What you should know about car loans, when obtaining one is your only option

By BOB CUNNINGHAM

Most personal finance gurus agree that the one type of debt that is acceptable to have is a home mortgage.  As soon as you can reasonably afford such a hefty monthly output, and provided you have some money for a down payment and closing costs, it’s generally better to buy a residence than to rent.

I agree completely with the second part of the above statement, but not the first sentence.  Well… not exactly as it is written.

I have learned that a home loan is, indeed, okay as long as you’ve avoided going in over your head.  I also believe that under the right circumstances, obtaining auto financing is just fine in the big savvy-money-management scheme of things.

To be clear, not everyone who desires new wheels should be out applying for a car loan. If you’re already in a lot of debt (i.e. credit card debt), and/or don’t have steady employment or another reliable source of income, locking up $300 or so per month for the next five or six years is foolish.  You likely wouldn’t qualify anyway.

However, the old-school thinking that you should pay cash for everything except your house, under all circumstances, is unrealistic and sometimes downright ill-advised.  Under certain reasonable but necessary parameters, you should feel fine about going into some debt for your car.  Why?  Because the risks of buying only what you can afford by paying cash often outweighs the temporary negative associated with using credit, even on a depreciating asset.

In a perfect world, you WOULD avoid traditional financing.  A dividend-paying whole life insurance policy, such as what this website has been detailing periodically since its inception, with sufficient funds in its cash value is a far superior method for buying a car because it is “self-financing,” and allows the policy owner to continue growing his/her money even while tying up funds in the new ride.  Set up properly, you wouldn’t lose the growth that money would earn had you not went car shopping.

It’s a really cool and wise way to go about it, but this particular post isn’t dedicated to that, because I realize many of my readers are younger and either don’t yet have the insurance policy or don’t have enough saved in cash value to collateralize a loan sufficient to buy the desired automobile.

So that means your choices are, 1) walk/ride the bus/ride a bike, 2) buy something so cheap for cash that it could break down at any moment, as mentioned above, or 3) qualify for a loan in order to buy a car that will likely last for several years.

It’s fairly obvious, I would think, that a huge majority in such circumstances will opt for Choice #3.  So here are some tips for making a smart purchase, and getting yourself financially to a point that this doesn’t hurt your ultimate bottom line much, if at all:

1. Buy pre-owned, not brand new.  The beauty of buying a car that is two or three years old is that you can save a higher percentage off the new model’s sticker price than has been spent in terms of the pre-owned car’s expected lifespan. Yes of course, I will explain.

For example, say you’re after a Toyota Corolla.  Not sexy, true, but usually super reliable. A brand new one typically goes for about $23,000, as per my research, but an average of the half-dozen or so appropriate pre-owned Corollas I found was about $14,000. The latter refers to a 2015 model or newer, less than 40,000 miles, and an average of no more than 15,000 miles per 12 months of the car’s life since it was originally bought new (I recommend 12,000 miles).  Most auto-buying websites list not only the year of the car, but info such as when the car was originally bought, month and year.  If you don’t have that information, a CarFax report – free for the asking from dealers – will show it.

OK, so $14,000 is about 61% of the car’s new price today (another way of stating this is the pre-owned car is discounted 39% from new), but 40K miles is only about 20% of the very reasonable expected lifespan (if maintained properly) of 200,000 miles.  That difference (19% in this example) is value for you.  Let the person who originally bought the car absorb that excessive depreciation.  KBB.com indicates a new car loses an estimated 20%-25% of its value as soon the buyers leaves the lot with it.

2. Get pre-qualified for a loan BEFORE you go see and drive cars. You have a lot more leverage knowing what you can pay ahead of time. But don’t qualify for the maximum your credit and other circumstances allow.  Be content to buy a little under your means, so that you have a comfort level with the payment and also have the option to pad the minimum required payments if you wish in order to reduce the principal balance faster and pay off the loan sooner.

Speaking of paying it off, do not apply or sign for a loan of more than five years (60 months).  It’s silly to pay for six or seven years on a car that, in great likelihood, you won’t have or want to retain before the end of the term. Plus, of course, you will pay more interest over the longer the term if you make just the minimum payments.  (Take note, however, that if the interest rate is identical on a six-year term vs. five years, which it frequently is, and you KNOW you have the discipline and willingness to pay at least 10% extra every month, it makes sense to go ahead and get the 72 months.  But ONLY if the above is accurate for you and your circumstances)

With the above said, it is generally best to go with the shortest loan term you can afford considering the aforementioned “padding” and comfort level for the required minimum payment.

3. Know the Kelley Blue Book (or comparable) values of your target car before you head to the lot.  It is important that you make your buying decision based on the total price of the car, and NOT based on the monthly payment.  Auto sales reps make a good living showing prospective customers how they can actually afford the car of their dreams (translation:  a car they really have no business buying) with the loan stretched out far enough.

With that in mind, know what your target car is worth and should sell for, allowing for a modest profit for the dealership – a good rule of thumb is no more than 10% above private party value.  Don’t be concerned with dealer retail or average price of similar cars sold in the area.  You can do better if you’re willing to work at it a little (see No. 4).

Lastly, it’s obvious that you must test drive your car of choice.  But when you do, really put it through its paces.  Ask the salesperson to direct you to a quiet side street and try an abrupt stop to test brakes, complete a sharp u-turn to test radius, and do a three-point turn to assure the transmission’s smooth functionality going from drive to reverse and vice-versa.  Ask for a certificate from the dealership guaranteeing all buttons, switches, lights, etc. are in good working order.  If that isn’t available, personally inspect and test everything.

4.  No-haggle pricing is NOT to your benefit.  Have your info, and stick to your guns while being reasonable.  Many car dealers are advertising no-haggle pricing in an attempt to cater to those who find the car-buying process stressful or even distasteful.  This is nonsense.  Haggling is to your benefit.  Arrive at what you’re willing to pay for the car based on the above parameters… and don’t buckle when the salesperson tells you their price is, “the best we’re going to be able to do I’m afraid.”  I can practically guarantee you that if you’re reasonable in what you’re willing to pay, and you’re willing to leave the lot if you don’t get close to what you’re requesting, the deal will get done to your satisfaction. The dealership wants and needs your business a lot more than the few hundred extra dollars they appear to be unwilling to discount for you.

5.  Make your car payments automatic through your bank’s online bill-pay. Set it to make the payment each month 3-5 days before it is due, and forget it.  And preferably, add at least $25 or 10% – whichever is greater – to the minimum payment when you set up the automatic payments.  You’re unlikely to feel the extra out-go in your monthly budget, and yet you could knock six months, a year, or more off the loan term.

There’s a lot to consider when buying a car, especially if you’re willing (and qualified) to make a long-term commitment by borrowing funds. Use the above as a basic guide, and you will undoubtedly come away pleased, while having not fallen into the trap of over-paying.

Once again, thanks for reading.

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DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.