Financial Management – A Young Professional’s Car Buying Guide

For most people, the list of Major Life Purchases is pretty short: your living space and your car. Financial tracking for either of them can be difficult, but we are here to help you make the most of your dollar.

Buying a car is no small project, as you’ve probably already experienced. New, used, leased or purchased, you’re forking over a sizable amount of cash for a hunk of metal and plastic. And you’re betting it will carry you thousands of miles, with all of its parts whirring along on four wheels. It’s quite a lot to ask, and if you’re not careful, you could end up spending a hefty bit of your paycheck on a rolling lemon. That new ride in your garage can cost you a lot more than you think, so we’re here to save you some money in that process.

New, Used or Lease?

You’ll need to decide whether a new, used or leased car is appropriate for your lifestyle and budget. Even though it’s tempting to buy that off-the-lot four-door with the fresh new-car smell, it’s rarely fiscally sound advice for a young professional with little to no savings – and limited experience making large purchases. Compound that with depreciation and you have some serious considerations on your hands: as soon as you drive off the lot, your car’s value drops to wholesale. And for the next three years, it depreciates at least 15 to 20% more each year. Still looking forward to that new-car smell?

Here’s an example of new car depreciation: If you spent $20,000 on a new car, in three years having depreciated at a rate of 15%, that no-longer-new car will only be worth $11,000 – a $9,000 loss!

Leasing a car, on the other hand, roughly translates to renting it for a specific period of time until you trade it in or opt to buy it. Up-front costs may include (but aren’t limited to) the first month’s payment, a non-refundable security deposit, taxes, registration, and insurance. Monthly leases can be lower than monthly car payments because you pay for the depreciation, not the cost of the car. However, you have to pay for your mileage (an amount agreed upon beforehand), including higher fees for every additional mile; and you pay for any damages incurred while it’s in your possession.

Mint’s Tip: Although you’ll have a nicer car, you’ll never stop making payments and you’ll never own the car you lease unless you opt to buy it. Leasing is probably better for middle to upper level professionals with a more disposable income and a penchant for the latest and greatest. Even then they better have great financial tracking habits.

Buying a used car has its benefits: the purchase price is lower, depreciation is slower, the insurance and sales tax are reduced, and financing options will be more affordable if you buy from a dealership. You can also save money if you buy from an individual dealer rather than from the lot, and negotiations may be easier. Just make sure you know what to look for when buying a used car, because no one’s going to hold your hand if you walk away with a lemon.

Can You Afford A Car?

Buying a car you can afford requires research – a lot of it. You need to know what you can afford, before you even set foot in a dealership. At a minimum, you should understand the “true cost of the car”, your credit score (handy for negotiating leverage) and how much you can afford to put down at the start. Financial tracking software can help you with the last part. Let’s walk through a few of these pointers so there aren’t any surprises once you sign on the dotted line.

Down Payments

Some say that you should put as much down on your car as possible. Putting 20% down means that your loan will be smaller, your interest rates will be lower, and your grand total will be small enough so you can actually afford today’s gas prices. But if you put zero down and drive it off the lot, the depreciation will make your total payments more than the car is worth. It’s called being “upside-down.”

20% down of a $20,000 car leaves you owing $16,000. A 48-month repayment plan at 7.5% equals about $387 a month. Zero percent down with the same repayment plan equals $484 a month. By the time you pay off your loan, you’re looking at a difference of $656.

However, if you were to take that $4,000 down payment and invest it in a high-interest savings account or CD with a return of, say, 4.75%, you’ll earn $760 by the time it would take you to pay off the 48-month loan. You’ll come out $104 richer than if you put $4,000 down.

So if you’re wondering whether or not to put a down payment on the car purchase, just think of it this way: if you don’t think you’ll be able to set aside $4,000 in a savings account and not touch it for four years, then use it as a down payment. If, however, you think you have the discipline, save the money and don’t put money down — this way you’ll come out with more money in the end.

True Cost of a Car Purchase

The asking price of the car doesn’t usually include costs for sales tax, title transfer fees, insurance, and other “additional fees.” Similarly, the dealer usually won’t include tax and licensing fees in your estimated car payments — after all, the less you think it costs, the more of you’ll feel you’re getting a good deal from them. Here’s where you’ll have to start outsmarting your dealer: Figure out those amounts before you go in, and you won’t have any surprises when you open your wallet.

To illustrate, we’ll give an example of just a few additional fees you’ll face when buying a car, as well as how they affect the true price of the car:

Example:Cost of car + Destination fees + Add on fees x Sales tax = True cost to purchase$20,000 + $450 +$400 x .075 = $22,413.75So if you’re buying a $20,000 car, fees and sales tax will bring the cost to $22,413.75. Already it’s almost $2,500 more than you originally thought.

Mint’s Note: Keep in mind that dealerships often claim that extended warranties are “included.” Included, though, doesn’t mean free. To include it, you’ll have to pony up: dealers belatedly explain you “have to” purchase the extended warranty, or the APR will shoot up. Don’t be fooled: your APR should only be affected by your credit worthiness.

After adding fees and sales tax, add to your total the upfront costs to the true cost of the car to see how much it will initially cost you. We’ve filled in some example figures here:

True cost to purchase + DMV fees + Initial insurance fees = All initial fees

$22,413.75 + $250 + $450 = $23,113.75

When all is said and done, you’ll be forking over at least $3,000 more than the original asking price! Clearly, there’s a lot more going on than what you see on the sticker.

Your True Worth

Most likely, you’ll need to finance your new or used car with an auto loan. If you have poor credit (or no credit), you’ll either be denied for a loan or receive a loan with a high APR. High APR means you’ll pay more in the long run, which ties in nicely with the “look before you leap” strategy we’ve detailed here: before you head into the dealer’s office, you should know the loans you’re eligible for so you can negotiate for the best deal possible.

Get Your Credit Report: Using the Big Three (Experian, Equifax, and TransUnion), you’ll be able to view your credit history and credit score. Annualcreditreport.com offers you a free peek at your credit history once a year, but not your actual credit score. For that, it’ll cost anywhere from $20 to $40 for a one-time viewing, or roughly $12 per month for a membership to view it regularly.

The lower your credit score, the higher the interest on your loans will be. Crunch some numbers to find out how much you can afford in monthly payments before you start browsing eBay Motors. Try to find a car you know you can afford, instead of sealing yourself into a “dream vehicles” that’s beyond your means. You’ll only end up with worse credit if you fall behind on payments.

Knowing your credit score also has another big advantage: getting the leg up on shifty salespeople. When a dealer offers you financing and it’s clear you haven’t checked your score, they might mislead you about the state of your score so they can sneak in higher interest rates. Don’t let them walk over you; they don’t need their commission check as much as you need a straight deal.

Mint’s bottom line: If you have poor credit, you might want to wait a bit before you buy a car, at least until you clear up some of your record blemishes. Although you can have someone co-sign the loan with you, you’ll have to watch out there as well: make sure that the paperwork is correct when you’re signing, as some car dealers put the co-signer as the primary borrower (a practice called a straw purchase). That definitely won’t help your credit improve.

Cash and Financing

Once you’ve done the quick calculations to determine the true cost of your car purchase and subtract the down payment, you can figure out how much you need to borrow to make it work. Car loans aren’t always simple: you’ll want to know if you’re eligible for that loan, and how much you’re allowed to borrow in the first place. As a whole, the Internet is a good place to start researching loan rates at banks and credit unions.

The Mint lesson here is: Get pre-approved for your loan before you stroll into the dealership. Right off the bat, you’ll have an ace up your sleeve: you’ll know what the current interest rates are, and you can compare them to the dealer’s offers. Usually the 0% Annual Percentage Rate offers that car dealers flaunt only applies to people with superb credit scores, so chances are you’ll have to do some comparison shopping to find the best APR possible.

You can go to individual banks (online or in person) to get current rates. MSN Money is a good resource: it lets you compare national averages of auto loan rates for new and used cars. It also lets you calculate local auto loan rates, and provides agency names, rates and fees.

If you get pre-approved for a loan, you receive a no-obligation check that you can take to your dealer and use to buy the car. These pre-approved loan checks are usually good for 45 days, allowing you plenty of time to scout out your new Ferrari… or Honda, as the case may be.

Mint’s Note: Car dealers try to claim car loan shopping can hurt your credit score. They say each time a financial institution makes an inquiry into your score, your score drops. The truth is that they tell you this so you’ll go with their financing department. Buffers are always in place such that any loan inquiries within 30 days of the initial scoring are ignored; and any inquiries within a 14-day period only count as one inquiry on your credit score.

Many dealers try to get you to use their lending office to finance your car. These “loans,” though, aren’t really loans: they’re actually known as Retail Installment Sales Contracts (RISC). The dealer signs it with you, and then sells it to the bank at a good markup (meaning yes, they make money off of your “loan”). The higher the APR they charge you, the more money they make. As a rule of thumb, most should avoid these types of loans unless you have good credit and know a lot about how these RISC “loans” work.

Typically financial lending sites will also have auto loan re-payment calculators. Some allow you to put in how much you’ll owe and the length of the loan. They’ll even tell you what percent of your income you can afford to pay.

Auto loans usually range from three years (36 months) to five years (60 months). Don’t let the dealer talk you into smaller payments over a longer period of time, though: a shorter-term loan will save you a lot more money. Always keep in your mind, “What’s in it for them?” when you are negotiating with car dealers, and don’t let them cause you to spend any more than 15%-20% of your income on your auto loan payments.

Additional Money-Saving Tips

Since your car (unlike a home) will never increase in value over time, you’re going to lose money on any car you buy — it’s the cost of convenience. So unless your local transit systems are stellar or you jet-set around on a Vespa, you’re looking at a lot of money upfront and down the line. It’s good to try to save money anywhere you can — and you can do that by doing your homework.

Know the Market Value of the Car

Wherever you’re looking, whether it’s online (craigslist.com or autotrader.com), in the local newspaper, or from an ad on TV, you’re going to see asking prices. Make sure it’s a fair price according to the current market value, especially if it’s a used car.

Sites like kbb.com and edmunds.com provide step-by-step calculations of the car’s current market value based on its general information (year, make, and model), its features and specifications, and its current condition. If you know enough about the car’s condition, you can calculate the market value and use that when negotiating for a lower price. It’s also a good way to verify their asking price.

Know the Quality of the Brand

Some car models have fewer problems than others. For example, older Pontiac Grand Am’s tend to have major coolant and head gasket issues, whereas the worst complaint on older Dodge Neons was the engine light coming on due to carbon buildup. You can expect that the repairs on that Grand Am are going to cost a whole lot more.

Use reputable site like consumerreports.com to investigate common problems of the car you are interested in. Google the year, make and model of your car with phrases like “common complaints” or “problems” to make sure you’re looking at a reliable car.

Know the Car’s History

You’ve seen the commercial for carfax.com where a seller boasts about “new upholstery” in their car that had suffered flood damage. They’re funny commercials, but they’re also closer to the truth than anyone would care to admit. You don’t know what that car has been through because you weren’t there.

You can check the car’s accident, damage and claims history by using its VIN number at carfax.com. As a secondary precaution, if the owner regularly services their car at a single location, you can ask that location for the car’s repair history and ask if it’s had any problems. As a final step, ask friends with the same car how theirs performs and if they have had any major issues.

Don’t Get Scammed

Not all car dealers are scammers, but a few are — and you should know what to look for to tell the good guys from the bad. Greedy dealers will do anything to nickel-and-dime you and jump as much money out of your pockets as possible. Some outright lie. Some even break the law. Just be warned that these dealers aren’t always Boy Scouts, and reading this article is preparing you for many of the steps you can take to avoid a bad deal. To really get familiar with other scams, visit sites like carbuyingtips.com or scam.com.

When Buying From Individuals

Buying from an individual seller rather than from a salesman can be an easier and less stressful process. Although you’ll still find scam artists, often people are simply selling because they’re shopping for a new car, moving, or just need the cash. They can be in a hurry, so they’re not looking to make a huge profit margin on their sale.

But buying from an individual has more risks when it comes to car quality. They either aren’t going to tell you the true condition of the car, or perhaps they don’t know it. Their opinion of “running fine” may differ from yours; they honestly might not have noticed that engine knock. You’re charged with asking the right questions and making sure you take the car on a thorough test drive before you agree to purchase anything. Take it to your mechanic so he or she can do a quick inspection, and don’t be afraid to negotiate.

You’ll need to ask the owner the right questions to find out anything he or she forgot to mention in the advertisement. Your questions should include:

• Are they the first owner? If not, how many previous owners does it have?
• Why are they selling the car?
• Have there been any major repairs or major parts replaced?
• Has it ever been into an accident?
• Is it currently in need of repairs?
• How old are the tires?
• When was the last oil change?
• When did they last change the brake pads/ rotors?
• Did it pass inspection this year?
• Has it ever failed inspection?
• Do they have the title in their possession? Is it in their name?

When you test-drive the car, put it through a well thought-out driving test to see how it handles. Drive various terrains like highways and steep curves. Keep in mind what the car’s main route will be. If you will be driving up hill to get to work every day, follow a similar route. Test how well it accelerates under pressure, and see if it stops on a dime.

Change lanes, keeping an eye out for unusual blind spots. Listen to the engine at different speeds and make sure you don’t hear any strange rattling. Open up the hood and check to see if any parts look like they are new – they’ll be cleaner than the other parts surrounding it. Check the color of the fluids. Transmission fluid should be red to pink. Coolant should be light green with no more than half water in the mix.

Don’t be Afraid to Negotiate

Car dealers expect to negotiate. They purposely ask for a higher price, knowing that if you think talk them down a bit, you’ll feel like you’re getting a deal and you’ll be more likely to buy. And if you’re buying from an individual, you can still suggest a lower asking price unless they have expressed their wishes for no negotiations.

Use the car’s estimated market value, and what you’ve found on consumer report websites, as negotiation tools. Start with a low offer, but keep it in the ballpark so they come back with another. Know the limits of what you can afford and don’t get distracted by the car’s extra features. Be patient — it may take hours or days for negotiations. And remember, the seller’s best negotiating technique is the ability to walk away, but this technique can work for you too.

Further Reading on the Buying a Car

• Personal Finance Tools
• Personal Budget Management
• Financial Budgeting Software
• Household Budget Software
• Financial Tools