How Much Can I Afford To Spend?

This step outlines some of the best and worst ways to pay for your motor vehicle purchase, recommends making a realistic budget to find out what you can afford, and summarizes the hidden costs of ownership.

Buying With Cash - The smartest people I know pay cash for their motor vehicles and the richest people I know pay cash for their motor vehicles.  I pay cash for mine, too, and I'm neither rich nor exceptionally smart, but I've progressed from foolish credit buyer to smart cash buyer by following the example of my smart and rich friends. You can too. If you must drive (and most of us must), you can eliminate the costs associated with financing and leasing entirely, reduce tax and maintenance costs considerably, and  keep your expenses to a minimum, by following this simple advice:  Buy used vehicles in excellent condition that are two to three years old, and always pay cash for them. 

Cars: A Necessity, But A Bad Investment - Motor vehicle ownership has become a rite of passage to some, and an addiction to others; it's a major part of American culture that many people don't question.  But I think it's worth questioning.  The hidden costs, personal, societal and global, make it costlier than it seems.  I'll concentrate here on the personal costs.

I traveled to work on a city bus for many years when my finances made that necessary.  I recommend the subway or commuter train or bus to everyone who lives in a metropolitan area, for both ecological and economic reasons.  You know the ecology arguments.  But have you considered the total personal economic cost to you of owning a car?   In my opinion, one of the worst investments you can make is to buy or lease a new automobile.  Used cars are a better choice, but still a bad investment.  Here's why: you can't recover most of the money you spend on your vehicle.  Financing, leasing, registration and taxes, insurance (almost always), gasoline, tolls and parking fees, maintenance, and repairs: usually this is money you won't see again.  The car itself depreciates (loses value) faster than any other consumer product.  If you purchase an average new vehicle and drive it for three years (36,000 miles), you may get 50% of your purchase price out of it.  

I'm aware, though, of the convenience and often the necessity of travelling by car for many of the jobs and lifestyles we have now.  The rest of this section itemizes the costs connected with buying and then owning a car: I call it Car Payment PLUS.  Installment-and-then-some.

Making A Budget - This is absolutely essential.  It's the only smart way to prepare to buy a car.  You need to know how much money you can spend without compromising your finances.  First determine your income, then your expenses without an automobile.  Subtract your expenses from your income.  What's left is your disposable income, or the amount available for entertainment, travel, and automotive expenses.  Don't forget, these expenses will include the hidden costs of car ownership detailed below.  

0% Financing - Desperate to unload slow-moving inventory, many manufacturers are offering the best deals in history, providing your have excellent credit and finance through the automaker's captive finance company.  If you qualify, take advantage of these incredible financing deals, they might vanish at any time. Unfortunately many new car purchasers won't qualify for the lowest (0%) rate so I advise you to read the rest of this page.

Borrowing Money - If you need to finance, use a payment calculator to see how changes in rate, purchase price, term, and down payment can reduce your loan payments. Unfortunately borrowing contributes to the high prices of cars: by simply spreading out the purchase price over a longer period of time, car manufacturers have been able to slowly raise the average price of a new vehicle over $23,000 in 30 years, from $2500 in 1970 to $25500 in 2000.  Although inflation accounts for some of this increase, the rise would have been much less if all new vehicle purchasers paid cash.  Longer financing periods (60 & 72 month loans are common) enable many people to buy more car (newer or better) than they can really afford; the long loan term includes far more interest than shorter ones.   I recommend paying cash, as I said, but if you must borrow, be aware.  Banks will want a history of your work experience, a history of your previous residences, and history of good credit (paying bills on time, etc).  Banks can easily make your financial situation seem better than it really is, and qualify you for a loan that will be a burden to repay.  Banks calculate your ability to borrow from your debt-to-income ratio, considering only your rent and credit obligations. They base approval on a debt-to-income ratio of 40% or lower.  I feel disposable income (in the sense I outlined above) is a better way to budget for a purchase, as it takes into account all of your expenses.  

Interest - Borrowers must have a good credit history in order to motivate lenders to part with their money at a reasonable rate.  A multitude of factors beyond your control affects the basic interest rates, but your credit history is the most significant contributing factor.  A person with an excellent repayment history (no late payments) is considered a good credit risk and may enjoy a rate as low as 6%.  Another person buying a similar vehicle could pay as much as 20% if their credit history is poor.  Keep in mind that interest is in addition to the original price, and can add as much as 35% to your total cost.  If you have no credit history or your report is poor, you will be required to have a co-signer or personal guarantor for your loan.  Technically the co-signer is taking the loan out for you, but you are making the payments.  If you find yourself in this situation, make sure you can make the payments on time, as ruined friendships and dysfunctional family situations  result from poor credit behavior.  Successful repayment of a co-signed loan will not benefit your credit history unless the co-signer sends the lender a notarized letter stating that you made the payments and deserve credit for completion of the installment plan.  

Down Payments - Most people will need a down payment (for a loan) or capital reduction payment (for a lease) in order to qualify for the loan or lease.  By reducing what you owe your payment will be lowered, so make as large a down payment as you can possibly afford.  

Hidden Expenses - The Cost Of Ownership is on the next page >

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