How to Financially Prepare to Buy a New Car

Don't plan your financing at the dealership

Photo courtesy reynermedia

You’ve done all your homework. You know exactly what make and model vehicle you want, even down to the wheels and tires. It’s time to head to a dealership to finalize the purchase. And that’s where most people make the biggest mistake in buying a car: not being financially ready.

Too many people leave it up to the dealer to arrange financing, and that can be a costly mistake. What people often save for the last step—arranging financing—should be the first step.

Stephanie Brinley, a senior analyst – Americas for IHS Automotive, said at U.S. News that doing your financial homework helps you determine the overall cost of a new vehicle. She said that should include not what you want your monthly payments to be, “but in total, factoring in things like loan costs, maintenance and insurance.” Her advice is to start this process about 3 months out.

Another reason to start the process early is to see what your credit score is. Experts say if it is below 720, you’re not going to get the optimal interest rates. Also, if there are late payments on your credit report, even waiting 6 to 9 months can help improve your score (assuming you clean up the late payments).

Allow me to share an anecdote from personal experience that will demonstrate how you can benefit from preparation. When it came time to buy our last new car, my wife and I arranged financing through a reputable, online company. That way we knew before car shopping how much we could afford.

That helped immensely when it came time to sit down at the dealership. The finance manager ran our credit and came back with a loan rate a full 1 percent above what we had been offered. Without having been previously prepared, our $15,000 loan would have cost us $17,241 over 4 years. Instead, it cost $16,909. That discrepancy gets bigger with a longer loan.

Loan length is another reason to arrange financing ahead of time. Simply put, if you have to finance a vehicle for 7 years, your budget can’t afford it. Dealers will try to sell you on monthly payments. That’s the worst way to finance a car, because you really need to look at the total cost of the vehicle—not just the monthly payments.

That begs a question. Say your monthly payments are going to be $350. Are you better off financing $15,500 at 4 percent for 48 months or $27,500 at 2 percent for 84 months? Both payments are roughly the same. But with the larger loan you will be under water for a lot longer. In effect, if something happens to your car, the insurance company is going to pay you less money than the balance of your loan. You will be paying for a car you can no longer drive.

Also, by paying off your loan in 4 years, you’ll be able to start setting aside money when it comes time to start thinking about buying your next car. Presuming standard usage, after a 4-year loan your new car should have about 60,000 miles on it. Reasonably, you would have at least another 40,000 miles before it was time to think about replacing it.

After you pay off a 7-year loan, your car will have about 105,000 miles on it—and you haven’t been able to set money aside. With the shorter loan, you have 3 years to set aside money; not so with the 7-year financing.

-Keith Griffin

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