Buying a car is usually the first big purchase a person will make. There is also no shortage of horror stories of people immediately regretting the decision, either by buying a new car and later struggling to meet payments, or a used car with hidden mechanical problems demanding costly repairs.
When you need to buy your first (or next) car, make sure these factors weigh in on your decision.
Establishing a Budget for Buying a Car
Before you get started, step 1 is establishing a budget for how much you want to spend on a vehicle. A common trap is picking the car you want first, then trying to find a way to pay for it.
Buying a car is not the same as buying a TV or most other big purchases. Your budget needs to factor in the life of the car’s loan, the interest rate you pay, and the cost of insurance. Most of these factors are negotiable, so a key is establishing your hard limits before you walk into a dealership.
Car Loan Life and Interest Rate
If you take a car loan, the price you pay will be a balance between the “sticker price”, the interest rate for your loan, and the length of the loan. Car dealers want to try to make cars seem as affordable as possible, so their negotiation point is usually the monthly payment (since this is the number in your budget), but smart shoppers know this is just a distraction.
Dealers want to lower your monthly payment to make the car seem affordable, so they might just extend the life of your loan. If you are concerned about the initial sticker price, they might be happy to lower it by a few hundred dollars, but give a slight bump to your interest rate.
This means when you are planning to purchase a car, you should have two budgets prepared. One is for the total cost of the car (including all interest payments over the life of the loan), and the other is how much you can afford in monthly payments. The dealer will always try to sell based on monthly payments alone, but make sure to keep the total cap in mind during negotiations. You can even keep a car loan calculator app on your phone as part of the discussion to keep both numbers in front of you.
All cars are not insured equally. When you are examining your options for vehicles, remember that while your car payments will eventually end when you pay it off completely, your insurance payments are for the life of the vehicle. Luckily, you can get multiple quotes for car insurance for any vehicle you are considering within a few seconds from insurance comparison websites. Get two or three quotes for any vehicle you are considering, and keep that number figured in to your monthly budget.
New Vs Used
The first choice you make will probably be deciding if you want to buy a new car or used car. There are some serious advantages and disadvantages of each, so keeping both in mind can end up saving a lot of money in the long run.
Depreciation and Resale
Cars lose value over time, but not at a constant rate. As soon as you drive a new car off the lot, it usually loses about 15% of its value (just because it is no longer “new”). Cars also tend to lose value every year older they get, so by the end of your first year, your car could be down 30% of the sticker price.
On the other hand, used cars do not have the same “lot” problem. If you buy a used car and try to sell it the next day, you will probably get back about as much as you paid for it. Used cars also lose value over time, but the dollar amount of loss is lower.
Take two car buyers. One buys a $30,000 car new, while the other buys the same car 3 years later at its fair market value. This is what the resale value of the car looks like if each of the owners hold the car for 4 years before trading it in.
|Resale Value||Sticker Price||Day 1||Year 1||Year 2||Year 3||Year 4|
|Used Car||$15,660.19||$ 15,660.19||$13,311.16||$11,314.49||$9,617.31||$8,174.72|
We can look at the direct loss of value over time for each buyer as well:
|Loss of Value||Day 1||Year 1||Year 2||Year 3||Year 4||Total Loss|
The used car buyer is both saving $14,339.81 in the initial purchase price, but is also getting $9,203.37 less depreciation over the life of the car.
On the other hand, new cars almost always have more flexible financing options than used cars, usually with much lower interest rates (nearly half!). This is important because used cars are so much cheaper. It is rare for a potential buyer to look at the exact same car and decide new vs used – instead, it is usually an inexpensive new car versus a higher-quality used car.
To find out how they balance, try out our Car Loan Calculator.
Reliability and Warranties
The biggest difference between a new car and a used car is basic reliability. A new car will always have a manufacturer’s warranty, which covers nearly all repairs, replacements, and any mechanical problems with the car for the first three years. Used cars usually have no or very little warranty, pushing all of the risk of a breakdown onto the buyer. There are many databases available to help gauge the risk of a used car purchase, like Dashboard-Light.
Before you buy used, it is also a great idea to take the car to a mechanic for a check-up. Spending a few dollars on an inspection is far cheaper than replacing a transition a few months later!
Technologies and Mileage
One of the main reasons why people choose new cars is simply the improved technology of cars built today versus cars built a year ago. The same model of car will have new and better features, like better crash resistance, better gas mileage. New technologies are also introduced, like electric motors and self-driving options.
These new features are what pushes most buyers to spend a bit more for the new cars. The new technology should enter your buying decision in two ways:
Directly Offsetting Cost
This is especially true for cars with better gas mileage, or electric motors. A small increase in gas mileage means it costs less to fill the tank every week, which adds up very quickly.
For 30,000 miles driven, a car with 30 mpg saves 1,200 gallons of gasoline compared to 25mpg!
Value of Technology
Finally, you can try to directly estimate how valuable the new technologies are to you. If you have a crushingly long commute every morning, you will probably put a high value on a self-driving car, allowing you to do other things. If you have a shorter commute, the technology is still valuable, but saves you less time and effort, so deserves less of your hard-earned cash.
Getting a Good Deal
When you are at the dealership, your main concern is always getting a good deal. One of the oldest tricks in the book for dealers is the 4 Square Presentation.
The 4 Square Presentation
A 4 Square Presentation divides your attention between 4 factors impacting the sale:
- Sticker price
- Trade-In Value of your current vehicle
- Down Payment
- Monthly Payment
The 4 Square Presentation does not need to be as bad as the video makes it look, but one of the main drivers is to keep your attention divided between those 4 areas instead of focusing on one at a time. Since many buyers come into the dealer focused on making sure the monthly payments can fit into their monthly budget, dealers will move around the other “squares” to get the monthly payment down to what you can afford.
Unfortunately, the 4 Square Presentation does not really focus at all on the items that you should be worrying about: both your Interest Rate and the Length of the loan are absent from the discussion, which is what really determines how much you pay over the life of the loan. There are a few ways to push the conversation back to the numbers that really matter.
Trade In vs Selling
Most people trade in their vehicle when buying a new one, and almost every dealership is happy to accommodate. However, you always have the option of selling your car yourself, which changes the nature of the discussion when talking with the dealer.
When you trade in your vehicle, the dealership will take your old car and either try to resell it themselves, put it up for auction for specialized used car dealers to pick up, or simply scrap it entirely and sell off any working parts.
How much you can get reselling your car yourself vs trading it in to your dealer will depend largely on its condition. If your car is in good condition and is a popular model, you will likely have no trouble selling it on your own quickly, and will make more money than if you trade it in. This is because the dealership needs to factor in the cost of selling your car when they give a trade-in offer. If they need to store it, clean it, and sell it, it takes some of their resources, which get reduced from your offer.
On the other hand, if your car is older with mechanical problems, trading it in might get you a better deal. It saves you the time of trying to sell it, and since the dealership already has established scrapping and resale networks, they will probably get a better price for the parts than you would alone. Even if you have an old junk car, your salesman will probably try to offer you a better deal just to get you to buy at his dealership.
One of the main advantages of selling your car yourself is that it removes one thing from the negotiations when buying your new car – helping you turn the conversation back to loan terms and interest rates. This is why it is important to have the total budget in mind for how much you plan on spending on the vehicle in total, not just monthly payments. Keep focusing on lowering the sticker price first – get this in writing as a quote, then focus on financing.
You are not tied to financing your vehicle through your dealership. The only advantage of doing so is usually that they make it required for trade-ins (which is another advance of selling your car yourself). The financing is also where you need to be the most wary of your salesman.
With most loans, you can simply increase your payments each month to pay off the loan sooner. This is usually not allowed with car loans that you get from the dealership, which use something called “precomputed interest”.
Precomputed interest means no matter how much you pay and how quickly, your total interest charge is fixed. This means there is no advantage of paying off your loan early, since you can never lower the interest payments.
Avoid precomputed interest loans whenever possible. Ask your dealer up front if their loans use precomputed interest. If they only have precomputed interest financing options, then simply take out the loan from somewhere else (like your bank). Since you already got the sticker price negotiated, you can get your financing from anywhere with better terms.
This lesson is part of the PersonalFinanceLab curriculum library. Schools with a PersonalFinanceLab.com site license can get this lesson, plus our full library of 300 others, along with our budgeting game, stock game, and automatically-graded assessments for their classroom - complete with LMS integration and rostering support!Learn More
- What are the advantages and disadvantages of buying a new car?
- In your opinion, is having a new or used car better for you and why?
- Using examples, what do you understand by the term depreciation?
- If you are to lease or take out a loan to buy a car, how does the down payment affect your payments?
- Would you rather have a bigger down payment and a smaller monthly payment, or a small down payment and a larger monthly payment?