Car Loan “Rules” to Always Break
We’re sure you’ve heard them: the car loan “rules” you always should follow. Here’s an example of one of our favorites:
- Know your monthly budget and what you can afford in a monthly payment and never go above it.
But this “rule” – and others – is wrong.
Read below for three car loan “rules” you should always break!
- Focus only on your monthly payment.
This is the number one rule to break. Why? Because a sharp salesperson who knows this number will help make sure you pay the monthly budget you have, possibly “helping” you to decide to purchase a car more expensive than you’d planned.
Instead, you should focus on the price of the car. (You can figure out the monthly payment on your own, away from the dealership). Don’t forget that your monthly payment includes interest on the loan and that the first several months of your loan payments are going only to pay interest, not the principle. You therefore pay a LOT more for a car than just its sticker price.
So if the salesperson shows you how a more expensive car can be financed in such a way that you still meet your monthly payment budget, look at what just happened: you’ve just bought a more expensive car! One that will cost you even more in the amount of money you’ll pay in interest over the years.
- Don’t even buy: lease a car; the monthly payments are less.
While it’s true that you’ll be paying less each month on a leased car than on one you purchase by financing, it’s not your car and you need to return it at the end of the lease period. If you go over the mileage as stipulated in the lease agreement, you could find yourself paying a few hundred or even a few thousand dollars extra at that time.
Buy a good used car and maintain it properly and it can last you far longer than the two- or three-year lease, saving you considerably over the long run.
- To help with the monthly loan coasts, opt for a longer financing term.
Again, while it’s true you will pay less per month on a five-year loan, the total cost of your car will be much greater than if you took out a three-year loan.
With a $15,000 loan at 6.5 percent APR over three years, your monthly payment will be around $460. You’ll also end up paying $1,550 in interest over the three years. So you’ll end up paying $16,550 for the loan.
Take out a five-year loan at 6.5 percent APR and you’ll see a monthly payment of $293, but your total interest comes to $2,610, so the loan costs you $17,610.
Now, saving $1,060 may not sound like much, but don’t forget that long loans often come with higher interest rates, so you may end up paying more than 6.5 percent APR, increasing the amount of interest you pay. That same loan could end up costing you $18,500 or more.
In addition –and this could be very important – longer term loans mean that it will take longer for your payments to even start giving you equity in the car. That is, taking out a five-year loan could mean that it might take you 1.5 years before the car is worth more than your outstanding loan amount. This means that if the car is totaled in an accident or is stolen, the amount you receive from your insurance company won’t be enough to pay off the remainder of your loan!
Bottom line: do your research before looking for a car loan. Don’t fall in love with a car and then work to finance it. Know how much you can afford, then go shopping.
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