Transportation is one of the most crucial household decisions. You need transportation, but there’s a difference between needs and wants. Buying more than you can afford and putting yourself upside down on a vehicle loan makes it hard to reach other financial goals.
Today’s car prices are astronomical too. The average cost for a new car in 2022 has hit record highs. The average transaction price is $48,043, up 12.7% from the previous year.
If that’s not enough, Experian’s latest car loan data shows that the average loan for a new vehicle is 8.8% higher than the previous year, with an average loan amount of $37,746 for a new car and $26,630 for a used car (a 20% increase year-over-year).
Despite the higher prices, luxury vehicles still account for over 2 million cars sold yearly, making up almost 15% of the total vehicles sold annually.
Getting in over your head only makes it harder to reach other financial goals. For example,
your transportation costs shouldn’t exceed 15% of your income in a perfect world. This includes the car payment, gas, tolls, insurance, and repairs. That might seem complicated, but here are ways to make it happen.
Don’t Borrow too Much
Avoid large loans. Ideally, you’d finance 50% or less of the vehicle’s price. This prevents you from getting upside down on your loan.
When you drive off the lot, your car instantly loses 15% – 20% of its value. If you borrowed 90% or more of the car’s price, you automatically become upside down on the loan. This means you owe more than the car is worth.
Even if you buy a used car but borrow most of its sales price, you could get upside down. A vehicle loses 60% of its original value when it is five years old. The depreciation slows down after five years, so if you focus your purchases on cars five years or older, it’s already experienced most of their depreciation, allowing you to stay on top of your financing.
However, you should still consider making a large down payment on a used vehicle to keep your payments and interest costs down.
Buy a Used Vehicle
Buying a used vehicle is the best way to avoid going upside down on your loan. This also helps you keep your transportation costs low.
When you buy a used car, it already reflects the depreciation, so you aren’t paying an inflated price for the vehicle. The car has also likely worked out its kinks, which will cost less, leaving you with a much lower car payment.
Your car insurance will likely cost less on a used car since the repair and renovation costs are less on used cars than on new cars.
Keep the Loan Term Short
If you put 50% down on the car, it’s easier to afford a shorter-term loan. The shorter your term is, the more money you’ll save.
First, a short-term loan decreases the risk of going upside down on your loan. It also minimizes the total interest paid. You could save thousands of dollars by keeping your loan term at three years or less versus 5+ years.
Buy a Car From the GSA Auction
Each year the General Services Administration auctions off cars to the public that didn’t sell as a part of their fleet program for people who work for a federal agency.
The GSA sells over 30,000 cars yearly at a savings of $2,000 or more off the retail price of used vehicles. The types of cars vary at each auction, but there is usually a decent variation to make it easy to find a vehicle that fits your household needs.
Final Thoughts
Think about your finances when buying a car versus your dream car. Yes, your dream car may feel great to you at first, but once the reality of the car payments, insurance, and worse yet, the deprecation hit home, it can feel like one of the worst decisions.
Unlike a home, cars aren’t an appreciating asset. You lose money buying a car, not make money. While you need a car, keeping your purchase within reason is the key to making the most of your financial situation.
Weigh your options and look at the big picture. This is a long-term purchase for the next 5 – 10 years. See how it affects your finances now and moving forward and how much it changes your financial goals before deciding to buy a car.