New cars these days have better safety features and more tech gadgets than models from a decade ago. And let’s face it: swapping out a beat-up clunker with grimy seats is a tempting idea.
But many Americans make big mistakes when buying cars. accept new car purchases with a trade-in. one-third of buyers reinvest an average of $5,000 in debt from their last car into their new loan. they are paying for a car they no longer drive. Oh! that’s not a winning personal finance strategy.
but don’t worry: the npr life kit is here to help. Here’s how to buy a car without going into too much debt or paying more than you have to.
1. Get pre-approved for a loan before you step foot on a dealer’s lot.
“The best advice I can give people is to get pre-approved for a car loan from your bank, credit union, or online lender,” says Philip Reed. is the car editor at personal finance site nerdwallet. he also went undercover at a car dealership to learn the secrets of the business when he worked for the car-buying site edmunds.com. Therefore, Reed will pull back the curtain on the car-buying game.
On the one hand, he says, getting a loan from a lender outside the car dealership leads buyers to think about a crucial question. “How much car can I afford? You want to do that before a salesman makes you fall 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 shopping for a car, you may want to increase your credit score or get erroneous information from your credit report.
and search for the best rate. “People are being charged more interest rates than they should be based on their creditworthiness,” says John Van Alst, an attorney at the National Center for Consumer Law.
van alst says many people don’t realize it, but the dealer may raise the rate they offer you above what you actually qualify for. So, with your credit score, “you could qualify for a 6% interest rate,” Van Alst says. but, he says she, the dealer may not tell you that and offer you a 9% rate. if he accepts that bad deal, he could pay thousands of dollars more in interest. Van Alst says the dealership and his finance company “will split that extra money.”
So, Reed says having that pre-approval can be a valuable card to hold in the car-buying game. can help you negotiate a better rate. “Prior approval will act as a bargaining chip,” he says. “If it’s pre-approved at 4.5%, 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 the terms, i.e. the down payment and the length of the loan, remain the same.”
A word of warning 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 conventional bank, credit union, or other lender whose name you recognize.
2. keep it simple at the dealership.
If you’re shopping for a car at a dealership, focus on one thing at a time. and don’t say too much to sellers. remember: this is a kind of game. And if you’re playing cards, you don’t pick them up and say, “hey, everybody, look, I’ve got a pair of queens,” right?
So, at the dealership, Reed and Van Alst say the first step is to start with the price of the vehicle you’re buying. The dealership salesperson will often want to know if he plans to trade in another car and if he too is looking to get a loan through the dealership. reed says he doesn’t answer those questions! that makes the game too complicated and you are playing against professionals. If you negotiate a really good purchase price on the car, they may raise the interest rate to make extra money off you that way or lower your trade-in value. they can juggle all of those factors in their head at once. you don’t want to keep it simple. one thing at a time.
Once you set a price, you can talk about a trade if you have one. but reed and van also say to do your homework there. A little research online can tell you what your trade is worth in approximate terms. reed suggests checking out the free price guides at edmunds.com, kelley blue book, and nothing else. On AutoTrader, you can also see what people in your area are asking about your car model. and he says, “you can get a real deal from carvana.com and also take the car to a carmax, where they’ll 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 think the dealer is paying you less for your old car. you have plenty of other good options these days.
3. don’t buy add-ons at the dealer.
If you’ve bought a car, you know how it works. you’ve been at the dealership for hours, you’re tired, you’ve set a price, you’ve haggled over the trade-in, and then they hand it off to the finance manager.
“You are directed to this administrative office. They often refer to it as the box,” says van alst. This is where the dealer will try to sell you extended warranties, tire protection plans, paint protection plans, something called gap insurance. dealers make a lot of money on these things. and van alst says it’s often very expensive and most people have no idea how to calculate a fair price.
“Is this plugin, you know, marked at 300%? You really don’t know anything about that,” van alst says. So he and Reed say a good strategy, especially with a new car, is to simply say no to everything. He says that, especially with longer-term loans, there’s more leeway for dealers to try to sell you on the extras. the finance person might try to tell you, “it’s just a little more money per month.” but that money adds up.
“As for the extended factory warranty, you can always buy it later,” Reed says. “So if you’re buying a new car, you can buy it three years from now, just before the warranty expires.” at that point, if you want the extended warranty, he says, you should call several dealers and ask for the best price each can offer. That way, he says, you’re not rolling the cost over to your car loan or paying interest on a service you wouldn’t even use for three years because it’s still covered under the new car warranty.
Difference insurance promises to cover any difference between the purchase price of replacing your nearly new car with a new one if your regular insurance doesn’t pay for full replacement if your car is destroyed. Van Alst says that gap insurance is often too expensive and fundamentally problematic. if you still want the product, it’s best to get it through your regular insurance company, not the dealer.
4. beware of longer term auto loans of six or seven years.
One-third of new car loans are now for more 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 seven-year loan will mean lower monthly payments than a five-year loan. but it will also mean paying a lot more money in interest.
Reed says that seven-year loans often have higher interest rates than five-year loans. And like most loans, the interest is charged up front – you’re paying more interest compared to the principal in the early years. “Most people don’t even realize this and don’t know why it’s dangerous,” says Reed.
Don’t see the graph above? click here.
reed says if you want to sell your car, decide you can’t afford it, or maybe you have another kid and need a minivan instead, with a seven-year loan you’re much more likely to sit still owing more than you what is the car worth so he says, “it puts you in a very vulnerable financial position.”
A better way to go, Reed says, is a five-year new car loan, and “with a used car you really should only finance it for 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 repairing (say, the transmission completely fails), you’re more likely to have paid off the loan by then.
Reed says a five-year loan makes 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 shape.” . There will still be value in the car at the end of the five years.”
Also, Van Alst and Reed say to make sure dealers don’t slip in extras or change loan terms without your knowledge. Please read what you are signing carefully.
reed says a colleague at nerdwallet recently bought a minivan and “when he got home, he looked at the contract.” she had asked for a five-year loan, but she said the dealer gave her a seven-year loan. “And they included a factory warranty that she didn’t ask for and didn’t want.” Reed says she was able to cancel the entire contract, remove the extended warranty, and get a refund.
“but the point is,” he says, “I mean, here’s someone who’s very financially savvy, and yet they were able to do this to him. And it’s not an uncommon scenario for people to think I 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 buying a used car to save a lot of money!
“The rule of thumb is that all your car expenses should be no more than 20% of your take-home pay,” Reed says. and says that’s the total cost of the car, including insurance, gas, and repairs. “so the car payment itself should be 10-15%.”
And if a new car with a five-year loan doesn’t fit your budget, you may decide you don’t really need a new car.
“Actually, we live in the golden age of used cars,” Reed says. “I mean, used car reliability is remarkable these days.” Reed says there’s an endless stream of cars coming off three-year leases that are in pretty good shape. and even cars that are older, he says, are definitely worth considering. “You know, people are buying nice used cars at a hundred thousand miles and driving them another hundred thousand miles,” says Reed. “so I’m a big fan of buying a used car as a way to save money.”
He recognizes that the car you buy is important and that it’s a good idea to read reviews and ratings about which makes and models are more or less likely to have costly repair issues in the future. he says that some European cars are notorious for their high maintenance cost.
npr has a personal finance facebook group called your money and your life. and we asked group members about buying cars. many said they were surprised by the amount of money others in the group said they were spending on cars. Patricia and Dean Raeker of Minneapolis wrote: “40 years of vehicle ownership and our total transportation purchases don’t even add up to the cost of one of the financed ones these people are talking about.”
dean is a freelance audiovisual technician and patricia is a stewardess. They say, “Our newest and best purchase was a $2,400 2004 Honda Accord, purchased last year, which with regular maintenance could probably last another 100,000 miles.” and they say they “can’t understand those who insist on chasing away their retirement funds.”
Even if you buy a slightly newer used car than the raekers, the pair make a big point. What else could you be spending your car payment money on? And if you can cut what you’d otherwise spend in half, that’s a lot of extra money for your retirement account, your kids’ college fund, or whatever else you’d rather do with that money.