By Gregory Karp Chicago Tribune
Vehicle purchases are vitally important money decisions. Not only are autos expensive — the average price of new cars is more than $31,000, according to Kelley Blue Book — the buying decision could hamstring your cash flow for years into the future.
So before you dive in and research which next vehicle you should buy, answer the most important question first: “How much car can I afford?”
Here are a few rules of thumb.
BORROW FOR FOUR YEARS OR LESS: As vehicles become more expensive, loan terms have lengthened. Loans can go to six or even eight years — that’s 96 months. Nearly one-third of loans are for 72 months or longer, according to a recent J.D. Power and Associates report.
While some consumers are buying larger and more expensive vehicle because they need them, others have a case of the “wants.”
A general rule of thumb is to take an auto loan for no longer than four years.
Money guru Clark Howard, who doles out advice on radio and television, has long advocated not taking out a loan longer than 42 months, or 3.5 years. “If your payment is too much at 42 months, that means you’re buying too much car,” he has said.
KEEP PAYMENTS TO 20 PERCENT OF TAKE-HOME PAY: A focus on car payments is dangerous because simply lengthening the financing term lowers the monthly payments but makes the vehicle more expensive.
To determine how much car debt you can absorb, ideally you would do in-depth analysis of your finances. But as a rule of thumb, keep the total of all vehicle payments to less than 20 percent of take-home pay, not gross pay.
The National Foundation for Credit Counseling advice is more strict — suggesting that no more than 20 percent of take-home pay should go to all non-housing debt, including credit card debt. The idea is that the 20 percent for debt plus the 30 percent that often goes toward housing leaves you half your take-home pay to eat, pay utilities, put gas in the car and pay for the rest of life’s necessities, said National Foundation for Credit Counseling spokeswoman Gail Cunningham.
DON’T BUY A NEW CAR. Depreciation is the issue here. A new car can depreciate 30 percent in the first year. That’s losing $9,000 in value on a $30,000 car during the first year. Is $9,000 a big deal in your life?
If you’re uncomfortable buying used, perhaps it would ease your mind to buy a used vehicle that is certified by the manufacturer.
“I’m a big fan of certified used vehicles, especially leased cars that have just come back to the lot,” said Farnoosh Torabi, personal finance expert and host of Financially Fit on Yahoo.
DON’T LEASE. If you leased a car because you couldn’t afford payments, your automotive tastes might be outpacing your wallet. Generally, financial experts frown on serial leasing for most people because they are continually paying for only the most expensive part of a car’s life, the first few years.
PAY CASH. Paying cash for a new vehicle seems absurd in households that don’t have an extra 30 grand stashed away. But it’s not as crazy as it sounds. First, recall that not everybody buys new cars. So, maybe the purchase price is closer to $15,000. And most people have some value left in their existing vehicle that they can sell or trade in. If that’s worth $5,000, the balance you need to come up with is $10,000.
One long-term trick is to continue making car payments to yourself — perhaps in a separate bank account — long after you stop sending in auto payments to your lender. If your payment was $400 per month, it would take only about two years to build up $10,000 to pay cash for your next vehicle.
DRIVE UNTIL THE WHEELS FALL OFF: Not to be taken literally, this hints at the wisdom of keeping a vehicle a long time, say, more than 10 years. Indeed, even the depreciation hit you absorb in buying a new car softens if you keep a vehicle a long time. The average age of a car on the road today is 11 years, Gutierrez said.
Remember that car repairs are typically cheaper than car payments, Cunningham said. Another rule of thumb: If an auto repair costs less than half of the trade-in value, repair it. Otherwise, considering selling your vehicle and buying another.
Perhaps the best advice is realizing the importance of car affordability in your financial life.