Almost anyone will tell you when it comes to expenses and major purchases a car will rank second only to a home. This has always been the case when taking relative prices of these two assets into consideration, but only if they were purchased at around the same time. For example, if you bought your house when John Travolta was still a Sweathog on Welcome Back, Kotter, the odds are that the sticker price on a new car today will be considerably higher than what you initially paid for that roof over your head. Inflation is a wonderful thing, isn’t it?
Ways to pay
Put simply, new cars are not cheap, but the manner of payment hasn’t really changed. Basically, you have two choices at your disposal: You can either save up enough money to buy the car for cash, or a lender can finance it. Most people don’t have enough disposable cash lying around to be able to exercise the first of these options, so this leaves borrowing the money and paying it back over a specified amount of time. By the time some of you read this the average price of a new car will be around $30,000. With that established, some new cars will cost considerably less while others will be priced considerably more. When you plan to buy a brand new car, the first order of business is to determine how much you can afford. Since most people will be making monthly payments as opposed to buying a car for outright cash, a budget must be calculated to meet that obligation. A general rule of thumb is to keep that monthly payment down to 15% of your net income or less. Thus, if you bring home $3000 a month, the most you should allot for a car payment is $450.
Other expenses must also be factored in. In most states, you’ll have to pay an additional sales tax on top of the car’s retail price. Auto insurance is another cost that can vary greatly. If you happen to be a 19-year-old male interested in a fast sports car, your insurance premiums are going to be a lot higher than those of a 35-year-old soccer mom looking to buy a minivan. Regardless of where you stand, insurance premiums are a lot easier to pay each month as opposed to coughing up a lump sum every six months. Some people want piece of mind when acquiring a new car and will purchase an extended warranty. This can cost hundreds or even thousands of dollars and will be added to that monthly car payment. Is the car you’re interested in buying an economical fuel sipper or a behemoth gas guzzler? At this writing, gas is close to $4.00 a gallon. Some cars are cheaper to repair and maintain than others as well.
Reducing that payment
Obviously, the best way to reduce monthly car payments is to make an intial down payment. On a typical 60-month term, every $1000 equates to roughly $25 in monthly payments. Thus, if you have decided to buy a car that costs $30,000 after “the dust” (tax,title, license, dealer fees, extended warranties, other add-ons) settles, you’re looking at approximately $600 a month for the next five years. By putting $1000 down, that payment will drop to $575. Put $3000 down, and the payment drops further to $525. Therefore, it’s a good idea to start thinking about a new car years ahead of time. Suppose you typically keep a car for eight years. Of those eight years, five are spent making payments. If you continue to make “payments” to a savings account for the following three years, you will have quite a nice sum saved up for a down payment on your next new car! And don’t forget this, either: That old car can be traded in to further reduce not only the monthly payment on the new car, but also the sales tax. Many who give car-buying advice claim that you are better off selling your old car outright as opposed to trading it in, but if the savings in sales tax exceeds the difference in private party value to trade-in value, then trading it in is the way to go.
Other ways to budget
The 15 percent rule-of thumb mentioned above won’t necessarily work for everyone, especially if you’re living from paycheck to paycheck. Dig out all of your monthly bills or look in your checking register to determine how much you’re spending each month. This will include rent/mortgage, utilities, groceries, credit card bills, other loans, and entertainment. Some of these expenses will be fixed (the same every month) while others will be variable. For example, you’ll pay more for heat in January than in May. Similarly, you may spend different amounts on groceries. The important thing to do is to take an average over several months or even a year. Whatever is left over is your disposable income. If this amount is enough to cover the monthly payments of the car of your choice, then go for it. Likewise, if you can discipline yourself to reduce nonessential expenses and really want that shiny new car, such a commitment can serve as a trade-off.
However, if this cuts it too close for comfort, then wait until another loan or credit card balance is paid off. Don’t bite off more than you can chew. It’s easy to believe you’ll simply cut out a portion of entertainment, but compromising a lifestyle you’ve become accustomed to is far easier said than done. If you have to sacrifice all fun and sustain yourself on a diet of water and Ramen noodles to afford that new car, it’s not worth it. Patch up that old car or shop the used lots instead.