Buying that new SUV, pickup truck or sports car you've waited so long for is an exciting life event - and it should be. However, the prices of new cars are climbing fast and hitting record highs. As a result, a staggering number of car shoppers are taking out larger and longer-term loans and landing in a dangerous cycle of debt. These practical tips will help you drive away in a car you're happy with and a car loan that won't put you in a risky situation.
Don't Let Temptation Take Over
Most car shoppers have a dream car in mind, but oftentimes that dream car doesn't fall into their budget. Ignoring the research and budgeting steps in the car shopping process can lead to an impulsive decision that lands the buyer in too much debt. Car loans make it possible for shoppers to bite off more than they can chew, and when they aren't able to keep up with payments they risk damaging their credit and even repossession. According to LendingTree, the average loan as of December 2018 was $23,438 which is 6.4% higher than three years before. Even more disconcerting is that 4.7% of outstanding auto debt is “seriously delinquent” (90 days late or more).
Before rushing into a dealership to buy your car, create a list of features that are important to you like good reliability ratings, plentiful cargo space or safety tech. Then compile a list of affordable cars that check most of your boxes. Just remember that if you're considering buying a new car, starting MSRPs can be deceiving. Make sure you're looking at the price by trim levels and price out all the extra options you're interested in so there are no surprises later.
Should you buy a new or used car? According to LendingTree, the average price of a new car in May 2019 was $37,185 which is an increase of 3.7% compared to the previous year. This can put a burden on many car shoppers causing them to stretch their budgets and spiral into multiple months of missed payments. A smart way to avoid this situation is to buy a used car that is a few years old. While still up 2.5% from last year, the average price of a used car is significantly lower at $20,247. As long as it comes with a clean vehicle history report and is inspected and cleared by a mechanic, you'll drive away with a great deal.
Scrape Up Cash for a Down Payment
An unexpected accident or mechanical issue can force someone into purchasing a new vehicle without much notice or planning. This emergency situation can make it difficult to put a large sum of money down when financing a car. If you have the luxury of time on your side, you should make sure you can comfortably put down 10% of the purchase price for a used car to 20% for new. In some cases, you'll be able to take out a loan without a down payment, but it's not advised.
So what's so important about having that $5,000 ready to put down on a $25,000 new car? First, if your credit score needs some help, a down payment will improve your odds of getting approved for your car loan. Your "Fair" or "Poor" credit score can be seen as a red flag for lenders and a down payment gives them confidence that you're responsible with your finances and can make your payments on time. Once you are approved, your down payment will reduce the total amount you owe on your loan, and make your monthly payments more manageable.
Another way that a down payment can save you from unnecessary debt is by lowering your interest rate. Your interest rate is determined by the amount of risk the lender assumes when approving your car loan. Those with poor credit often get stuck paying higher than average (even double-digit) interest rates. A 20% down payment can bring interest rates down into a more reasonable range and save you thousands of dollars over the course of the loan.
Play the Short Game
When you finance a vehicle, the available car loan terms come in increments of 12 months and usually range anywhere from 2 to 8 years. Anything over 5 years (or 60 months) is considered a long-term car loan and these financing plans are becoming more and more common. 72% of new car loans have terms of over 5 years and the average auto loan term is 69 months for new cars and 65 for used cars.
Following this trend is not recommended when financing your vehicle because the longer the loan term, the more interest you will pay over the course of the loan. You'll also be more likely to go upside down on your loan and own more than the car is worth. The proposition of the lower monthly payments for a long-term car loan can sound appealing, but it a risky move. When comparing auto financing offers, go with the lowest possible interest rates and the shortest possible loan terms, with the goal of not exceeding 60 months.
Beware of the Upside Down Car Loan
Being upside down or underwater on your car loan means you owe more on the car than it's worth. Even if you're not planning to sell your car for many years, being upside down on a loan is a dangerous game you don't want to play. If you lose your source of income and can't make payments, you can fall into a negative equity cycle.
If you need to trade-in your car before your loan is paid off and you're upside down, you may be able to do so, but you'll also risk falling into a debt cycle that's difficult to dig yourself out from. Most car dealers will take your trade-in, even if you owe more than it's worth. They're able to do this is by taking the amount you're upside down for on your current car and applying it to the balance of your new car loan. Some car owners do this multiple times and their finances spiral out of control with the ever-growing debt.
Instead of stretching out a loan to 6, 7 or even 8 years, consider going with a less expensive vehicle or buying a used car instead of new. When you buy an affordable used car, in addition to being able to pay it off faster and get a lower interest rate, you'll also bypass the instant depreciation once you drive off the lot.
What should you do if you have an existing car loan with terms longer than 60 months and/or a high interest rate? Your best bet can be refinancing your loan to make the terms and interest more favorable and reduce your chances of drowning in debt.