STRATEGIES FOR FITTING A CAR PAYMENT
What's your car payment threshold?
You know, the amount of money you just can't or won't exceed each month for a car payment? Researchers at CNW Marketing/Research in Bandon, Ore., say the threshold for most buyers is about $328 a month.
Your personal threshold may be higher or lower. Maybe you have other priorities now and your threshold, even stretching your budget to the max, is more like $128 a month! Here are some ways to manage your monthly payment, and the impact each will have on your personal finances.
-- affects the size of a monthly payment and what you'd otherwise earn by saving or investing the money. Keep in mind, savings form part of your safety net against unknown future financial challenges, and help you reach personal goals such as continuing education or a special vacation. So just because you have money in savings doesn't mean you automatically should put it toward a down payment. Still, if you find car payments out of reach, perhaps saving more money for a down payment before you buy is your key to driving a car you can afford.
Longer loan term
-- Reduces your monthly payment, but you'll pay more overall for credit, a trade-off you may be happy to make. And, even with a longer loan, you always have the option of paying more any month you're able to. Just be sure you'll pay no prepayment penalty (dealers may impose this penalty; credit unions seldom do). And ask about the "rule of 78s." Lenders calculating loans this way make you pay more interest in the opening months of a loan, so if you pay off the loan later in the term but before maturity, you won't get much of a break on the financing expense.
Home equity loans
-- Can be the least expensive way to borrow, but may take some time to set up. If you itemize deductions on federal income taxes, your after-tax interest rate is lower because you can deduct home equity loan interest (just confirm with your tax adviser).
But remember up-front costs to obtain this type of loan. As with any mortgage loan, you're likely to pay fees for an appraisal, title insurance, a title search, a credit check, and so on. On the calculator below, add fees to the total borrowed only if you roll fees into the total loan. If you pay fees out of pocket, remember that they increase your cost of borrowing even if not expressed in the calculation below.
Another point: Some lenders only ask you to pay 2% of the outstanding balance of a home equity loan each month. As described in the section "longer loan term," this increases your borrowing expense, although it certainly will keep payments affordable. Think of it this way -- you can take longer to repay a home equity loan, but the cost of doing so (in higher total interest expense) could eat up your tax savings. To make a better comparison between a home equity loan you use to buy a vehicle and a conventional vehicle loan, use the same number of months for each. In other words, compare a 72-month auto loan with a 72-month payback on a home equity loan.
The result won't tell the whole story because the interest rate for a home equity loan typically will be higher than for a conventional auto loan. That means your monthly payment may be higher even if the final after-tax cost turns out to be lower. And, home equity loans often have variable rates, so be prepared for your rate to adjust upward.
Finally, before using this type of loan to buy a vehicle, make sure you don't have other priorities for your home equity -- such as paying education expenses, starting a new business, or improving the house.
Take the rebate
-- if available, and add it to any down payment you already have, plus the money you'll get by selling your car (use the retail value in your credit union's pricing guide) or by trading it in (use the wholesale value from the same guide). A higher down payment, no matter from what source or sources, reduces your monthly payment and your total finance expense.
And remember, taking the rebate often makes more sense than accepting a dealer's low-rate financing: Usually, the low rates that most dealers advertise are for short-term loans. For example, one dealer offers 1.9% financing, but that's only available on two-year loans. A new $20,000 car with a $2,000 down payment (10% down) will require $18,000 financing. This translates to an astounding $765 monthly payment -- clearly out of reach for most buyers.
If you choose this dealer's rebate plan, you forego the low-interest-rate loan but get a $1,500 cash rebate. Adding the rebate to your down payment can make credit union financing very attractive, because the larger down payment reduces the amount you need to finance.
-- is a price you negotiate, not the manufacturer's suggested retail price (MSRP). Use pricing guides available free at your credit union or public library, or on-line (for a fee), to determine a realistic starting place.
-- Any one of these strategies will help reduce your borrowing expenses, but combining them really pays off. Use this calculator to compare your financing options. Don't worry if you don't have a trade-in, or if you're not planning to use a home equity loan. Fill in the fields that apply to your situation, and leave blank any fields that don't apply.