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Modern cars had more technology and safety features than the models a decade ago. Let’s face the facts: Selling a rusty old car with dingy seats is a tempting idea.
Many Americans make huge mistakes when buying cars. Trade in your old car to get a new one. One-third of buyers transfer $5,000 of debt from their previous car to their new loan. They are paying for a vehicle that they no longer drive. Ouch! This is not a winning personal financial strategy.
1. Before stepping on a dealer’s lot, get preapproved for a loan.
Philip Reed says, “The best advice I can offer people is to get pre-approved for a car loan from your bank or credit union. NerdWallet’s autos editor is Philip Reed. While working for the car-buying website Edmunds.com, he did undercover work at an auto dealership to gain insight into the business. He says buyers looking for a loan outside the dealership will be forced to ask a critical question. “How many cars am I able to afford?” Before a salesperson makes you fall in love with a limited-model model with a sunroof, leather seats, and other features, it is essential to know your financial limits.
Reed states that getting preapproved can also reveal any credit problems. You should also improve your credit score and remove incorrect information from your credit report before you begin car shopping.
Shop around to find the best rate. John Van Alst, a National Consumer Law Center lawyer, says that people are charged higher interest rates because of their creditworthiness.
Van Alst claims that many people don’t know this, but dealerships can offer you higher rates than you are eligible for. Van Alst says that depending on your credit score, you might qualify for an interest rate as high as 6%. Van Alst says the dealership may not inform you and offer a 6% rate. If you accept that deal, you could pay thousands more in interest. Van Alst claims the dealership and its finance firm will split the extra money.
Reed believes that having preapproval is a valuable card in the car-buying process. You can negotiate a lower rate. He says that preapproval can be used as a bargaining chip. The dealer will say, “Hey, you know what, I can get your 3.5 if you’re preapproved at 4.5%.” Are you interested? It’s a great idea to accept it. However, ensure that all terms, such as the down payment and the term, are the same.
Van Alst warns against lenders. There are many shady online lending companies. Reed recommends choosing a bank, credit union, or other lender you know.
2. Keep it simple in the dealership
Focus on one thing when you buy a car from a dealership. Be specific with the salespeople. This is a game. You don’t say, “Hey everybody, I have a pair queens” when you’re playing cards.
Reed and Van Alst agree that determining the cost is the first step in buying a vehicle. A salesperson will ask you if you plan to trade in another car and if you are looking for a loan through your dealership. Reed advises against answering those questions. This makes it too complicated, and you are playing against pros. They might raise the interest rate or lower your trade-in if you get a great deal on the car. They can manage all of these factors simultaneously. It’s not something you want to do. Keep it simple. Take one thing at a given time.
After you’ve settled on a price, you can discuss a trade-in. Reed and Van Alst advise you to do your research. You can find out the approximate value of your trade online by doing some research. Reed recommends reviewing the Edmunds.com pricing guides, Kelley Blue Book, and NADA. Autotrader allows you to see what other people are asking for your model. He says that Carvana.com can provide an actual offer and that you can also take the vehicle to a CarMax, where they will issue you a check right there.
Van Alst and he both advise that you feel free to walk away from the dealership or to buy the car for a fair price without trade-in, if the dealer is trying to lowball you. There are many other options available.
3. Do not buy add-ons from the dealer.
You’re familiar with the process of buying a car. After hours of waiting at the dealership, you are tired and have settled on a price. You then negotiate the trade-in. The finance manager will hand you over.
“You’re lead to this back office. Van Alst says that they will often refer to it simply as the box. Here, the dealer will attempt to sell extended warranties, tire protection programs, paint protection plans, or something called gap insurance. These items are a hefty profit for dealerships. Van Alst claims that it is often overpriced, and most people need to learn how to determine a fair price.
“Is this add on, you know being marked up 30%? Van Alst states that you have yet to learn about any of this. Reed and he agree that it is an intelligent strategy to say no to all offers, especially when you are buying a new car. Reed says that dealers have more room to try and sell you extras, especially when the loan is longer term. You might hear the finance representative tell you that it’s just a little more each month. That money adds up.
Reed says that the extended factory warranty can be purchased later. Reed says that if you buy a new car, it can be purchased in three years, right before the contract expires. He suggests that you call multiple dealerships to get the best price for an extended warranty. He says that this will ensure you don’t pay interest and roll the cost of the extended warranty into your car loan.
Gap insurance covers the gap between the cost of buying a new car and replacing it with a new one. This is if your regular insurance does not cover full replacement costs if your vehicle is totaled. Van Alst states that gap insurance can be expensive and very problematic. You can still get the product if you contact your regular insurance company rather than the dealer.
4. Avoid long-term 6- or 7-year loans for cars.
One-third of all new car loans last longer than six years. Reed says that this is a “very dangerous trend”. We have an entire story about why this is the case. A seven-year loan will result in lower monthly payments than a 5-year loan. However, you will have to pay more interest.
Reed states that seven-year loans have higher interest rates than 5-year loans. Like most loans, interest is charged upfront. You pay more interest than the principal over the first year. Reed says that most people don’t realize it and don’t understand why it is dangerous.
Reed states that if you’re looking to sell your car, and you either decide you can’t pay it or you have another child who needs it, a seven-year loan will make you more likely to be stuck with more debt than the car is worth. Reed says that it puts you in a very vulnerable financial position.
Reed suggests a five-year loan for a new vehicle and that you “should really finance a used car for only three years which is 36 months.” Reed says that this is because if your car isn’t worth fixing, such as the transmission, you are more likely to have the loan paid off by then.
Reed believes a five year loan is a good option for new cars, as it “is the traditional way — it’s kinda a sweet spot.” The monthly payments aren’t too high. The vehicle will be in excellent condition after the five-year period. The car will still have value after five years.
Reed and Van Alst also advise that you ensure dealers only add extras to your loan terms or alter the duration of your loan with you being aware. Pay attention to what you are signing.
Reed claims that NerdWallet colleague bought a minivan last week and that she “reviewed the contract” when she returned home. The dealership offered her a seven-year loan instead of a five year loan, which she had requested. “And they included an extended warranty that she didn’t ask for and she didn’t want.” Reed claims she was able cancel the whole contract, get rid of the extended warranty and receive a rebate.
He said, “But the point is, I mean, here’s someone who is very financially savvy and yet they were still able to do it to me.” It’s common for people to believe they have a great deal. But when they look at the contract, it turns out that something is wrong.
5. Buy only a few cars. To save money, consider buying a used car.
Reed says that the golden rule is to keep your car expenses below 20% of your net take-home income. Reed also states that this includes insurance, gas, and repairs. “So, the car payment should be between 10 to 15%.”
Consider a 5-year loan if you can’t afford a new car.
Reed says, “We are actually living in the golden age of used cars.” Reed says, “It’s amazing how reliable used cars are these days.” Reed claims there are a lot of cars that have been on three-year leases and are still in good condition. He says that even older cars are worth looking at. Reed says, “You know what? People are buying used cars with a hundred-thousand mile range and then driving them for another hundred thousand miles.” “So, I love buying used cars as a way of saving money.
He recognizes the importance of what car you choose and recommends reading reviews and ratings to find out which models and brands are most likely to have costly repairs. He said that some European cars can be pretty expensive to maintain.
NPR hosts a Facebook group devoted to personal finance called Your Money and Your Life. We also asked members of the group about car purchasing. Many were surprised at how much other members of the group were spending on cars. Patricia and Dean Raeker, both from Minneapolis, wrote that after 40 years of owning cars, our total transportation expenses don’t add up to the price of one of these financed vehicles.
Patricia is an air attendant and Dean is an AV technician freelance. According to them, the 2004 Honda Accord was their most recent purchase. It cost $2400 and could last for another 100,000+ miles with regular maintenance. They also say that they don’t get it.
Even if your car is slightly older than the Raekers’, this couple still has a point. What other things could you spend that car payment money on instead? You can save half of what you would normally spend on car payments, which is a lot more money to put towards your retirement fund, your children’s college fund, or any other purpose you choose.
