Wonder Why You’re Broke? Look in the Driveway

Budgeting, Paying Off Debt, Personal Finance
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If you’re struggling to make ends meet, your problem may not be too many lattes or dinners out. It may be sitting in your driveway.

Your monthly car payment is the tip of the iceberg.

Counting gas, registration and taxes, depreciation, tires, insurance and finance charges, Americans spend $8,700 a year on average — $725 a month — for the privilege of owning a typical midsize sedan, according to AAA, and more than $10,600 a year for an SUV. If you’re struggling with bad credit, the increased cost of financing and insurance will push those numbers even higher.

Transportation is a typical household’s second-largest expense after housing. And many can’t afford what they spend.

People in the direst financial straits may be trying to swing a car payment that eats an entire paycheck, says Shirley Benning, a certified financial coach with Baltimore’s Guidewell Financial Solutions. Others routinely overspend on cars to the point where they can’t pay down other debt or save for the future.

“My clients have incomes that range from $25,000 to $225,000, and they all have the same problem,” Benning says. “Their eyes are always bigger than their stomach.”

For only a few dollars more

It’s not just the lure of the new-car smell. The traditional car-buying process encourages overspending, because dealers and lenders know borrowers will make the payments even as the rest of their financial lives suffer.

Dealerships focus buyers on the monthly payment to the exclusion of more important factors — like how much you’re paying overall for the car and what interest rate you’re getting.

“It’s the most widespread sales tactic. The salesman asks what monthly payment they can make, and they always say $350,” says Phil Reed, NerdWallet’s car-buying expert. “The salesman says, ‘That’s not going to work. We can do $425.’ ”

As people mentally struggle to work that payment into their budget, they may forget all the other costs of car ownership, including insurance, maintenance and, of course, fuel. They also might not be thinking about the places that extra money could be better spent, such as:

An emergency fund: If you don’t have an emergency fund, anything unexpected becomes an emergency. Even $500 in a savings account will handle minor car repairs, school expenses or medical copays. Otherwise, you’re forced to borrow, digging yourself in deeper.

Starting a nest egg: Put aside $75 a month, let it earn 6.5% for the next 30 years, and you’ll have $83,000. Or divert it into your 401(k) and grab that company match — that’s an instant 25% to 100% return, depending on the match, plus all the future compounded growth. (See “How to Prioritize Your Savings and Investing Goals.”)

Getting out of debt: Making minimum payments on a $5,000 credit card balance at 18% interest, you’d be debt-free in about five years. Add $75 a month to that and you’d be debt-free in half the time.

When you choose leather seats or a sunroof or simply give in because the payments go up only $75, you’re giving up real luxury — the luxury of financial flexibility when you need it most.

The downside of low, low monthly payments

As car prices climb and wages stagnate, people are going further into debt for their vehicles. Consider the following:

  • More than 90% of car loans are for more than four years, and 70% are longer than five years, according to car comparison site Edmunds.com. “Once you go past 60 months, you’re paying for a car and you’re also spending on repairs,” Reed says.
  • Data shows that the longer the loan, the higher the interest rate people typically pay, Reed says. In pursuit of lower monthly payments, car buyers agree to pay more over time — and so remain “upside down” for longer, owing more on their cars than they’re worth. This can spell financial disaster if the car is stolen or totaled, because the insurance payout typically won’t be enough to pay off the loan.
  • Many people don’t finish paying off a car before buying the next one. Thirty percent of people who trade in their car for a new vehicle haven’t paid off their loans, according to Edmunds.com. The average amount of negative equity rolled into the new loan is $4,800.

A more sensible approach

Consider alternatives. A car may well be a necessity in a rural area with little or no access to public transportation. In major cities, though, many people discover the costs of insuring and parking a car far outweigh the benefits. Uber, Lyft and Zipcar suffice for many, augmented with the occasional rental when they go out of town.

The $8,700 you save each year you don’t own a car can pay for a lot of alternatives.

Opt for used over new. You don’t have to settle for a clunker. Cars are better built than ever before and can last well over 100,000 miles, Reed says. Buying a 2- or 3-year-old car means someone else takes the huge depreciation hit of driving a new car off the lot, while you get the reliability and much lower cost of a still relatively new car. Consumer Reports regularly offers lists of the most reliable used cars.

Rethink leasing. You typically can lease a more expensive car than you could buy, but over time you pay dearly for the privilege of switching cars every two or three years. You’ll shell out far more than if you owned each vehicle for five, eight or 10 years.

Burnish those credit scores. Bad credit can limit your financing options to predatory lenders that saddle people with oversize loans and repossess the cars when they can’t pay. That further damages borrowers’ scores while providing the dealerships another opportunity to sell the same car. Good credit means you have your pick of lenders and low-rate loans. (In most states it means you will get dramatically cheaper insurance as well.)

Get financing before you visit a dealership. Credit unions and online auto lenders typically offer the best rates. Once you’re approved for the loan, you can opt for dealer financing if it’s better — but you’re not at the mercy of the dealership’s financing department. Cut-rate financing deals from manufacturers typically go only to those with a good credit score, if not better.

Set your own limits. Sticking to a 20% down payment and taking a loan for no more than four years will ensure you have equity in your car from day one.

Negotiate each part of the deal separately. Agree on a price first, using research from various car-comparison sites. Only then should you discuss financing. Be wary of add-ons such as extended warranties that can needlessly inflate the cost.

And be willing to slam the brakes on the deal if you suspect you’re being talked into overspending.

“That whole concept of affordability isn’t one people want to talk about, but it’s important,” Reed says.

Liz Weston is a columnist at NerdWallet, a personal finance website, and author of “Your Credit Score.” Email: lweston@nerdwallet.com. Twitter: @lizweston.


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