Thinking of entering the market for a new car? If you’ve been driving your current model for several years, then you haven’t been in the market for a while and are probably wondering what you can really afford.
If you go to a dealership with pay stubs in your hand, the dealer will give you one answer to that question. Smart borrowers know, though, that you should never ask someone who wants to lend you money how much you can afford to borrow. A lender is interested solely in the likelihood of you defaulting on your loan. You, on the other hand, are interested in to what extent buying a new car will impact you financially. Will you find it difficult to make the payment month after month? Will your insurance or your gas costs go up? What will the car be worth three, five, even ten years down the road?
As you start thinking about a new car, start saving. If your current car is paid off and you have not been making car payments, start setting aside each month the amount you think you can afford in payments. Not only will this let you know if you can handle the payments, the money you accumulate can go toward your down payment. During your pre-shopping phase, contact your insurance company and get an idea of how upgrading to a new vehicle will raise your insurance. Don’t forget that you may want greater coverage for your new car than you carry on your current car; while comprehensive and collision coverages are often not considered necessary on an older car, chances are you’ll want them for a new car.
You may not be familiar with another kind of insurance that you should consider if you take out a new car loan: gap insurance. If you are in an accident and the insurance company finds that your car is not repairable, or if your car is stolen, the payment you receive will not be based on the outstanding balance on your loan. It will be based on your car’s fair market value, which can be significantly less than the loan balance. The instant you exit the dealer’s parking lot in your new car, it becomes a used car, and its value drops. But in the early years of a car loan, the payments go primarily toward interest, so the principal of the loan does not decrease as fast as the car’s value. Should your car be totaled and the payment you receive from the insurance company not be enough to pay off the loan, gap insurance steps in to pay off your loan so you don’t have to continue making payments on a car sitting in a salvage lot. Find out if your insurance provider offers gap coverage; not all providers do, but you can get a gap insurance-only policy from a different company if necessary. Get an idea of the approximate monthly cost. Add this cost to the monthly increase in your regular insurance, and add this total to the amount you’re putting aside each month as an experiment. Making a larger down payment and financing for a shorter loan period may mean that you can skip gap coverage, because you start with a lower loan balance and the balance drops more quickly.
Not all cars cost the same to operate, of course, and a change in your gas mileage should be your next concern. To research gas mileage, you can draw on the calculations that the manufacturer makes public. Be realistic about your usage of the car, including both highway miles and city miles. If you’ll be upgrading to a newer model of the same car, or a similar car, you may find that your gas mileage is likely to go down, as of course it will if you will be switching to a smaller car, and the decrease in your monthly expense will affect how much car you can afford. If you are thinking of getting a larger vehicle- a bigger car, a minivan, or particularly an SUV- you may see a significant increase in your gas expense that you’ll need to take into account. Don’t let yourself be surprised by the cost the first time you fill up. If you are looking at buying a bigger vehicle that will increase your monthly gas costs, add the estimated increase to the amount you are setting aside each month.
A final cost you should be prepared to take into account is the personal property tax that many localities charge on vehicles. Find out what the rate is in your locality- this tax is usually charged as a percentage of assessed value- and calculate how much your rate will increase. Be aware, too, that in some areas there is an extra tax, or surcharge, for the owners of pickups and SUVs, which are classed as light trucks.
Taking all these costs into account, you should be setting aside a nice sum each month, and you should lay the full amount aside for at least three months before purchasing a car. If you take into account possible future changes in your financial position, you are also gaining an accurate idea of how much car you are able to commit to, and you can compare different makes and models of vehicles that might have different sale prices, but also might have a different financial impact elsewhere in your budget. As you get ready to make your final decision, take into account some other considerations that should affect how much car you decide you can afford, namely, the term of the loan you’ll be taking out and the car’s resale value.
You might plan to hold onto the car you’re getting ready to buy for a long time, but your situation could change and a new job, new home, or new baby could make you want a different vehicle. Long-term loans of five or even six to eight years have become common, but with longer-term loans it’s more likely that at a given point you will owe more on a car than it’s worth. While gap insurance will protect you in the event of an accident, it will not protect you if you want to trade in a car on which you owe more than the value. Your financial position will be healthiest if you calculate the expense you can afford per month- and then figure out how much car you can get with a three-year loan.
Next, take into account the car’s likely resale value to calculate what it will really cost you to own over five years. The Web offers a number of side-by-side calculators which look at two cars’ resale values at the end of five years, likely maintenance costs, and gas mileages to tell you what each car would actually cost to own for five years, and how much value would be left at the end of it. A car that costs a little more to begin with might actually be cheaper to own, if it costs less to insure, fuel up and maintain and is worth more at the end of five years.
If all this sounds complicated, it is! A car is a major expense for most Americans; most Americans, in fact, spend more of their monthly income on their car than they really should. As you get ready to commit to years of making payments, make sure you understand exactly what you’re committing to.
