But many Americans make big mistakes buying cars. Take new car purchases with a trade-in. A third of buyers roll over an average of $5,000 in debt from their last car into their new loan. They're paying for a car they don't drive anymore. Ouch! That is not a winning personal finance strategy.
Ways To Buy A Car Without A Loan
"The single best advice I can give to people is to get preapproved for a car loan from your bank, a credit union or an online lender," says Philip Reed. He's the autos editor at the personal finance site NerdWallet. He also worked undercover at an auto dealership to learn the secrets of the business when he worked for the car-buying site Edmunds.com. So Reed is going to pull back the curtain on the car-buying game.
For one thing, he says, getting a loan from a lender outside the car dealership prompts buyers to think about a crucial question. "How much car can I afford? You want to do that before a salesperson has you falling in love with the limited model with the sunroof and leather seats. "
So Reed says having that preapproval can be a valuable card to have in your hand in the car-buying game. It can help you negotiate a better rate. "The preapproval will act as a bargaining chip," he says. "If you're preapproved 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 of the terms, meaning the down payment and the length of the loan, remain the same."
So at the dealership, Reed and Van Alst both say, the first step is to start with the price of the vehicle you are buying. The salesperson at the dealership will often want to know if you're planning to trade in another car and whether you're also looking to get a loan through the dealership. Reed says don't answer those questions! That makes the game too complicated, and you're playing against pros. If you negotiate a really good purchase price on the car, they might jack up the interest rate to make extra money on you that way or lowball you on your trade-in. They can juggle all those factors in their head at once. You don't want to. Keep it simple. One thing at a time.
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 feel the dealership is lowballing you on your old car. You have plenty of other good options these days.
"Concerning the extended factory warranty, you can always buy it later," says Reed. "So if you're buying a new car, you can buy it in three years from now, just before it goes out of warranty." At that point, if you want the extended warranty, he says, you should call several dealerships and ask for the best price each can offer. That way, he says, you're not rolling the cost into your car loan and paying interest on a service you wouldn't even use for three years because you're still covered by the new car's warranty.
A third of new car loans are now longer 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 a colleague at NerdWallet actually bought a minivan recently and "when she got home, she looked at the contract." She had asked for a five-year loan but said the dealership instead stuck her with a seven-year loan. "And they included a factory warranty which she didn't request and she didn't want." Reed says she was able to cancel the entire contract, remove the extended warranty and get a rebate on it.
"The single best advice I can give to people is to get preapproved for a car loan from your bank, a credit union or an online lender," says Philip Reed. He's an automotive expert who writes a column for the personal finance site NerdWallet. He also worked undercover at an auto dealership to learn the secrets of the business when he worked for the car-buying site Edmunds.com. So Reed is going to pull back the curtain on the car-buying game.
For one thing, he says, getting a loan from a lender outside the car dealership prompts buyers to think about a crucial question: "How much car can I afford? You want to do that before a salesperson has you falling in love with the limited model with the sunroof and leather seats."
"The preapproval will act as a bargaining chip," he says. "If you're preapproved 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 of the terms and conditions, meaning the down payment and the length of the loan, remain the same."
The salesperson at the dealership will often want to know if you're planning to trade in another car and whether you're also looking to get a loan through the dealership. Reed says don't answer those questions! That makes the game too complicated, and you're playing against pros.
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 feel the dealership is lowballing you on your old car. You have plenty of other good options these days.
A third of new car loans are now longer than six years. And that's "a really dangerous trend," says Reed. We have a whole story about why that's the case. 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.
As with other types of loans, you pay a lot more interest than principal in the early years, so you're paying off what you actually owe much more slowly in a seven-year loan. "There's so much interest front-loaded in that," says Whitmire.
Seven-year car loans are financially dangerous because cars depreciate in value the moment you drive off the lot. "You're waging this battle against depreciation because basically you're paying off a loan while the car drops in value," says Reed.
One big risk is that you might need to sell the car well before seven years. You might lose your job, or you have a kid, or a third kid and need a minivan. When you go to sell that car on a seven-year loan, you're likely going to find out that you owe thousands of dollars more than the car is actually worth.
A lot of people could apparently use this advice. According to industry data, 32% of new car buyers with a trade-in are rolling over about $5,000 in negative equity into their next loan when they buy a new car.
"Concerning the extended factory warranty, you can always buy it later," says Reed. "So if you're buying a new car, you can buy it in three years from now, just before it goes out of warranty." At that point, if you want the extended warranty, he says, you should call several dealerships and ask for the best price each can offer.
Are you on the car loan merry-go-round? Do you pay off the loan from one car and immediately borrow money to buy another one? Or, do you buy a new car and trade in the old one before completing all of your payments, carrying over your old loan balance to the new loan? If you do, you are on the car loan merry-go-round, and it's time to make a plan to get off. It is possible to buy a car without borrowing money.
Pay Cash
The best way to stop the ride is to pay cash for a vehicle or to pay off the loan. Surprisingly, many people seem to have sufficient cash available in their savings account but still borrow money to buy a car. With rates on car loans currently between 5% and 6% while savings accounts typically pay far less than 2%, it makes no financial sense to borrow money to buy a vehicle. But remember, despite the difference in interest rates, everyone should keep sufficient cash available to cover emergency expenses. Only money above and beyond the minimum emergency fund should be used for a vehicle.
Lower the Price of the Car
If you do not have enough cash to purchase your desired vehicle without a loan, work to lower the cost of the car. Instead of a new car, purchase used; instead of a luxury model, purchase a smaller, more economical car. Cars that cost less to buy often cost less to own. For example, insurance rates are based on the value of a car, so less expensive cars usually cost less to insure. Small cars may also be more fuel-efficient than larger models and maintenance costs are often lower. A friend recently reported that replacing a broken sun visor on a Mercedes would cost $500. That same part on a Ford may cost $50. These savings add up over time.
Break the Cycle
The car loan cycle often begins with young adults purchasing their first vehicle following graduation. Transitioning from starving student to employed adult often means no cash savings, making the loan necessary. Minimize the amount of money borrowed for that first car by buying a low-cost used car, and keep the length of the loan as short as possible. As soon as the debt is paid, redirect the monthly payments into a personal savings account and keep paying yourself month after month. By the time you need to purchase a new vehicle, cash will be available.
If you have been on the merry-go-round for a while, more drastic steps may be needed. Can you sell the car with the loan and then apply the proceeds to pay off the loan? If yes, consider doing that, and then downgrading to a less expensive car that you can pay for in cash, or that would have a much lower monthly payment, or a much shorter loan period. Getting the best value when buying a new or used car is relatively easy given the vast amount of information available on the Internet. Websites like Kelley Blue Book and Edmunds.com provide purchase and sales price information for new and used vehicles throughout the country. Arm yourself with this information before beginning negotiations. These websites also provide valuable hints and tips on buying vehicles.
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