Did you know that in the 1950s, only 25 million cars were produced and sold in the U.S.? This number has now surged to 278 million cars, meaning that up to 91.7% of households own at least one car.
In this article, I want to share with you some incredibly important information to consider before making a decision to purchase a car.
Things You Need to Know Before Buying a New Car
Unlike real estate, a car is considered a depreciating asset - its value decreases over time. According to a report by Morgan Stanley, cars are the world's most underutilized asset. Therefore, if you spend too much unnecessary money on buying a car, you'll end up bearing significant monthly costs.
Let's take a look at the average costs when buying and using a new car:
- Car loan: On average, around $26,162 per year.
- Fuel costs: On average, 1 gallon will get you 25.4 miles (city) or 41 miles (highway). So, you'll spend about $150 per month.
- Insurance: Full coverage insurance averages about $168 per month, equivalent to $2,014 per year.
- Car Registration Fee: This fee depends on the purchase price of your vehicle (MSRP) and the state you're in, ranging from a few hundred dollars per year.
- Maintenance and repair costs, excluding expenses for personal vehicle upgrades.
- Depreciation: Right after purchase, your car loses 11% of its value, and within 5 years, it continues to depreciate by over 63% compared to a brand-new car.
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Now, I'm here to help you estimate a suitable budget for buying a car.
The 20/3/8 Formula
In this formula, you'll allocate 20% for a down payment. The loan term is within 3 years or less. But why 3 years instead of a longer period? Statistically, the average ownership lifetime of a car in the U.S. is 79.2 months. This is why if you finance a car for 72 months (5 years), you're practically stuck in a long-term debt loop. By shortening the loan term, you'll ease the burden of your car loan.
The 8% in the formula represents the portion of your annual income allocated for transportation. You should spend less money on this because, as I mentioned before, cars are depreciating assets. Their value decreases over time. So, it's wiser to invest your money in other areas.
The 20/4/10 Formula
Similar to the previous formula, you still set aside 20% for a down payment, but the loan term will be longer, around 4 years, and 10% of your income will cover transportation costs. By applying this formula, you can afford more valuable cars, but remember that it comes with higher monthly debt repayment pressure.
DTI (Debt-To-Income) Ratio
As I've shared in previous articles, DTI is the debt-to-income ratio, commonly used as a measure of an individual's financial capability. A DTI of 50% is the highest limit, but banks often approve lower percentages.
For example: If your monthly income is $10,000 and your DTI is 45%, your available amount for car financing consideration is $5,000. If you pay $500 for Credit Card and $2,000 for Student Loan each month, you'll have $2,500 left to be considered for a car loan approval.
Remember, it's crucial to manage your finances wisely and choose a car within your means. Making informed decisions will help you enjoy your new ride without unnecessary financial stress.
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Should You Buy a Used Car or Not?
Buying a used car has its benefits, one of which is the potential to save money on insurance, registration fees, taxes, and depreciation. However, the downside of searching for a used car is that you might only sometimes find the right fit at the exact moment you need it. Moreover, you have to carefully inspect the car to ensure it's still in good working condition.
Another challenge when buying a used car is that you need to know how to negotiate with dealers or thoroughly research market prices before making a decision. Unlike new cars, everything has a clear sticker price. When purchasing a used car, everything depends on the car's quality, mileage, remaining lifespan, and potential wear and tear.
You should check the Vehicle History Reports from Carfax (costs $44.99) or AutoCheck ($24.99) to examine important information about the car's previous owners, any accidents, mileage, warranties, and upgrades.
The decision between buying new or used ultimately depends on your preferences, budget, and individual circumstances. Both options have their pros and cons, and the key is to make an informed choice that aligns with your needs and financial situation.
To Buy or Lease: What's the Right Choice for You?
As of June 2023, the average car price in the U.S. is $48,800. If you need more time to be ready to buy a car or intend to own one, leasing a car could be an alternative solution.
Leasing a car offers several benefits
You get to drive the latest models, still within the manufacturer's warranty period. Many people enjoy leasing because every three years, you can switch to a new car and keep up with the latest releases. Additionally, since the car is new, it operates well, and all its functions are ensured.
New lease agreements might also come with promotions such as free oil changes or regular maintenance. If you're a business owner, a lease agreement can also serve as a tax deduction.
Before deciding to lease a car, you need to thoroughly research the following information:
Contract Length: When leasing a car, you'll sign a contract with the dealer for 1 to 5 years, with an average of 3 years. It's important to think carefully because once you've signed a lease agreement, you can't change the return term. If you return the car before the agreement ends, you'll face an early termination fee.
Mileage Limit: Lease contracts usually have a mileage limit, typically around 10K - 12K or 15K miles. If you exceed this limit, you'll have to pay an additional 15-25 cents per mile. Calculate it out; if you drive over 2.5K miles beyond the limit each year, that adds up. Therefore, leasing is suitable for those who don't drive excessively or work from home.
Residual Value: Dealers base your monthly payments on the car's value at the time of leasing and its value after the lease ends. Usually, this figure is lower compared to purchasing a brand-new car.
Total Lease Costs: This includes the first month's payment, registration fees, taxes, refundable security deposit, paperwork fees, and any other potential costs.
If you want to transfer your current lease to a new one, carefully review the bills and documents to avoid promises from dealers regarding fee-free transfers.
Through this article, you've gained insights into planning your car purchase. An automobile is essential for life in the U.S., so allocating your budget wisely can ease monthly financial pressures, allowing you to invest in valuable assets like real estate.