How to Keep a Car Loan from Ruining Your Finances

For most, the thought of the car buying process rivals that of being trapped in a pit of snakes, being covered in spiders, or jumping from an aircraft.  These fears can be laid to rest by some proper planning and a different way of thinking about automobile purchases or leases.

 ThinkRich  ThinkPoor
  Below 15% of Income   Above 15% of Income
  View as 3 separate transactions

(Car Price, Trade-in, Financing)

  View as only 1 transaction
  Know your Credit Score  What’s a Credit Score?
  Shop around for best loan offer  Take dealership’s first loan offer
  Shorter Loan Length, No More Than 36-Months  Accept 72-month auto loan
  20% Down payment  Roll negative equity into new auto loan
  Pay cash for “extras”  If dealership offers it, it must be good!

 ThinkRich

Think Rich mindset is having the ability to keep in mind your overall budgeting strategy while making individual purchasing decisions.

This mindset is more of a future looking strategy that allows you to keep transportation expenses at a reasonable level and invest the additional funds into college savings, retirement account, low cost index funds, or good old fashion fun.

 ThinkPoor

Think Poor mindset focuses only on the instant gratification of a new car purchase, typically tries to “Keep Up with the Joneses”, does not know the value of a little research before the purchase, or all of the above. This mindset could lead to what is known as “car poor”, where your lifestyle in other areas of your life suffer due struggling to make hefty car payments.

Budgeting for Automobile Purchase: “Below 15%, Above 15%” Way of Thinking

After determining that there is a need for another automobile the thinking should shift to budgeting for the purchase or lease. Think Rich, Think Poor mindset works for purchasing, leasing, or paying cash for a vehicle, but this article will explore the right and wrong way to look at financing an automobile.

   ThinkRich Tip: “Below 15%”

Below 15% of gross income should be the initial target for budgeting a car purchase or lease.  Gross income is the amount of money received on a yearly basis before any taxes or deductions. For example, earning $48,000 a year would translate to a budget of $600 a month for transportation costs. ($48,000/ 12 = $4,000 a month; $4,000 times 15% = Think Rich, below $600 a month)

** Keep in mind in that the monthly car budget (15%) should include ALL EXPENSES including gas, registration fees, insurance, depreciation, maintenance, and repairs.

Pieces to the Car Buying Pie: Break the Pie into 3 Piece Mindset

 ThinkRich: Car buying or leasing should be viewed and discussed as 3 separate transactions.

  1. Automobile Price
  2. Trade In Value
  3. Financing

Breaking the overall transaction into smaller, more manageable, pieces will allow more clarity into where your money is going.

Negotiate each individually, and in order – start with price of the new or used automobile. Use websites such as Edmunds.com and truecar.com to determine the invoice price of the vehicle and start the negotiations from there. Without research it’s very hard to know if you’re getting a good deal as the sticker prices and lists on vehicles can be very confusing (sometimes on purpose!) Focus on overall price of the vehicle as opposed to just a desired monthly payment amount.

Second, trade in value of any vehicle you’ll be using as down payment, discuss this only after agreeing on the new or used car price. Websites such as KBB.com can be used to get estimates for trade in values. Car dealerships use what is called the “black book” for values; this is updated often as information comes available based off dealership sales and auction bids, having a set of research in your hands will put you in a better position to negotiate.

Third, financing – below we are going to give you all  you need to know about this!

How to Think when Financing a car purchase:

 ThinkRich:

Think of financing the car, truck, or suv purchase as a separate transaction, with its own set of guidelines.  Paying cash is sometimes not an option or not the best option, in those cases, think rich.

  • Credit Score
    • Credit Score is used when interest rates are determined for the loan; even shaving one percentage point off the interest rate could save you hundreds of dollars over the life of the loan.
    • Know your score before going into car dealership
      • Rating of creditworthiness from credit agencies – Equifax, Transunion, and Experian
        • Do not allow the car dealership to dictate your credit worthiness, know before you go!
      • Websites such as CreditKarma.com are good resources to keep an eye out on your credit scores
    • If your credit score needs some work; you could look into adding a co-signer on the loan to help with getting a lower rate when financing.
  • Interest Rates
    • Lower interest rate means less money paid in interest (and out of your pocket) over the life of the loan
      • Example: $30,000 automobile at 5% interest rate verse 6% interest rate over 4 years will save you about $650.
    • Do not just rely on the car dealership to give you the best rate: shop around!
      • Traditional Banks
      • Online Loans
      • Credit Unions
      • Car Dealerships
    • Traditionally you will receive a lower interest rate on a new car as opposed to used car, however, a lower interest rate alone doesn’t justify buying a new car.
  • Length of the Loan
    • Go with the shortest length of loan that you can reasonable afford. Why?
      • Shorter loan length typically means lower interest rate which saves you money over the length of the loan
      • Keep in mind, if offers such as zero percent financing or cash rebates for financing terms are offered – then more research into the decision is needed. There are many online websites that offer comparison tools for car rebates. (Insert a link here)
  • Down payment
    • Think Rich means do everything possible not to roll negative equity into the new loan. If you owe more than your trade in is worth — work to pay it down quickly or drive the car until the value and loan at least equal one another. The optimal situation is to have positive equity, but zero equity is better than negative equity.
    • Same as a house, the traditional recommendation is that putting down 20% on the car purchase is a solid financial decision because it allows you to receive lower interest rates which can significantly reduce your interest expense over the life of the loan. 20% down also helps to ensure you stay ahead of the depreciation curve and maintain positive equity as you own the car.
  • Skip the “Extras”, if needed – pay cash
    • Shop around and pay cash for the extras!
      • Gap Insurance – if car is totaled this insurance will pay for the difference between the car’s value and the amount owed on the auto loan. Example: Car value is $8,000 and amount owed on the loan is $10,000; Gap Insurance would cover that $2,000 difference
      • Extended Warranty – most cars come with 3-5 year limited warranties, these extended warranties cover future years or additional items – it’s best to shop around to find the best deal the works in your situation.
      • Credit Life Insurance – this insurance covers the car payments in case of a loss of life – again, if interested, shop around!
      • Rust proofing undercoating – most newer cars are manufactured with adequate corrosion protection and undercoating from a third-party could void the manufacture warranty. These rust proofing undercoating typically run somewhere between $200 to $1,500 depending on the vehicle.
      • Fabric Protection – this service ranges from $50 to $200.  New cars come with quality interiors that use fabrics and materials which are naturally stain resistant.  If you want extra protection, save some money and head to your local auto parts store and pick up a $5 bottle of Scotch-guard.
      • Paint sealant – essentially high cost wax, similar products can be found at local auto parts store at a much more reasonable price.
      • VIN etching – very interesting concept, this procedure puts your vehicle identification number (VIN) on your windows and is used as a theft deterrent.  Some states actually require car dealerships to offer this service to customers and certain auto insurance agencies offer discounts for having this option.  Like many of the “extras” offered at a car dealership, it is overpriced ranging from $150 to $350; there are several do it yourself options online that are under $50.

ThinkRich, Think Poor is simply about gaining the proper financial knowledge and mindset that will allow you to make the best purchasing and financing decision when looking for a new or used automobile.  Separate the car buying process into smaller tasks and have a check list of items needed for each task. A little research on the front end goes a long way in saving you hard-earned money.

Thomas

Certified Public Accountant, Masters of Business Administration, Masters of Science in Accounting, Chartered Global Management Accountant, Family Man

One thought on “How to Keep a Car Loan from Ruining Your Finances

  • June 21, 2018 at 7:54 am
    Permalink

    Thank you so much for the great article, it was fluent and to the point. Cheers.

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *