I was riding to work and overheard someone talking about getting a new car. They said the one they want is originally priced over $100K, but could get it for $40K used. Props to them for willing to get a used car, however, at this price it is pretty crazy. I also heard them talking about timesheets and being a couple years out of college, so let’s assume they make asalary of $60K. Spending 2/3 of an annual salary is far too much in my opinion for a car and more than 6x Financial Samurai’s 1/10th rule.
It’s been a year since we purchased a car. We don’t drive much so we’ve only added 3,000 to the preexisting 180,000 miles. During the purchase process I considered financing, but it wasn’t as in your face as if when you buy a car from a dealer because that is how they make a lot of their profits. It was $10K, which was within my budget to do without financing. However, according to Experian data from Q2 2019 millennials have an average auto loan balance of $18,201 while the national average is $19,231. Let’s analyze auto loans.
Step 1: Do you really need a car?
Nowadays it isn’t necessary to have a car everywhere. I’ve written about alternatives before and depending on your city they can be very convenient or even better than a car. I have coworkers who are totally fine without a car despite Austin not being the most transportation friendly city.
Step 2: Choose a car
If you decide you need a car, then you should choose one you can afford. Mr. Money Mustache provided a guide in 2012, so just think how much cheaper those cars would be today! However, your goal is not to get the most expensive car you can afford, but find something that works for you. Don’t buy a truck if you never haul anything. Once you do your research and select a car then you should determine what is a good value for it. There are websites like KBB.com that can help determine.
Step 3: Pay
Cash or financing are your options. If you go with financing you have many options. You could go with lender like a bank, a private company that focuses on loans, or the the seller. Before you go in, explore your financing options so you aren’t stuck with a bad loan with high interest in order to drive off the lot. Sales people will try to get you into more expensive stuff or ask you what monthly payment you would like. Be careful of the details like the term of the loan and the interest rate. The payment is a function of those. I’ll give you two examples for a $25,000 car putting $5,000 down and financing the remaining $20,000.
With a 3-year term at 5% your payment would be $599 a month. Over the course of the loan you’d pay $1,579 in interest. However, the dealer may suggest that you should get a lower payment of only $349 a month. That could be achieved with a 7.8% interest rate and a 6-year period. You’d pay $5,107 in interest.
Conclusion
If $600 a month seems like a lot, well, it is! It probably means you should you look at cheaper vehicles. You may be tempted into the $349 payment, but in 4 years you’ll have a car worth very little and still have two years of payments left on it. Good luck on your next purchase, if that day never comes even better!