Financing Your Vehicle

Most car buyers fall into two categories, ‘ I need to buy a car right now’ and ‘I’m planning to buy a car sometime soon. The first group needs a car because the one they have is dead or dying and the cost of repairing it is too high. The second group has more time.

I Need To Buy A Car Right Now 

Many used car buyers fall into this category. You need a car right now because your vehicle is dead or dying. They’ve been to the shop and it’s going to cost more to fix than it will to get another car.

If you are in this group you’re going to make your purchase within days, which means you can’t fix your credit, you don’t have a down payment and you haven’t gotten financing from a bank or credit union. If this is you, this is what you need to do:

Buy the cheapest vehicle you can that’s reliable – explain to the dealer(s) you are working with that you need something cheap and reliable and that if the dealer works with you you’ll trade up when you improve your credit and save for a bigger down payment. 

Start planning and saving for the next car – Assuming you can get into a cheap dependable car, use the 6-12 months (or more) go through the steps outlined in the next section.

I’m Planning To Buy A Car

Buyers who are planning to get a car sometime in the future can use the time to improve their credit, save for a bigger down payment, and in general increase their financial position with the goal of buying a better, newer car at a lower interest rate by going through the steps outlined in the next section.

Getting the Right Financing

It should be pretty clear by now that the most difficult thing to figure out when you are buying a car is what you can afford to pay in terms of total cost and the all important monthly payments. Figuring out what you can pay isn’t simple because it involves your finances, credit, interest rates and loan length , but if you follow a few simple guidelines, you’ll have a much better understanding of what you can really afford and you’ll probably get a better deal in the bargain.  OK lets get started:

Make a budget -Because what you want and what you can pay for are often different, the first  thing to do when you go to buy is to start by making a realistic budget with all of your monthly expenses, and we mean everything. This will give you a pretty solid idea of what you can afford before we get into credit, interest rates and loan length. To make budgeting easier we’ve provided a link to a simple budget that you can download. [NEED TO INSERT DOWNLOADABLE LINK]

Using it is simple, all you do is fill in all of the blanks that apply to your life and it will automatically calculate your annual budget then tell you how big a payment you can make every month without getting into trouble. Don’t fill out the transportation section we’ve entered in the average cost of gas and maintenance, the spreadsheet will do the rest.

If some of the sections don’t apply, don’t worry, just leave them blank. When you’re done you’ll have a budget minus the car payment. The spreadsheet will automatically calculate your potential monthly car payment in the last line (line 100). Keep in mind that this doesn’t include any down payment and as we will explain you need to plan for that. While we strongly suggest you use the spreadsheet or get someone to help you, if you don’t want to or can’t, just copy the budget items to a piece of lined paper and calculate the monthly costs in the same way.

Manage your credit – Once you’ve figured out how much you can afford to pay each month, the next step in the process is to find out about your credit. Its easy to access you score. The largest credit bureaus like Equifax and Experian offer free credit scores. Here’s  a link to Experian’s free product, (https://www.experian.com/consumer-products/free-credit-report.html ) and it’s easy to find on the other sites

Credit scores are critical because they determine the interest rate that you will ultimately pay. This is particularly true for used cars. As a rule the rate of interest a dealer, and more important the lenders they use will give you depends more than anything else  on your credit history. Bad credit, high rates. The following table will give you some idea of how much interest you will typically pay based on your credit score:

The good thing is that most people can improve their credit scores with the major credit scoring firms like Experian, Equifax and others by filing dispute, paying down the cards and making sure they pay on time. There are lots of sources of information on managing your credit but the single best source we’ve found is the Consumer Finance Protection Bureau, a government agency that specializes in helping consumers of all kinds with credit and other consumer issues. They have a lot of information including detailed documentation on how to improve your credit score. We’d recommend starting at (https://www.consumerfinance.gov/consumer-tools/credit-reports-and-scores/ ).

The important thing to understand here is that you can absolutely increase your score if you have the time. Depending on where you start it can take weeks or months, but with a few simple steps you can increase your score substantially. The most important things to do to increase your score are:

• Fix errors on your credit reports – Look at your credit report and if you find any errors (usually late payments) that you can dispute and document the credit bureau will take them off. Disputes typically take up to 60 days to resolve, but if you are diligent disputes will have a big impact
• Stay below your credit limit – credit bureaus pay close attention to how far below your credit limit you are. As a rule you should be 50% below your limit
• Deal with past due bills – Paying your bills on time and sometimes before they are due shows that you have extra money, and are therefore a better risk

As you will see from the link we’ve provided you with there are lots of other techniques to improve your score, but if you focus on these three simple approaches you’re score will go up.

Understand Interest and Loan Terms – Once you’ve improved your credit score, understanding the relationship between interest and the length of the loan is the next step. The current average interest rate is 9% and if you’ve already gotten a loan from your Credit Union which we recommend in the previous section, you’ll be paying in that range. If you couldn’t get a loan you’re going to deal with the dealer and they charge higher interest rates, sometimes much higher.

Used car dealers often charge 15% or more for loans  because they borrow from what are called ‘sub-prime’ lenders who charge high rates based on the credit score of the borrower. In some cases the rates can go up to as high as 20%-25% for people with no or bad credit histories. Often dealers who finance cars will try to mask the interest rate by focusing the buyer on the monthly payment and stretching the loan period out until the car is within range.

This approach works for dealers because as discussed earlier, most buyers are focused on the monthly payment and they think of it the same way they think of paying their cell phone or utility bill it’s easy to just think of it as a monthly cost. The thing to understand is that you are BUYING the car (unless you lease) and the longer the term of the loan, the longer you have to pay before you OWN the car. Given how long used cars last today, this is a really important thing to consider. As a rule the average buyer should not even consider a loan whose term is 48 months or longer, and we recommend that your loan term should be no longer than 36 months and that you calculate your payments based on this and back them into your budget

The key thing for a smart buyer is to understand how much those interest rates really amount to. There are lot of interest rate calculators and what you want to use is an ‘amortization’ calculator for example (https://www.amortization-calc.com/auto-car-loan-calculator/) which calculates exactly how much interest you’ll pay over the life of a loan. You’ll be surprised at how much interest you pay. Its not unusual for interest payments to be 25% of the total purchase price over a 4-5 year loan period. This is why we tell you to limit the loan length to 36 months.

The final thing that every buyer should do is buy what’s called GAP insurance. GAP insurance is a type of policy that covers the difference between the loan you take out and  the value of the car in the event you get into an accident. GAP insurance essentially pays the difference. Let’s say someone takes a loan for $15,000 on a car and gets into an accident. The insurance company decides the car is totalled and calculates the value of the car at the time of the accident at $10,000, the owner of the car still owes $5000 on the loan. If the owner has GAP insurance it pays the $5000 difference (hence the term GAP). If not the owner still has to pay off the loan at the time of the accident. You can see from this how important GAP insurance is and why we advise EVERYONE who buys a car to get GAP insurance.

Financing Scenarios

By now you may be a bit confused so we’ve created a couple of examples that will help you understand both the relationship between price, interest rate and loan term and how to deal with situations where you have to get a new car because the one you have has died or been repo’d. (Note: The calculator we used doesn’t factor in your down payment which as we’ve said before should be roughly 20% of the cost of the car).

Example 1 Luis –  Luis is a 34 year old single male with no children who lives on his own and works as an insurance agent. He made $52,000 in salary and commissions last year and expects to  make more next year. He has money for a downpayment, but had some issues in the past that hurt his credit and now has a credit score of 680. He has his heart set on a 2014 Infiniti QX 50 4WD SUV which Kelley Bluebook says will cost roughly $18,660 including sales tax, title etc from a dealer in the city where Luis lives. It’s a good car for Luis and fits his active lifestyle. Luis has also saved $4000 for a down payment which takes the car cost to right around $15,000.

Technically Luis shouldn’t buy the car if we go by the 25% rule, but when he uses the budget calculator, because he has no family related expenses and doesn’t spend a lot of money on going out, the calculator shows him that he can pay up to $600 per month and a loan at 13% which is average for his credit score comes out to $530 per month with a 36 month loan.Luis will be OK. We used this example to illustrate the fact that if you use all the tools and techniques we’ve shown you there is some wiggle room.

Example 2 Maria  – Maria is a far more typical used car buyer. She and her husband make $78,000 per year, have two kids, a second car and a mortgage. Maria has a 10 year old Camry that runs OK, but their mechanic has told them it will require major engine work in the next 6-12 months and that will cost $4000.

When Maria and her husband add all of their costs to the budget calculator it tells them that they can’t afford a monthly payment of more than $380 per month. Based on an income of just under $40,000 for Maria shouldn’t even consider a car that costs much more than $10,000 and assuming that she wont have much of a down payment the real amount she can pay is probably closer to $9,000 when you factor in taxes, title etc..Add to this the fact that Maria and her husband pay most of their bills by cash so they have very little credit history which will mean they will probably be charged north of 20% for financing from the dealer.

While Maria would like a newer/nicer car she and her husband should keep the car they have for at 6-12 months and use the time to increase their credit score and save money for a downpayment.

Example 3 – The third example is the one no one wants to get into, the one where you need a car now.   There are different variations of this, but the bottom line is that you don’t have time to save, shop extensively, or improve your credit score. The approach you take at this point depends on whether you owned the car outright or borrowed money to buy it.

You Own The Car

If you own the car outright you’ve got several options:

Collect the insurance and buy another car – if the car is totalled and you have good insurance the simplest thing to do is to collect the insurance and go get another car

Borrow money and fix it – if the car just died but you have credit, the best alternative is to borrow the money to fix the car – either from a finance company or if you have to on a credit card. You’ll have to pay off the loan as quickly as possible, but this will improve your credit score and you will have a car to sell or trade-in when you buy the next one

Sell the car for salvage – If you can’t borrow the money and the car just died, the next alternative is to call up a salvage yard and see  what they’ll give you for the car. Typically a junk yard will discount the Kelley Blue Book value of the car by 60%+.Painful, but in a lot of cases a salvaged car will give you enough for a downpayment on another car.

You Owe Money On The Car

If you have a loan on the car you’ve got fewer options:

Use GAP insurance to pay off a totalled or stolen car and buy a new one – if you had GAP insurance on your car – which you should always have – it will cover the difference between what you still owe and the insurance settlement. Not great in the sense that you lose what you’ve put in the car, but good in the sense that your credit will be good as you will have paid the loan off which will make getting another car easier.

Get the finance company to lend you some percentage of the money –  While it may sound strange, getting your finance company to lend you the money to get the car fixed is pretty standard, particularly if the car is relatively new. Typically the finance company will lend you some percentage, but not all of money to fix it and extend the  length of the loan. This is by far the best approach since it gets you on the road and keeps your credit solid.

The last and most unpleasant scenario is that your car got repossessed. There’s not much you can do in this case other than saving for another downpayment and finding another  car. To be honest you’re going to pay a high interest rate, so the thing to keep in mind is that you want to buy a cheap, dependable car and work on repairing your credit by paying it off as quickly as possible. At this point the most important thing is repairing your score. Just get something that runs and mind your finances.

Everybody’s car experience is unique, but as you can see from the examples above if you follow our guidelines, you’ll be able to buy the car you need. Everyone can repair their credit and everyone can almost always get a car that is dependable for a lot less than the car they want. You just have to be disciplined…