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Purchasing a new car is an exhilarating, yet stressful process. It takes a lot out of you, primarily a lot of your time. Going from dealer to dealer, negotiating, working out the numbers and most importantly not trying to be taken for a fool by the salesman at the dealership. The biggest mistake most make when purchasing a new set of wheels is not doing their homework. Working out your numbers, doing the research on the different models and checking out all of their financing options. That being said, I’ve put together a few tips on whether a new car purchase is a feasible option for you.
Budget the Purchase
First step in the car purchasing process is to determine how much of a car you can truly afford. You should include taxes, highest purchase price, insurance and a rough estimate of maintenance. Other questions to consider; Are you going to purchase the car outright? New or used? Lease or finance? There are benefits to all of the options, but not all options work for everyone. For example, if you purchase a new car, you don’t have to worry about previous maintenance, but the downside of it, you are paying premium dollar for that brand new spanking car. On top of it, as soon as you drive the car off the lot, you’ve lost $5,000 at least on the car, due to depreciation.
Leasing a car offers a low monthly payment, which is quite attractive to most. The downside of a lease is that you are limited in mileage, typically 20,000 km to 25,000 km annually. On top of it, after your lease term ends, you have a buyout option, which means you either pay the remainder for the car in cash or finance the remainder. Personally I’ve never been for leasing. I’m so against it, but that’s just me.
Existing Debt?
If you have existing short term debt, such as credit-cards, I would highly encourage you to pay your credit card or cards off before purchasing a new vehicle. If you must buy a new car, it would be wise to buy a car that can get you around for a few years, instead of purchasing the car you really want.
Car Price to Equity Ratio
Do the math and be honest with your self. Take the total price of the car and divide it by the assets you have in the bank. The lower the number, the better off you are. You are shooting to have a number lower than 1.
For Example:
Let’s say you have $10,000 in the bank account. The new car costs $25,000. Take the $10,000 and divide it by $25,000. Your ratio would be 2.5. Which is quite high.
A good example would be, let’s say you have $40,000 in the bank and the car costs $15,000.
$15,000 / $40,000 = 0.38
Monthly Payment = Less than 20% of your monthly income
This is pretty straight forward. Your total monthly payment, including interest ,principal and taxes should be less than 20% of your net monthly income. Keep in mind that different loans compound differently. Some are monthly, some daily and others annually. Either way you can calculate a basic monthly payment.
Here’s an example:
Car Cost – $25,000
Interest Rate – 6%
Loan Term – 4 Years (48 Months)
Interest Cost for4 Years – $3,186
Next take the total car cost $25,000 x 1.13(13% Tax Rate) = $28,250 (total car cost, including tax)
Next add the total car cost $28,250 + $3,186 (interest) and divide by 48 (total term) = $654.92
Your total monthly payment, including interest & taxes is $654.92
Say for example your monthly net income is $3,100, a payment of $654.92 per month equals to 21% of your net monthly income. Therefore you are over the 20% suggested number to be allotted towards a car purchase.
What are your thoughts on purchasing a new car?
Eddie
Your interest cost wouldn’t be $1500 a year for your example. As the balance declines, so does the interest. After plugging the numbers in a loan calculator, I get a total interest cost of $3595 and a payment of $663 and change.
A 6% interest rate is criminal. The car depreciates 20% a year and you’re paying 6% for the privilege? Taking out a loan to buy a liability is a bad idea. The only way I’d be okay with anybody buying a new car is if they had the cash to pay for it.
Good eye!@financialuproar:disqus Yeah I re-caculated and got a lower interest rate too. $3,186 to be exact, calculated annually over 4 years. As for interest declining, I highly doubt that. You pay full interest on the full payment of the car. It’s just evenly divided amongst 48 payments.
As for the 6% interest rate, that’s pretty standard for a used car. Typically it runs anywhere from 5-8% in any of the big 5 banks. I totally support your idea of buying a new car with cash, but how many people in their 20s can actually buy a new car in cash? Very few sadly, including my self.
I couldn’t even afford to take ownership of my parents’ old (bought with the intention of giving it to me once day) 97 Lumina because I couldn’t handle the insurance and maintenance for it. Sigh! But oh, do I want a car!
Melissa, you have to start off with insurance at some point. Yes insurance is a bit pricey if you’re under 25, but 25+ is not all that bad, then you’re considered an adult in the insurance world. Go figure..lol
I drive a 1999 Pathfinder that belonged to my (now-deceased) mother, and pay about $65-$70 a week for gas (my daily round-trip commute is 45 miles). It has over 197,000 miles on it now, so I think I should consider buying a new one–one that’s also more fuel-efficient. I’ve never bought a new car, though, and am scared at the prospect of adding a car loan to my $400/month in student loan payments. I have good credit and think my salary is just about at the national average. In your opinion, could I do it?
Thanks for your note!
I will do a full post/opinion on your question and get some reader opinions too, hopefully giving you some food for thought.
Personally, I think setting the monthly payment benchmark at 20% is too high. Most other places recommend that your total transportation costs (payment, insurance, gas, maintenance, etc…) don’t go over 15% of your budget. If your car payment costs alone are close to 20% of your income, your budget is going to be in a world of hurt.
Cassie recently posted..Well That Was Intrusive
Cassie,
Great point, but to each to their own. I do think 20% is maybe on the higher end, but certainly not impossible.