs too!
When you finance a car, consider what other goals you have in the future. Are you saving for a new home? Paying for college? Trying to build a retirement nest egg? Those goals should not suffer at the expense of a hefty car loan. Avoid this by opting for shorter-term loans.
There are plenty of preowned and economy-size vehicles on the market below $10,000 that can be easily paid off in just a couple of years. If at all possible, avoid loans that are over 48 months. While you may appreciate the lower monthly payments that come with a long-term loan, you are freezing part of your budget for four years or more.
If you do finance a car, the goal should be to shop for the best possible loan, purchase the least expensive option that meets your needs, and pay off the loan as quickly as possible. The sooner you do, the sooner you can use that payment for another purpose, such as saving it.