Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Friday, December 02, 2016

Figuring out loans and insurance with a new car purchase

The first car I owned was a 1999 Cadillac de Ville. White with blue leather interior. I could fit four adults comfortably on the front seat and the trunk was spacious enough for me to move into my first house in two trips. Unfortunately it was of an era less austere than now and that showed in its thirst for gasoline and oil. Frequent, expensive oil changes would frequently turn up expensive repairs  related to the oil. The car's history (it was once the unstoppable force that collided with a somewhat movable brick wall) also made it a looming liability. I swung the opposite way when I bought a Prius this past summer.

A quick note on leasing vs buying. When you are leasing a car, you do not own it. This will often give you the lower monthly payment but be very careful evaluating the deal. Traditionally, leases lower your monthly cost but raise your overall cost. However, sometimes manufacturers craft lease deals very attractively to entice more people to pick up their cars. Look at the total amount of payments and the purchase price at the end of the lease before jumping on one of these. This article will focus on the loans attached to a car purchase.

Unless you've saved up for a cheap used car you are probably going to finance your purchase. As always with debt, don't let the availability of cheap money tempt you into buying a more expensive car than you can really afford. Cars dot com has a great Affordability Calculator that you should have a look at before you even think about what you want. Plug in a reasonable monthly payment that works with your budget and see what the maximum you can pay is. The main unknowns will be the term and interest rate. The term is the length of time you will be paying the loan and the inters rate is the cost of the loan. For calculation purposes, check a fairly short term like 36 months.

But what term should your actual loan be? Having a longer term reduces your monthly payment, but sometimes can raise your interest rate and raise the total amount you end up paying. You will likely be offered a range of term options. Common terms are 36, 48 and 60 month, though longer and shorter ones are sometimes available. There is no hard and fast rule on how long of a term you should have, but the 36-60 month terms are a sweet spot. If you get a term shorter than 36 months, it may make more sense just to save up for the car instead of borrowing for it. Anything longer than 60 months is risky because of what can happen in that amount of time. In 5 years, you could change your mind about the car, get into an accident or just need a new car. Having to pay a loan on a car you don't want to own is not a good feeling. Additionally, you are generally required to carry comprehensive insurance the entire time you have a loan on the car. Comprehensive insurance can be expensive. If you wanted to lower your car insurance costs (especially on a car several years old) you wouldn't be able to with the loan still there.

What if the interest rate is too high? Auto loans are somewhat uniform, but there is room to play. The lowest rates you will be offered are often at your bank or a larger dealership. Checking with your bank what their rates are is a good practice anyway so that you know what to expect. If you are not offered something comparable, you know you have better options. If you cannot get a good interest rate anywhere, you may need to revisit the affordability of the car altogether. Extending the term on a high interest loan just to lower your monthly payment drastically increases the amount of interest you pay.

With new car purchases, zero interest loans are offered to get cars off of the lot. These are often juxtaposed against cash back discounts. How do you decide which one is worth it? Look at the total payments you will make under each plan. Part of this may be determined by the monthly amount you can pay. The total amount paid, including interest and taking into account any discounts or fees, should give you the best comparison between offers.

What other costs are there with a new car? When you buy a new car, you will also have to pay a host of taxes and fees. Depending on your state and local area tax structure, this could end up being quite a lot. These add to the total cost and can sometimes be financed for convenience. Ask the dealer what sort of taxes and fees will be involved before you commit to a car. While they won't be perfect until the calculations come back on your final price, there is no reason they cannot give you a good idea to keep in mind while shopping. Subtract fees from your maximum cost before continuing.

Keep in mind that some taxes or fees are annual. You will also have to get insurance. If financing the car, you will need comprehensive insurance. Check with your agent or an online outlet (most compare prices across insurers) to get an idea how much your monthly payment will be. Keep this in mind when calculating your affordability.

How do I reduce these costs? The  biggest cost will be the price you pay for the car. Keep in mind that the sticker price is the dealer's starting maximum, so don't rest until you've gotten yourself a discount on that. I won't tell you how to negotiate - there is plenty of that online - but just do it. I've heard of people sending written requests for a specific vehicle to dozens of dealerships and just seeing who gave the best deal, I personally just happened upon someone who needed to hit a quota at the end of the quarter and negotiated against himself as I silently test drove the car. Maybe it works best to buy when it is raining, maybe only when it is above 75 degrees, perhaps Tuesdays are best but maybe that is only if you wear blue. Whatever you do, work to reduce the price you pay.

So to get a good deal on my Prius, I did my research and made a spreadsheet to calculate the value of all of my options. I knew what I wanted when I walked into the dealership. I used the same insurance company I have had for a while because the transition was seamless. I had already gotten a quote for my new insurance rates so I was prepared to deal with the cost. I had a good idea what rates were available from my bank and other lenders, and was pleasantly surprised when my rate came in a tiny bit below that.

The biggest price difference is between new and used cars. You probably know that used cars can be much much cheaper than used cars. The amount of depreciation, or value lost, by a new car varies between makes and models, but it can be a significant amount of the price of the car. I was able to get a $25,000 car for less than $17,000 even though it was only six months old. That is savings that I couldn't have gotten just through negotiation. When buying any car, you are buying the future miles you are going to drive on it. For the same price, a car which is expected to drive more miles will be worth more to you than a car that won't make it as far. This makes new cars more valuable, but there is also a "new car premium" that can't be explained in cold dollar terms. If you don't have a hugely emotional connection to your car, you can save a lot of money buy shopping used.

When looking at used cars, you will need to do more research. Check Consumer Reports reviews to see if any particular year was more problematic than the rest. For a car that has been produced for a while, redesign years in which they made a lot of changes are often have the lowest reliability ratings. Avoiding those particular years can help you avoid potential problems lurking under the hood.

You will be required to carry a minimum liability coverage on your new car. This is the most basic level of insurance. Liability insurance covers damage that you cause to other people, their property or vehicles in an accident. If you are worried about being hit by an uninsured motorist, you can get fairly cheap uninsured motorist insurance that will cover damage to your property or person in the event of an accident.

Beyond the basics, there is Collision and Comprehensive insurance. Collision insurance covers damage to your own vehicle even if you cause the accident or the other motorist does not have adequate coverage. Collision insurance covers your car, so the value of it is limited to the value of your car. Comprehensive insurance covers other damage to your car, and may include theft, vandalism and damage in a disaster. If you have a loan on your car, you may be required to keep comprehensive and collision insurance on the car.

Your insurance may come with some hidden benefits. It is fairly common for insurance to cover some sort of roadside assistance. Many comprehensive policies will give you a free windshield repair each year. My policy also covers replacement of keys and any harm to pets in an accident. These extra benefits may be repeated elsewhere too, so check your policy to make sure you are not paying someone else for duplicate coverage.

Buying a car can surprise you with hidden costs and fees and options, but it is often very necessary. Do plenty of research beforehand so that you know what you are getting into and you can reduce the price you pay. Make sure you get the necessary insurance, but don't pay for coverages you do not need. Once you have your car, take care of your regular maintenance to avoid surprise repairs and your car should take care of you.