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Back in April of this year, one of my graduate school friends asked for some advice with buying a new car. Unfortunately, since I’ve never had to go through the car-buying process myself yet in life, I wasn’t able to provide him with as much insight as I would if he asked about investing for retirement.
However, in an attempt to learn some more about car-buying in order to offer help to future inquirers, I’ve decided to roll-out a post series speaking to this important topic. In Part 1, I discussed the various considerations and steps I would take to sell my car. You can view the complete post at the link below:
What Would You Do If You Needed to Buy a Car? – Part 1 – Sell Your Current Car
Having sold my car using the steps discussed (and hopefully freed up some cash from the proceeds), it would then be time to nail down the financial picture that will be involved in purchasing my new car. Similar to buying a house, you must first determine how much car your finances can afford before you even think about setting foot on a new/used car lot.
So, let’s get started with how I would nail down the financial specifics needed to buy a car.
Step 1 – Determine What Type of Car Buyer You Are
Just like we saw in Part 1, the first step (in my opinion) to determining the financial specifics of your car purchase is to do some inner-self reflecting to determine what is important to you in a car.
The ultimate goal of this exercise should be to determine whether or not you are a used car buyer or a new car buyer. Listed below are some guidelines to help you determine which category of buyer you belong in:
New Car Buyer
- People that fall in to the new car buyer category are very similar to the “Category 1” sellers described in the first Part of this posting series.
- New car buyers are those individuals to whom price is really not the main issue when buying a car. These people are well-off enough to be able to afford a car comfortably, with the biggest concern being that their normal life is not interrupted by the car purchase process.
- These buyers want to purchase a car quickly and can be assured that no wear has already been placed on the vehicle that would result in anything more than the car needing a routine oil change.
- Examples of people who fall in to this category are doctors, lawyers, professional workers, etc. that have enough money in their bank accounts to pay for a new car (or can easily obtain the financing required).
- I would propose that these individuals typically receive high enough pay that the extra 10 hours of time that would be required to become a semi-expert in car value in their local area would not be worth it financially. After all, if you are a lawyer or contractor charging $300-$500 per hour, that extra 10 hours could be costing you THOUSANDS of Dollars.
- However, you could also fall in to this category if you simply do not have the will, desire, or capacity to learn about the in’s and out’s of car buying and car value. While this is perfectly acceptable, I would definitely encourage everyone to read about the used car buyer category below before deciding to which you belong.
Used Car Buyers
- While everyone (at least to some extent) probably aspires to be in the New Car Buyer category, for a large amount of the population, buying a new (unused) car is either 1) not economically justified (because the car decreases in value 30-50% by simply driving it off the lot) or 2) not financially feasible.
- For the people that fit either one of these two descriptors, we have to rely on being able to buy used (pre-owned) cars.
- Used cars cost much less up-front, but will most likely require more up-keep, maintenance, and on-going costs in general in order to stay on the road. All of this must be factored in to your decision about which car to buy.
- Furthermore, within the used car buyer category, I believe there exists two subcategories – extreme frugalists and value shoppers.
- Extreme Frugalists – This first category is for those rare special souls (like a college instructor I had) that take frugal living to the extreme! These people buy the cheapest of the cheap cars (think $1000-$2000), don’t carry collision coverage (only liability coverage), and don’t care one bit about the appearance of the car as long as it gets them to where they need to go. They are OK with it breaking down because they only drive it around town and can be picked up if needed.
- Value Shoppers – The second category is probably where most used car buyers will be. These folks need a dependable car they can take on an occasional long trip, drive to work each day, run errands, and live life in general. The car needs to be dependable enough to not break down with this normal use.
So, take a moment and look at which category you think you fall in to before we move on. Personally, I probably fall in to the Value Shoppers used car buyer category. Being in graduate school, I don’t yet have enough money to be able to buy a new car the way I’d like to (more on this later in the post!).
Step 2 – Determine How Much Money You Have Currently to Purchase a Car
Once you’ve decided what type of car buyer you are, it’s now time to think about how you will pay for your new vehicle. To get started with this exercise, you need to take stock of all of the money you have available at the present time to go towards a car payment.
Listed below are some common places to look:
- Cash obtained from selling your car (Part 1).
- Money saved in savings accounts or taxable investing accounts (not retirement accounts).
- Important note: Your emergency fund should NOT be used to buy a car. If you got in to a wreck with your current car and needed some money to pay for medical or car insurance deductibles, that would be an acceptable use of an emergency fund. However, if you’re buying a new car, you should theoretically be able to plan far enough ahead so that you don’t have to touch your emergency cash reserves.
- You should also not tap in to savings that you have earmarked for other purposes, such as achieving your life values or dreams, to buy a car. This may be tempting, but it really should be avoided! After all, you want to actually achieve your life dreams/values at some point correct?!
- Cash from parents or relatives that might be able to help you buy a car.
Step 3 – Determine Your Time Frame for When You Need to Buy a Car and Automate Savings Accordingly
So, in an ideal world, all of the money a person needed for buying a car would be obtained from one of the cash sources above. However, the truth of the matter is that selling your current car may not generate all that much cash, you may not have well-off parents, and your savings may be non-existent.
In the real world, we have to take a more active approach and plan/save for our upcoming vehicle purchase. Listed below are the steps I would recommend taking:
- Determine how many months from the present time you’d like to purchase a car.
- From tracking your spending and determining your monthly cash allocation needs, figure out how much extra money per month you can comfortably save for purchasing a car. In other words, make saving for your car purchase more of a priority for any extra money you have after your other monthly cash needs.
- Once you determine the amount, set up an automatic transfer for this quantity to a high yield online savings account to occur at the beginning of each pay period.
- Please note that it’s important for the transfer to take place at the beginning of the pay period so that you don’t have a chance to spend the money.
Step 4 – Determine How Much Car You Can Afford Before Looking Around + Financing Options
After you’ve gone through Steps 2-3 above, it’s time to sum up the total amount of money you will have that will be available for buying a car both from existing funds and future savings according to your automated transfer plan. Take a minute to calculate this for your situation.
Once you have added the values up, I can imagine one of two scenarios happening:
- Scenario 1 – The number you calculated is, in your opinion, sufficient to buy a decent car for your needs.
- Scenario 2 – The number you calculated is too low, in your opinion, to get a dependable car (even a cheap used one).
If your calculations result in Scenario 1, then great! You’ve successfully secured the money you need to buy a car, and you’re ready to begin the car shopping process. This topic will be covered in Part 3 of this series (on the way soon!).
If it’s looking like you are experiencing Scenario 2, don’t feel bad! There’s still hope; you just have a little more work to do.
Step 4b. – Car Financing
Personally, I am not a big fan of taking out loans on depreciating assets (such as a vehicle that depreciates in value with each year it’s on the road). Because of this, I would try with all of my power to avoid taking out a car loan for my car purchase.
However, I also strive to be a practical person (even if I am a head-in-the-sky engineer! haha). And, the reality in today’s society is that unless you live in a big city with lots of public transit options, you need a car. And, more exactly, you need a sufficiently dependable car.
Because of the strict need for a car in today’s society and fairly favorable financing options (because it’s a secured debt), taking out a car loan isn’t as bad in my book as racking up thousands of Dollars of 25% daily-accruing credit card debt or taking out a 50% interest payday loan.
So, as I’ve mentioned, car loans aren’t all that bad. However, you do need to take some precautions in order to maximize your success with the car financing/purchasing process.
First, let’s take a look at the different possible sources you can turn to for where to get a loan for a car.
- The first option available to you for obtaining a loan for a car is your friends and/or family.
- Personally, I would advise against obtaining this type of financing, as loans to friends/family are rarely ever paid back and often cause stress on relationships.
- If getting a loan from family/friends is absolutely your only option, it’s important to draw up an explicit loan agreement to protect both parties’ financial and legal interests.
- In-House Financing from Dealership
- Pretty much any dealership that you visit will offer some variety of in-house financing/loan options. Why is this? Because dealerships make most of their money off of 1) these loans and 2) reselling used cars. Fairly little money is made on selling new cars.
- An example of in-house dealership financing is Honda Financial Services.
- One of the benefits of in-house financing is that promotional loan packages are often offered (you’ve probably seen them on TV or heard them on the radio!) to entice consumers to get to the dealership and buy a car. In fact, currently, on the Honda website above, they are offering a loan special for Accords for 1.9% interest financing for 24-36 months.
- Personally, I am not the biggest fan of in-house financing because I feel like they are trying to almost trick me in to buying a car. I also do not like how they try to get you paying for too expensive of a car by offering low monthly payments, but spread them out over MANY years! Why would you want to be paying off a car loan for 15 years?! This is not a house!!
- However, if there was a SUPER low interest financing deal on a car I wanted, I would consider in-house financing, but would make sure to examine the loan details very closely. Some red flag tricks to look for are hidden loan fees, balloon payments, and/or jumps in interest rate after a certain introductory time period is up.
- Auto Loan from a Bank
- My preferred method of obtaining financing for a car purchase would be from a reliable bank. At banks, I feel like you are more likely to get unbiased loan assistance as compared to a dealer who is also selling you the car.
- If you go to the website of almost any bank in your area, you’ll most likely be able to pull up their options for auto loans. Listed below are several current loan packages I found for used car purchases from a dealer:
No matter what route you choose for obtaining an auto loan, the most important thing is that you define what you’d like your approximate monthly payments and loan payoff period to be before looking at cars. These two specifics should be defined by looking at how much cash you have on hand for a down-payment and how much free income you have each month to put towards a car payment.
To assist you in determining these specifics, I created a car loan payoff/amortization schedule spreadsheet at the link below. I’ve shared it as “view-only,” so just download it as an Excel spreadsheet so that you can adjust it to fit your specific situation.
The spreadsheet can be used to determine the approximate “amount of car” you can afford by performing the following steps:
- Enter the following information in Column A –
- Amount of cash you currently have on hand.
- Interest rate on the bank/dealership loan you are considering (or use the default value of 2.99%.
- Tentative loan term that you’d like to have (or use the default value of 36 months). Please note that if you increase the loan term, you’ll need to simply add more rows at the bottom of the calculation table.
- Next, using the Solver function in Excel, set the cell in the last row of Column G to a “value of 0” by changing your Target Car Purchase Price in cell A14. Then, click “OK.”
- The Solver function should generate the appropriate car purchase price that you can afford based on your cash savings and monthly payment specified.
Once you’ve used this spreadsheet to determine how much car you can realistically afford, you can start thinking about shopping around for your car. And, you will not lured in to buying a car that you cannot afford simply because the dealership tries to talk you in to a promotional loan package.
So far in this post series, I’ve talked about the first two big steps I would take in buying a new car. In Part 1, I discussed how I would sell my car london. After freeing up some money from the sale, I would first nail down the financial specifics of how I would pay for my new vehicle before going shopping.
In determining these details, it’s important to consider 1) what type of buyer you are, 2) how much cash you have on hand for the purchase, 3) how long you want/can wait until buying a car, and 4) how much car you can comfortably afford, either solely from money you have or supplemented by an auto loan. By arming yourself with this information, you can make your car-buying process a more satisfying and less painful process.
How about you all? How did you go about figuring out the finances for buying your last car? Did you take out a loan? If so, did you get the loan from the dealership or a bank?
Share your experiences by commenting below!
***Photo courtesy of http://www.flickr.com/photos/rjs1322/1009831723/sizes/l/in/photostream/