When I was growing up, car manufacturers made a big deal each fall about unveiling next year's models, literally shrouding them in secrecy under tarps in print and TV ads until the launch date. Car-crazy dads would then rush down to the dealer for a test drive.
These days, new models roll out year round -- and financing methods have gotten more flexible as well. Back then, many people saved up for years in order to pay cash for their cars; today, most people I know take out car loans. In fact, many saddle themselves with debt that might take five or more years to pay off -- money they could be saving for a home or retirement.
Although a longer-term loan may lower monthly payment amounts or allow you to buy a more expensive car than you could otherwise afford, it can also have unexpected, costly consequences:
- The longer your loan term, the more interest you ultimately pay. For example, on a $25,000 loan with a 6 percent interest rate, you would pay $1,659 more in total interest for a six-year loan than for a four-year loan. (Click HERE for an auto loan calculator that shows how different loan interest rates, term lengths and extra payments impact your monthly payments and overall interest paid.)
- When calculating how much car they can afford, many people forget to factor in such routine expenses as a down payment, insurance, sales tax, registration and emission fees, maintenance and repairs, which can add thousands of dollars to the overall cost.
- New cars typically lose 20 percent or more in value the minute you drive them off the lot. Thus, if you put 10 percent down on a $25,000 car and borrowed the rest, you'd automatically owe $22,500 for a car that might only be worth $20,000. If you suddenly had to sell the car, would you have the difference -- $2,500 -- to pay off the loan? (Not to mention having to come up with the cash to buy another car.)
- Worse yet, if the car were stolen or totaled in an accident, depending on your insurance coverage you could owe much more. You can protect yourself somewhat with gap insurance, but that's yet another expense to be factored in.
- According to Edmunds.com, one-fifth of car loans include debt rolled over from a previous vehicle's loan balance. This further increases "negative equity" in the new car (where you owe more than it's worth), which often leads to higher interest rates.
Before you sign on for a new car payment you can't afford, consider these points:
- Today's cars are much better constructed and more reliable than in the past. With proper maintenance, you might be able to get 150,000 or more miles before repair costs become prohibitive. Check your car's service manual for maintenance guidelines.
- If you can't find the manual, go to your car manufacturer's website for service recommendations. Other good resources for maintenance tips are Edmunds.com, Automotive.com, and Yahoo.
- Rather than investing in a new car, buying a quality used car could save you thousands of dollars, both in purchase price and insurance costs. To find a reliable used car, look for a certified pre-owned (CPO) vehicle backed by a manufacturer's warranty. Kelley Blue Book and Cars.com have good discussions on CPOs. Also, ask your friends or reputable mechanics for referrals to people selling their cars who they know have taken good care of them.
- Before purchasing a used car, you may want to obtain a Vehicle History Report, available from CARFAX, AutoCheck and other sites for a small fee. These reports will trace the car's history by vehicle identification number on a nationwide database to make sure it's not a lemon, has been involved in a serious accident or has ownership title problems.
- Try to hold onto your current car for a couple more years and sock away the money you would have spent on a monthly loan payment to use as your next down payment.
Bottom line: Although a car may be a necessity, depending on your particular situation, don't fall into the trap of treating it like a status symbol. There are many more productive ways to spend your hard-earned cash.
This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.
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