Budget, Credit, Debt, loans

Auto financing 101

Did you know the average car payment is about $500 month?

That the average car loan is for $30,000?

And the average loan term is over 5 years?

Those statistics can easily be found online but those figures are pretty disconcerting.

There are many (MANY) articles (not even kidding – Google it) that suggest that you should be following the 20/4/10 rule which basically states that you should be able to put down about 20% of the value of the vehicle you are purchasing, try not to finance for more than 48 months (4 years), and keep your monthly car payment at or under 10% of your gross (pre-tax) income.  This car payment should include the loan payment, insurance and any other auto related expense.

Most people far exceed these figures and many don’t put anything down when they purchase a new car.  Not only do they not put anything down but they over finance and end up spending more than what the vehicle is worth between interest and longer terms to make the payments lower.  
There are many vehicles, in many different price points and it is really important to do your research before you make such a large purchase.  In many cases, taking out an auto loan will allow you to get more car than you can afford.  If you go through a dealership they are more likely to try to push the envelope as far as loan terms to try to make the vehicle you want within your reach, which makes it that much easier for you to justify that payment and that vehicle instead of looking at something with less options or maybe something used as opposed to new.

My thoughts on auto loans – in my mind a vehicle is a necessity (in many cases).  But you definitely need to be able to afford your new vehicle and not let that vehicle own you.  That means you need to have payments that aren’t difficult to make and don’t cut into the rest of your budget.  You need to make sure that you have some equity in the vehicle you are purchasing and don’t extend the term of your loan to make the payments reachable.  If you can’t pay off your vehicle in 5 years or less, then you probably can’t afford that specific vehicle.

If you are purchasing a used vehicle, you need to make sure you have at least 20% equity in the vehicle.  You want to make sure your term is short since the vehicle has already depreciated in value and you are the second owner.  Some banks will give you a free Carfax so you can view the history of the vehicle.  You want to make sure it hasn’t been salvaged or that the engine hasn’t been rebuilt.  This information would show up on the title.  If you are going through a dealership, you want to make sure the title was properly signed over to them.

If you need a cosigner or a coborrower for your auto loan and it’s not because you have little or no credit history, then you need to think about purchasing your vehicle with cash.  I say this with love and not judgement.  Cosigners and coborrowers are necessary for those with poor credit history and lower FICO scores.  But, if you are struggling to deal with your current obligations, adding an auto loan to the mix is only going to hurt you and the other person who signs for you.  Buying a vehicle outright with cash is the best option as you don’t have to use someone else’s credit to get a vehicle that you may struggle to pay for.  And it is less likely you will hurt someone else’s credit or your relationship with that person by not taking the risk.