How Much Should You Spend On A Car?

Thinking about getting a new ride?  Buying a new car can be an exciting time as you start to imagine yourself cruising around in a new set of wheels.  But it can also be stressful the more you get thinking how much you can afford, haggling with the dealerships, and trying to avoid getting ripped off.

Never fear!  Here’s everything you need to know about buying a car without spending any more than have to.

how much should you spend on a car

What Does A New Car Typically Cost?

Let’s say you’re about to go shopping for a brand new, light-duty vehicle.  What kind of prices could you expect to find?

While the total price of a car should always be taken into consideration, unfortunately, it’s not.  Financing has skewed the perception of buying a car so that most people think only about the monthly payment that they’re going spend.  Here’s why that’s bad. 

The Misconception Of Auto Loan Financing

Just like taking out a mortgage on your home, most people can’t afford to walk into a car dealership and buy a car outright.  That’s why lenders have been offering 48-month (4-year) and 60-month (5-year) loans for decades.  By breaking down your car purchase into smaller, more manageable bite-size pieces, more people will effectively be able to purchase a car.

However, nowadays you can find loans for 72 months (6 years) and even 84 months (7 years).  While a longer loan might “seem” better because your payments will effectively be smaller every month, they’re generally not a good idea. 

Not only will you pay substantially more in interest over the life of an 84-month loan, but keep in mind that you’ll also be making payments on a vehicle that’s losing significant value every year (more on that to come).  Think about if you bought a used car that was 5 years old with an 84-month loan.  There’s a good chance the car would die before you’re even done making the payments!  

However, according to Experian, this trick from the lenders is regrettably working.  38% of new-car buyers in the first quarter of 2019 took out loans of 61 to 72 months, and 32% of car shoppers are signing loans for between 73 and 84 months.

Used-car financing is unfortunately just as bad.  42.1% of used-car shoppers are taking 61- to 72-month loans, and another 20% are financing between 73 and 84 months.

Auto Loan Financing

Insurance And Registration

Let’s not forget that when you’re budgeting for a car purchase, you have to also be conscious of how much you’ll be spending year after year on the insurance and registration.  Newer cars are going to demand the greatest rates while used cars will typically carry lower expenses.

The Depreciation Of A Car’s Value

Perhaps one of the biggest factors that should be taken into consideration when you’re about to buy a car is the fact that your vehicle is going to rapidly depreciate in value from the moment you drive it off the lot.

To give you some idea of what you can expect, Carfax estimates the value of a new vehicle can drop by more than 20 percent after the first 12 months of ownership followed by an additional 10 percent every year for the next 4 years.  

Here’s an example to illustrate the decline in value:

  • New / sticker price = $37,851
  • Value after the first year = $30,281 
  • Value after the second year = $26,496 
  • Value after the third year = $22,711 
  • Value after the fourth year = $18,926 
  • Value after the fifth year = $15,140

This means the vehicle is worth approximately 40 percent of its original purchase price after five years.

Luxury cars and models that are in high demand tend to retain their value a little bit more.  But overall, they are still depreciating year over year.

Your Best Car Buying Strategy

Buying Strategy

Taking all of these points into consideration, how can you get the best car without spending any more than you have to?

Buy Used

Clearly from the example above, buying a new vehicle makes no sense financially.  What you want is one that has already depreciated but still completely functional.  If you can find one that is 3 to 4 years old but in great shape with low miles, then this is the optimal price point.

Pump Up Your Credit Score

Anytime you’re about to make a big purchase or apply for a loan, you never want to underestimate the power of your credit score.  

While you don’t necessarily need the highest score of 850, according to Experian, a score of 660 or more seems to be a tipping point.  Consider that people with:

  • Scores less than 660 received loans with average interest rates of 7.52% to 14.41% for new vehicles and 10.34% to 18.98% for used cars.
  • Scores greater than 660 received loans with average interest rates of 3.68% to 4.56% for new cars and 4.34% to 5.97% for used vehicles.
  • Scores of 781 or more got even better rates!

Therefore, it pays to make sure your credit is on track.  If you haven’t already, check your score for free with Credit Sesame and download a copy of your report to make sure that it is free of errors.

Shop Around For The Best Price

The Internet has made it incredibly easy to find the price of just about any vehicle you can imagine.  You can use sites like CarGurus or Edmunds to quickly lookup and compare dealerships within a hundred-mile radius (or as far you’re willing to travel).  

By all means, spend some time comparison shopping and seeing which dealerships really have the best prices.  Be sure to also note the details of each of the options you find such as the mileage, condition, model year, engine size, interior type, etc.  Though initially, a price may seem higher through one dealer versus another, it could be the case that you’re getting a better package overall.

Get Pre-Approved For A Loan

To make more sales, many dealerships now offer financing through a variety of banks and lenders.  However, their rates may not always be in your favor, even if you have superior credit.

As a better approach, shop around for your own rates.  Not only will this take the pressure off of you when you go to buy your vehicle, but you also easily compare rates online or work with lenders who already know you (such as a local credit union).  Once you’re sure you’ve found the best rate, apply to get pre-approved for the loan.  This will usually be in the form of a letter that you can take with you to the dealership.  

Negotiate A Better Price

One of the great things about buying a car is that the price is rarely ever fixed in stone.  Most car dealerships are perfectly willing to work with you at a lower price.  But you have to demand it!  They’re not going to come right out and just offer it to you.  This is where being a little assertive can pay off.

Again, getting the loan pre-approved can be helpful in your negotiation strategy.  If you show that you’re serious about buying the vehicle, then the salesman might be more willing to lower the price if they believe they can make a sale.

Consider Leasing

If you really want the look of a new car but don’t want to pay full sticker price, many people swear that leasing the car is a better overall bargain.  Take this example from Consumer Reports where they analyzed the total amount of money spent on a 2017 Mazda CX-5 Touring with an automatic transmission.  After three years, you would have paid $16,976 out of pocket versus just $12,332 if you had leased the vehicle.

Just remember there are both pros and cons to leasing.  The most important one is that after the lease is over, you don’t own the vehicle whereas with a traditional purchase you do.  However, based on the residual value of a car after depreciation, that could end up becoming a moot point.

How Much Should You Spend On A Car: Final Thoughts

Buying a car can definitely get pricey, but now you know exactly how much you should spend on a car. Plus, you have also learned some good strategies for how to save and get the best deal for your money. Make use of this guide and spend what you should when you buy your car!

Buying a car comes with expenses; gas, upkeep, and even new tires. When the time comes to purchase new tires for your ride, you may enjoy our guide to the best time to buy tires.

DJ Whiteside

DJ Whiteside is a financial enthusiast who believes in helping other people to achieve financial independence. He’s constantly looking for practical ways to optimize savings, reduce spending, and create a lifetime of passive income. DJ holds an MBA from the University of Michigan, which allows him to take an analytical approach to financial topics. He has been a financial writer since 2011 and has self-published 5 personal finance eBooks relating to saving, retirement, and financial independence.

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