Whether a new or used car, always having a car payment can drain your disposable income and kill your financial future.
As of March 2023, the average price of a new car is $48,008, according to Kelley Blue Book, while the cost of a used car hovers around $26,510. No small investment no matter which path you choose.
The easiest way most people find to handle the cost of a new or used car is to finance the purchase through the car dealership’s finance office, a bank, or credit union. Or they may decide to lease – which is essentially a long-term rental. Financing allows the buyer to spread the cost of the vehicle out over time.
But regardless of which finance option they pick, they leave the lot with a car payment. The average car payment for a new vehicle is $725 monthly, according to Experian. A lease payment averages about $586 and a used car payment, about $516.
With financing comes the interest rate – the cost of borrowing the money for purchase. Right now, the average interest rate on a new car is 6.58% and 11.17% for a used car – if you have a good credit score. Interest on a subprime loan for buyers with low credit scores can run between 14% to 21%, if not more.
In addition, the duration of payments has doubled from a standard 36 months back in the 1980s to more than 72 months today. That’s committing up to six years of future income to an asset that begins losing value the day you drive it home. That depreciation happens faster than you can pay off the loan, meaning eventually the vehicle is worth less than what you’re paying on it.
How Do I Purchase a Vehicle Affordably?
It’s not easy to figure out how to pay for a car, especially if you really need one. It takes time and patience – something a lot of people don’t have. Here are a couple of strategies.
Plan ahead
Start at least one year ahead to do your homework. Think about how much vehicle you really need. If you don’t have children or routinely haul supplies, do you really need an SUV? Would a sedan or two-door vehicle fit your lifestyle better. Think about the features that might cost extra. Now is the time to think about your needs – not just your wants.
Do a Budget Review
Consider how much you would need to pay if you financed the vehicle. Think about what car payment would comfortably fit into your budget. The rule of thumb is to spend no more than 10% of your take-home pay on a car payment. BUT if you have other debt, that number may be smaller.
Set Aside Before You Ride
Once you know what you can comfortably pay each month, set that amount aside in a separate account for at least one year. For example, If your take home pay is $3500, then put at least $350 in a savings account for 12 months. During that time, you can explore your lowest-cost financing options.
At the end of that 12 months, you will have $4200. Subtract $700, and use the remainder as your initial down payment, if you plan to finance. Keep the remaining $700 in that account as your car payment safety net. If you lose your job or become ill, you will have a short-term payment buffer just for your vehicle.
Dave Ramsey Plan
Financial guru Dave Ramsey also had a good plan for purchasing a car and keeping as much of your money in the bank as possible.
He recommended saving the cost of a car payment for 10 months and then purchasing an older, used vehicle with cash. The he suggested continuing to save that car payment for another 10 months, selling the used car and combining the proceeds of the sale with the money saved to trade up to a better vehicle…then doing it again.
Check out his video on buying a car.
While financing isn’t the optimal way to purchase a vehicle, it has a few upsides if your credit profile is thin.
Advantages of Car Financing
Immediate Vehicle Ownership: With a car payment, you can acquire a car without having to pay for it all at once. This allows you to have immediate access to a vehicle, which can be essential for daily commuting, work, or other important needs.
Credit Building: Successfully managing a car loan and making on-time payments can positively impact your credit score. A good credit score can lead to better interest rates on future loans and financial opportunities.
Access to Newer Vehicles: Car loans can make it more affordable to purchase a newer, more reliable vehicle with advanced safety and technology features. This can enhance your overall driving experience and potentially lower maintenance costs.
Tax Deductions: In some cases, the interest paid on a car loan may be tax-deductible, particularly if you use the vehicle for business purposes. Be sure to consult with a tax professional to determine your eligibility for such deductions.
But with the good, there’s also the bad. So consider the downside of car financing.
Disadvantages of a Car Financing
Interest and Cost: When you finance a car, you’ll pay interest on the loan, increasing the total cost of the vehicle. The longer the loan term, the more interest you’ll pay over time.
Depreciation: Cars typically depreciate in value over time. If you take a long-term loan and the car’s value depreciates faster than you pay off the loan, you may end up owing more than the car is worth.
Financial Burden: Car payments can become a financial burden, especially if you face unexpected financial challenges such as job loss or medical expenses. If you can’t keep up with the payments, it could negatively impact your credit score and lead to vehicle repossession.
Limited Flexibility: When you have a car payment, you have an ongoing financial commitment, which might limit your ability to save or invest in other areas. It could also restrict your flexibility to move or change vehicles if your circumstances change.
Higher Insurance Costs: Lenders usually require comprehensive and collision insurance for financed vehicles, which can increase your insurance costs.
Ultimately, whether a car payment is beneficial or not depends on your financial situation, goals, and priorities. Before taking on a car loan, it’s essential to assess your budget, consider the total cost of the loan, and evaluate whether it aligns with your long-term financial plans. If possible, try to make a larger down payment or opt for a short
