MAY 2007 :: CONSUMER ED

Driving a Smart Bargain
How to Buy and Finance a Car Without Overspending

Think you’re ready for your first new car? Then you might want to get ready for your first new-car loan.

›Adapted from "The Wall Street Journal Complete Personal Finance Guidebook," by Jeff D. Opdyke. Copyright 2006 by Dow Jones & Co. Published by Three Rivers Press, an imprint of the Crown Publishing Group, a division of Random House.

Cars are pricey. The average price of a new vehicle is hovering around $30,000. And unless you have a generous relative or a giant pile of savings, you’re probably going to have to settle for a small, inexpensive compact or a used car, or you’re going to have to take out a loan.

Logically, the smartest option financially is almost always to go for the inexpensive new car because it’s affordable, it’s under warranty and it will feed your psychic need for a new car. Yet car buying is rarely logical. It’s all about the emotion. That’s why there’s probably no point in telling you, no matter how true, that it is unwise to borrow money to pay for something that loses value the minute you drive it off the showroom floor.

So let’s look at car buying from a more practical perspective. If you’re intent on buying a new car, then you need to effectively negotiate a better price and find better loan terms. In the end, both will lower the cost of car buying and save you money every month.

‘S’ is for ‘Suggested’

Paying the sticker price on a car is a costly mistake. Think about it. What do all those car commercials advertise? The MSRP, the manufacturer’s suggested retail price. A suggestion is an invitation to negotiation.

So first things first: Before you get to the dealership, know exactly how much car you can afford and negotiate from that point downward. If you play the games car salesmen want to play, you could end up overpaying for the car and the car loan. Instead, never discuss what you can afford on a monthly basis; dealers can use that information to structure a car loan to meet or slightly beat your monthly-payment requirements, without addressing the more important issues: the total price of the car and the terms of the loan. When you’re at the dealership, focus your mind on the purchase price.

To negotiate on price, you must be armed with information about the true value of the car you want with all the options you demand. The Internet has made that very easy. A variety of Web sites now offer detailed consumer information comparing the dealer’s invoice cost—what the dealer paid the manufacturer—against the MSRP printed on the window sticker. Three sites to check out are nada.com, the National Automobile Dealers Association site; kbb.com, the Kelley Blue Book site; and edmunds.com, which not only provides an analysis of the MSRP and the invoice price but also shows what buyers near you typically pay for your exact car.

Pay attention to the destination and delivery charges, the necessary fees for getting a new car from the factory to the dealer. Some dealers will inflate that number to get a little extra profit into the price. The actual charges are spelled out on the Web sites. Do not pay a penny above those charges. Also, be very wary of dealer add-ons such as dealer-applied rustproofing. You don’t need that on a modern car.

You should never pay more than 3% to 5%, at most, above the invoice cost. What you’re doing is negotiating the dealer’s profit over invoice, not negotiating your cost under MSRP. If it is late in the model year, the new cars are coming out, and a dealer has a surplus of last year’s models, you should pay barely above invoice at all since the dealer has a clear incentive to negotiate—to make room for the new cars. If after doing your homework and if after negotiating you still think a dealer is asking too much, walk away and find another showroom.

So you’ve settled on a price. When do you start checking out your loan options? The answer: You should have done it before you even started car shopping.

The question you really must ask yourself at this point isn’t how much car you can afford but how much car loan you can afford. You must determine how much discretionary income you generate each month and how much of it you’re willing to set aside for a car. That determines how much car loan you’ll be able to cover comfortably every month for the next three to four years.

Running the Numbers

Assume for a moment that you can afford $300 a month. The next step is to talk to your bank or credit union to find out what rates they’re currently charging on new-car loans for 36 and 48 months. You don’t want to stretch the term of your loan out too far, particularly not out to 72 months. A six-year car loan will seem inexpensive from month to month, but you’ll end up paying far more over the life of the loan.

Let’s assume that the bank interest rates are 4.5% for 36 months and 5.25% for 48 months. The next step is to check the Web sites of various car makers to see what incentive programs—rebates and financing deals—are available in your area.

You now have all the necessary data to determine what you can afford in order to stay within your monthly budget for car payments. Dozens of auto-loan calculators are on the Internet, but if you have a computer spreadsheet, you can do it yourself with a very simple “present value” calculation. (See instructions with the accompanying diagram.) The result: $12,963.04 (or $10,085.08 if you entered 36 months and 4.5%).

Now, $12,963 isn’t necessarily the price of the car you can afford. That’s the size loan you can afford. To that amount you must add any cash you’re going to put down on the car as well as the value of any trade-in you have. If you have $5,000 in cash and a trade-in worth another $2,000, you can afford a roughly $20,000 car. If you have no cash or trade-in, you can afford only $12,963.04.

Using the spreadsheet, you can play with the numbers to see how adjusting the interest rate and term affects what you can afford. If you figure you can afford $325 instead of $300, and the dealership is offering special 0.9% financing, you can afford a loan of $15,316.90; with your cash and trade-in, you can afford a $22,000 car.

By doing your homework and working from the bottom up—starting with how much car loan you can afford—you’re prepared to walk into the dealership confidently, armed with knowledge of what your car costs, its fair selling price, what financing is available, and the precise impact it will have on your spending every month. You have become a savvy car shopper.