If you need to buy a new car or truck, no doubt how you are going to pay for it is on your mind. Financing a new car or truck can be as big a deal as choosing the vehicle itself. For most people, paying cash for a new car or truck is not an option; a car loan is the only alternative. So the two big questions are, “What’s my monthly payment going to be? and Who will loan me the money?”
Let’s take the first question. Your actual monthly payment depends on the following four main things:
The vehicle price, down payment (if any), interest rate, and the duration of the loan. But for your own budget, you should also include car insurance, given that monthly insurance premiums can add substantially to your total monthly outlay for the vehicle. (Big vehicles and vehicles with excess power (like muscle cars) tend to have higher insurance rates than other vehicles. This category includes sport utility vehicles and off-road vehicles.)
Let’s examine the four main items that will determine your monthly payment in more detail below:
Price Tag of the Vehicle
You might be able to haggle a car dealership down on the sticker price, but apart from that, you have little control over the vehicle’s price. Your actual ‘drive away’ price for your new car will have fees added such as registration, tags, and taxes. These are added to the sticker price prior to your signing the paperwork. Find out what the total price of the vehicle will be before signing anything. (You do not want to discover these things are added in later.) In any case, your down payment should at least cover these ‘extra’ costs.
And a good rule of thumb is to limit your spending on a new vehicle to twelve and fifteen percent of your annual net income. (“Net” income is your ‘take home’ or ‘after taxes’ income.) Make sure you don’t exceed this, otherwise you will likely find yourself in financial trouble. Take into account your current income and your monthly bills in order to see what you can truly afford for a new vehicle. (Subtract your total bills from your net income to see what you can afford.)
The Down Payment
A down payment will help you out on your monthly payments. It’s a good idea to figure a down payment of a minimum of a thousand dollars. Ideally, you’ll be able to put down enough to pay for the ‘add-on’ fees that are typically added on the price of the car, as mentioned above. You might get offered a ‘nothing down’ option by the dealer, but you should put something down on the car anyway.
Interest Rate (Whether the Dealership’s or Your Bank’s)
The interest rate you get will depend on your credit history, which you can control by maintaining good credit. The only exception is when you have little or no credit history. But even then, you can still get a decent interest rate – for the simple reason you won’t have a bad credit history. In any case, it would be smart to expect a slightly higher interest rate than the lowest ones advertised. Since interest rates can be affected by a variety of things, it is better to budget for a slightly higher one than you may have hoped for.
Interest can vary from 6 to 9 percent for banks and down to zero for dealer financed cars. How can dealerships offer 2% or lower interest rates? Because the finance department at dealerships figure a way for you to pay more for vehicles sold at lower rates of interest. Not only is it their job, but the finance department personnel work on commission. So they are motivated to do their job well!
Regardless, expect a higher interest rate on a used car – no matter if you get financing through a bank or the dealer.
Loan Repayment Duration (Number of Months to Repay the Loan)
How much you can afford to pay each month will determine the length of your loan. Generally, you can spread out a car loan as long as 60 months – sometimes more – but your interest rate will be higher. Typical car and truck loans are given in 12 month, 24 month, 48 month, 60 month, 66 month, and up to 72 month terms. You can usually choose which term you would like. Obviously, the longer the loan duration, the smaller the monthly payment, but the more you will pay for the vehicle over the loan’s duration.
Who will loan me the money? Here are two scenarios. Which one is yours?
Scenario #1: The best situation for financing a new or used vehicle is to have a good credit rating, put down cash on the car, and get a loan through a bank at the lowest going interest rate.
Scenario #2: If the above “ideal situation” just isn’t possible, take heart. Say your credit is not good, therefore you have to get a high interest loan through the car dealer (because the banks won’t loan you money). And not only that, but you can’t afford a down payment. To top it off, you have to get a 60-month or longer loan in order to be able to make the monthly payments.
Scenario #2 describes most people. But don’t worry, there is a deceptively simple solution! Here it is:
With this less desirable situation, it is still possible to end up not over-paying for your car: Simply make extra payments now and then! While you may have heard of this before, the key here is to actually follow through and DO make those extra payments.
This should not be so difficult because the payments will be relatively small – being spread out like they are. In this way, it is possible to end up only paying slightly more than Scenario #1. The only caution here is to ensure the car loan is a fixed rate loan; not “front-loaded.” (A “front loaded” loan has most of the interest in the beginning payments. So paying it off early will not save you money.)