New cars these days have better safety features and more tech gizmos than models from a decade ago. And let's face it, trading in a beat up clunker with grimy seats is an enticing idea.
But many Americans make big mistakes buying cars. Take new car purchases with a trade in. A third of buyers roll over an average of $5,000 in debt from their last car into their new loans. They're paying for a car they don't drive anymore. Ouch! That is not a winning personal finance strategy.
But don't worry, NPR's Life Kit is here to help. Here's how to buy a car without getting over your head in debt or paying more than you have to.
1. Get pre-approved for a loan before you set foot in a dealer's lot
"The single best advice I can give to people is to get pre-approved for a car loan from your bank a credit union or an online lender," says Philip Reed. He's the autos editor at the personal finance site Nerd Wallet. He also worked under-cover at an auto dealership to learn the secrets of the business when he worked for the car buying site Edmunds. So Reed is going to pull back the curtain on the car buying game.
For one thing, he says getting a loan from a lender outside the car dealership, prompts buyers to think about a crucial question. "How much car can I afford? You want to do that before a salesperson has you falling in love with the limited model with the sunroof and leather seats. "
Reed says getting pre-approved also reveals any problems with your credit. So before you start car shopping you might want to build up your credit score or get erroneous information off your credit report.
And shop around for best rate. "People are being charged more for interest rates than they should be based upon their credit worthiness," says John Van Alst, a lawyer with the National Consumer Law Center.
Van Alst says many people don't realize it but the dealership is allowed to jack up the rate they offer you above what you actually qualify for. So with your credit score, "you might qualify for an interest rate of 6 percent," says Van Alst. But he says the dealership might not tell you that and offer you a 9 percent rate. If you take that bad deal you could pay thousands of dollars more in interest. Van Alst says the dealership and its finance company, "they'll split that extra money."
So Philip Reed says having that pre-approval can be a valuable card to have in your hand in the car-buying game. It can help you negotiate a better rate. "The pre-approval will act as a bargaining chip," he says. "If you're pre-approved at 4.5 percent, the dealer says hey you know I can get you 3.5, would you be interested? And it's a good idea to take it but make sure all of the terms meaning the down payment and the length of the loan remain the same."
One word of caution about lenders. Van Alst says there are plenty of shady lending outfits operating online. Reed says it's a good idea to go with a mainstream bank, credit union, or other lender whose name you recognize.
2. Keep it simple at the dealership
If you're buying a car at a dealership, focus on one thing at a time. And don't tell the salespeople too much. Remember, this is a kind of game. And if you're playing cards you don't hold them up and say, "Hey everybody look I have a pair of queens," right?
So, at the dealership, Reed and Van Alst both say the first step is to start with the price of the vehicle you are buying. The salesperson at the dealership will often want to know if you're planning to trade in another car and whether you're also looking to get a loan through the dealership. Reed says don't answer those questions! That makes the game too complicated, and you're playing against pros. If you negotiate a really good purchase price on the car, they might jack up the interest rate to make extra money on you that way, or low-ball you on your trade in. They can juggle all those factors in their head at once. You don't want to. Keep it simple. One thing at a time.
Once you settle on a price, then you can talk about a trade-in if you have one. But Reed and Van Alst say do your homework there too. A little research online can tell you what your trade is worth in ballpark terms. Reed suggests looking at the free pricing guides at Edmunds.com, Kelly Blue Book and NADA. You can also see what people in your area are asking for your model car on AutoTrader. And he says, "you can get an actual offer from Carvana.com and also by taking the car to a CarMax where they will write you a check on the spot."
So he and Van Alst say don't be afraid to walk away or buy the car at a good price without the trade-in if you feel the dealership is low-balling you on your old car. You have plenty of other good options these days.
3. Don't buy any add-ons at the dealership
If you've bought a car, you know how this works. You've been at the dealership for hours, you're tired, you've settled on a price, haggled over the trade in, then you get handed off to the finance manager.
"You're led to this back office, they'll often refer to it as the box," says Van Alst. This is where the dealership will try to sell you extended warranties, tire protection plans, paint protection plans, something called gap insurance. Dealerships make a lot of money on this stuff. And Van Alst says it's often very overpriced and most people have no idea how to figure out a fair price.
"Is this add-on, you know, being marked up three hundred percent? You don't really know any of that," Van Alst says. So he and Reed say a good strategy, especially with a new car, is to just say no. To everything. He says especially with longer term loans there's more wiggle room for dealers to try to sell you the extras. The finance person might try to tell you 'it's only a little more money per month.' But that money adds up.
"Concerning the extended factory warranty you can always buy it later," says Reed. "So if you're buying a new car you can buy it in three years from now just before it goes out of warranty." At that point, if you want the extended warranty, he says you should call several dealerships and ask for the best price they can offer. That way, he says, you're not rolling the cost into your car loan and paying interest on a service you wouldn't even use for three years because you're still covered by the new car's warranty.
Gap insurance promises to cover any gap between the purchase price of replacing your almost new car with a brand new car if your regular insurance doesn't pay for full replacement if your car gets totaled. Van Alst says gap insurance is often overpriced and is fundamentally problematic. If you still want the product, it's best to obtain it through your regular insurance company, not the dealer.
4. Beware longer-term 6 or 7-year car loans
A third of new car loans are now longer than six years. And that's, "a really dangerous trend," says Reed. We have a whole story about why that's the case. But in short, a 7-year loan will mean lower monthly payments than a 5-year loan. But it will also mean paying a lot more money in interest.
Reed says 7-year loans often have higher interest rates than 5-year loans. And like most loans the interest is front loaded — you're paying more interest compared to principal in the first years. "Most people don't even realize this and they don't know why it's dangerous," says Reed.
Reed says if you want to sell your car — you decide you can't afford it, or maybe you have another kid and need a mini van instead — with a 7-year loan you are much more likely to be stuck still owing more than the car is worth. So he says, "it puts you in a very vulnerable financial situation."
A better way to go Reed says is a 5-year loan for a new car and, "with a used car you should really finance it for only three years which is 36 months." One reason that makes sense he says is that if your used car breaks down and isn't worth fixing, say the transmission totally goes, you're more likely to have paid the loan off by that time.
Reed says a 5- year loan make sense for new cars because, "that's been the traditional way, it's kind of a sweet spot. The payments aren't too high. You know the car will still be in good condition there will still be value in the car at the end of the five years."
Also Van Alst and Reed say make sure dealers don't slip in extras or change the loan terms without you realizing it. Read carefully what you're signing.
Reed says a colleague at Nerd Wallet actually bought a minivan recently and "when she got home she looked at the contract." She had asked for a 5-year loan but said the dealership instead stuck her with a 7-year loan. "And they included a factory warranty which she didn't request and she didn't want." Reed says she was able to cancel the entire contract and remove the extended warranty and got a rebate on it.
"But the point of it is," he says, "I mean here's somebody who is very financially savvy and yet they were able to do this to her and it's not an uncommon scenario for people to think that they've got a good deal, but then when they go home and look at the contract they find out what's been done to them."
5. Don't Buy Too Much Car. And consider a used car to save a lot of money!
"The golden rule is that all of your car expenses should really be no more than 20 percent of your take home pay," says Reed. And he says that that's total car expenses including insurance, gas, and repairs. "So the car payment itself should be between 10 and 15 percent."
And if a new car with a 5-year loan doesn't fit into your budget, you might decide you don't really need a brand new car.
"We're actually living in a golden age of used cars," says Reed. "I mean the the reliability of used cars is remarkable these days." Reed says there is an endless river of cars coming off of 3-year leases that are in very good shape. And even cars that are older than that he says are definitely worth considering. "You know people are buying good used cars at a hundred thousand miles and driving them for another hundred thousand miles," says Reed. "So I'm a big fan of buying a used car as a way to save money."
He acknowledges that which car you buy matters and it's a good idea to read reviews and ratings about which brands and models are more or less likely to run into costly repair problems down the road. He says some European cars are famously expensive to maintain.
NPR has a personal finance Facebook group called "Your Money and Your Life." And we asked group members about car buying. Many said they were shocked by how much money some other people in the group said they were spending on cars. Patricia and Dean Raeker from Minneapolis, MN wrote, "40 years of owning vehicles and our total transportation purchases don't even add up to the cost of one of the financed ones these folks are talking about."
Dean is a Freelance AV Technician, and Patricia's a flight attendant. And they say, "our nicest, newest purchase was a 2004 Honda Accord for $2400, bought last year, that with regular maintenance could likely last another 100,000+ miles." And they say they "can't understand those who insist on driving their retirement funds away."
Even if you buy a slightly newer used car than the Raeker's, the couple raises a great point. What else could you be spending that car payment money on? And if you can cut in half what you might otherwise spend, that's a lot of extra money for your retirement account, or your kids' college fund, or whatever else you'd rather be doing with that money.
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