Resist the temptation to lease. Leasing is basically an extended car rental. When you lease a car, you must return it at the end of the lease or buy it from the dealer at a predetermined price — usually higher than what you’d pay for a similar used car. When you take a loan out to buy a car, you pay down the loan and then the car is yours, free and clear. The only payments you’ll have to make after that are for gas, repairs and insurance.
Lots of people lease. Smart, respectable people lease. It’s not a terrible thing to do, but it’s not the best way to keep a car, because you’re always making payments. Lease a car for three years and, when the term expires, you need to look for a new lease or shell out thousands to purchase the car you’ve been driving.
Consider factory certified pre-owned cars. “Certified pre-owned” is another term for for “used.” But these cars do come with extra assurances about the car’s condition. Going pre-owned can be a really smart move, because most cars lose 18% of their value in their first year. A certified pre-owned car is one that has been inspected and fixed before it goes on the market, and comes with a manufacturer-backed warranty, like new cars do.
Size up your future car loan. Once you decide you want a new car, the first thing you should do is figure out how much car you can afford. Calculate this amount before you go shopping; don’t let a car dealer influence your decision.
Figure out how big a loan you should get. A good rule of thumb: Your monthly car payment should be no more than 20% of your disposable income. That means that after you’ve paid all your debts and living expenses, take one-fifth of what’s left. That’s your maximum monthly auto expense. Ideally, this number should cover not only your car payment, but also your insurance and fuel costs.
Consider all pools of money. Should you sell investments to pay for the car instead of borrowing at 7%? That’s a tough call; usually, we’d say no. Do not spend any of your tax-sheltered retirement savings (IRAs, 401(k)s), as you’ll pay through the nose in penalties and taxes and rob from your future. As for taxable investments, consider whether cashing out would have tax implications (you’ll pay 15% in capital gains for investments held longer than one year; investments held less than a year are taxed at your ordinary income-tax rate) or whether you may need that money for something else over the next two to three years.
Should you take out a home equity loan to pay for a car, since the interest of those loans are tax-deductible?
Many people think home loans are the perfect way to finance the purchase of a new car. But the length of the term for a home loan — most require payments over at least 10 years, with penalties for early repayment — will send your total costs through the roof, even after the tax savings. Borrow for no more than five years, lease (if you must) for no more than three. If you’re considering a home-equity line of credit to pay for your car, remember that most HELOCs have a variable interest rate, so it’s possible your payments will rise over time.
How to Find the Best Auto Loan
You’re going to show up at the dealer with your own loan, but where should that loan come from?
Begin by getting a sense of the prevailing rate for a new-car loan. Focus on is the APR, or annual percentage rate offered by each lender. The APR is the annual cost of the loan, or interest rate. With this number, you can cross-compare loans from one lender to another, so long as the durations of the loans are the same.
You’ll probably get the best deal at a credit union— a members-only, nonprofit bank that can offer lower-cost loans than a traditional bank can. But check out rates at traditional banks and online-only car lenders such as Capital One and E-Loans.
Don’t be distracted by dealerships offering rebates or zero-percent financing if you obtain your loan through them. “Zero-percent financing” means you are not charged any interest on the loan. So if you were buying a car that cost $24,000 and you had a 48-month car loan, your monthly payment would be $500, without any added interest. A rebate is money taken off the price of the car. Rebates are also called cash-back deals.
Here’s the thing about those offers: The money you save via interest and rebates is probably coming from somewhere. If you qualify for 0% interest (and most people don’t, as it’s given only to people with near-perfect credit), your dealer won’t budge on the sticker price. If you take the rebate, you won’t get a rock-bottom or 0% interest deal.
That’s why splitting up the financing and purchasing of your car is a good idea: First, you can shop around for the best credit-union car loan, and then you go to dealer and focus on negotiating the purchase price of the car. Bundling the transactions can lead to lots of stress and added expense — you may be so focused on financing costs that you the punt on the purchase price — so keep them separate.
If you do choose dealer financing, be extra vigilant about what you agree to, and what you’re signing—it’s not uncommon for dealers to add in various unnecessary fees (rustproofing, extended warranty) that fatten their bottom line. Question everything that wasn’t explicitly discussed during negotiation, and don’t be afraid to walk away.
There are some easy ways to catch a break with your dealer when negotiating the price of your car. Timing can be everything: Shop early in the week. Weekends are prime time for dealers. But if you show up on a Monday, a salesman may be more motivated to cut a deal because business will be slow for the next few days.
Shop at the end of the month. Car dealers get monthly bonuses if they move enough metal. If you show up on the 30th and your salesperson is two cars short of a bonus, he or she may cut you a better deal so to make numbers.
Shop for a car that’s about to be replaced/discontinued. Pretty simple logic here: Things that are about to be considered “old” sell for less.