Preparing a Car Budget
If you're planning to buy a car, you are in for one of the biggest financial decisions in your life. For this reason alone, creating a good car budget is essential.
Before you buy a car, you should be prepared to pay for insurance costs, oil changes, regular maintenance, and unexpected costs. Once you're ready to start looking, finding money for a car is the next hurdle.
Unless you can pay for the entire price of the car in cash, you'll probably need a car loan. It's important that you know how much you want to spend on the car and pay off your loan within a specific amount of time to avoid paying too much in interest.
A good rule of thumb is to have enough money to put 20% down on the car. If 20% is still too much, you may want to think about a cheaper car, or hold off on buying altogether. Putting down 20% helps to keep the car from turning upside down—where you owe more than the car is worth.
The optimal loan period is 48 months. Take the price of the car minus your down payment. Then divide the remaining balance by 48 months. Can you afford that monthly payment? Remember that's not even counting interest. Then there's insurance, gas, maintenance. If you can afford all of this, then seek out a loan.
If you choose to get a loan—be prepared. Go in to the dealership knowing your credit score. If you have no credit history or bad credit, your chances of loan approval are extremely low, and if approved, your interest rates will be extremely high.
Lenders want to see an established pattern of credit showing you have paid your bills on time, etc. If you have credit cards, keep them to a minimum number of accounts, and keep the balances lower than 30% of your credit line. Lenders do not want to see late or minimum payments. Try to pay off as much as your credit card debt where you can.
To establish good credit history, you might have to put off buying a car for six months. The simplest way is to get a gas card, or a small retail card. Shop normally, but pay the balance in full every month—your patience with this process will pay off in the long run.
Over time, a credit score of over 700 is what you're aiming for—anything under 550 with bad marks on your credit record won't be considered by most lenders. Again, patience is key—if your loan request is rejected, don't resubmit it immediately, over and over again, as it will only drag your score down further, keeping you away from getting that car and a lower interest rate.
This table shows the average monthly car payment on a 15,000 dollar car depending on your interest rate.
Interest Rate (% APR) Monthly Payment Total Interest Paid on loan in 48 months 4% (Good Credit) $339 $1257 10% $380 $3261 15% $418 $5038 21% (Bad Credit) $464 $7296
Another way of establishing credit is through a co-sign loan. With this type of loan, a co-signer with a good credit score (most likely your parents) essentially vouches for your payment, and subsequently agrees to take over payment of the loan in the event that you do not pay. This is a serious agreement to ask someone to enter in with you, since they will have to pay if you choose not to, and your actions could have serious consequences for someone else's credit record. For this reason, it's better to ask close family members to help you out with this loan.
What lenders look for to approve you for a car loan
- Documented monthly income of $1600 or more
- Living at the same address for at least 6 months
- Employed by the same company for 6 months
- A year of established credit with no black marks
- Credit score of 680 or higher to get the lowest interest rates
- If your credit score is 600 to 680 you'll pay higher rates like 10%-15% APR
- If your credit score is below 600 it's very difficult to get approval, and below 550 it is nearly impossible
But getting a loan is only the beginning. If you're paying for your car on your own, you'll need a steady income that covers your loan payment, and all other costs of owning a car.
Insurance and maintenance costs
Unfortunately, with insurance, age is against you. Young drivers usually have to pay at least $2,500 a year. That's about $200 a month to add to your car budget. There are some things you can do to lower this payment. You can take a drivers safety class to get a safe driver discount, register as a part time driver, keep good grades, install a car alarm, buy a four-door car. Find out what you can do by speaking with your insurance agent.
In addition, there's maintenance costs and fuel. Gas is only getting more expensive: on an average sedan with a ten gallon tank, if gas is 5 dollars a gallon, filling up your tank just once a week will be $50 dollars. That's $200 a month, or $2400 a year. Oil changes every 3000 miles are about $30, but can cost half that if you do it yourself. Assume that your tires will need replacing once a year—with dependable car tires around $150 each, that's $600 annually. Together, gas, oil, and tires may be very costly.
Car budgeting isn't just about getting the car. It's anticipating the expenses that will come down the road. Just remember not to bite off more than you can chew—if gas and maintenance costs are too much, consider a cheaper car.
Budgeting for a car is about knowing your bounds—a new Corvette might be too much, but a reliable car that gets you from point A to B could be just the thing.
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