The car is a big part of American culture, representing freedom, independence, and status. A car is also a necessity for a lot of people, and for many, their second biggest expense after housing. So let's try to keep the cost down. Before you go search for a new car or a used one, we'll show you how to budget for both.
It's About Percentages
Just a note before we get started. I'm going to use the term "car" throughout this article. "Vehicle" sounds so odd to me, like what an alien trying to imitate what a human would say, and the word "car" has kind of become the catchall for any type of vehicle- be it a car, a truck, an SUV, or a van. Kind of like how the word "Coke" is a catchall for any type of soda in the South. "What kind of Coke do you want?" "A Sprite please."
Because everyone has different incomes and expenses, we can't give you a hard number: "You should spend X dollars on a car." It's the same for most expenses; the number will be unique to each person. What we can give you is a percentage.
There is a rule of thumb you should spend no more than 30 percent of your net income (the amount you actually see in your paycheck after taxes have been deducted) on housing. There is a rule of thumb for how much you should spend on a car as well. Your total car payment, which includes the principal, interest, and insurance, should not be more than 15 percent of your net income.
If you're not paying cash for the car, you should have at least 20 percent as a down payment. Because new cars lose value so quickly, putting down less than 20 percent means you're at risk of becoming underwater on the loan (you owe more on the car than it's worth).
Should you need to sell the car before the loan is paid off or if the car was to be totaled in a wreck, you would have to come up with the difference between the value of the car and the balance remaining on the loan.
Interest is one of the most expensive things in life, and the longer the term of a loan, whether it's for a car, a home, or a business, the more interest you'll pay. The length of your car loan should be no more than four years.
I want to give an example with a dollar amount, but net pay depends on a lot of factors that vary for everyone. Where you live, how many dependents you have, whether or not you contribute to a 401(k) (you should!), or you have to pay a portion of your health insurance premium not covered by your employer.
I'm going to use $50,000 as the gross income and my own tax situation so you can see what the numbers look like. I used a net pay calculator to come up with my numbers.
Based on a $50,000 salary and the other numbers I used, the yearly net pay is $32,620. That means you should spend no more than $4,893 per year on a car. Over a four year period, that is $19,572. Your down payment should be $3,914.
For simplicity, let's round up. You should spend no more than $20,000 on a car, and you should put down $4,000.
For many of us, the question of new car vs used is answered so long as we follow the guidelines explained above. The average cost of a new car is $36,000, well short of the $20,000 a person making $50,000 gross per year should be spending.
But plenty of people won't heed those guidelines (insert angry emoji face here), and plenty of people make enough money to comfortably afford a new car. We also can't say new cars don't have some advantages over used cars:
Better Interest Rate: Lenders typically offer a lower rate on new cars because they're worth more, which makes them more valuable collateral than a used car.
Warranty: New cars include a full warranty, so you're protected against certain defects for a set amount of time.
Backstory: When you buy a new car you know it hasn't been in an accident or had any repairs, so it has no hidden potential problems that can be caused by those things.
Dependability: New cars don't tend to have problems, and if they do, they're likely to be covered under the warranty.
New Tech: New cars come with all the fancy gizmos like semi-autonomous driving, wireless charging, and instant Bluetooth.
Safety Features: Car makers are always innovating ways to make cars safer, so new cars will include all the latest safety features.
More Choice: When you buy a new car you get to customize stuff like the trim, color, detailing, accessories, etc.
You Will Feel like a Baller: Really needs no explanation!
But new cars have plenty of disadvantages too:
Depreciation: A new car's worth drops by more than 20% in the first year and 10% each year for the next four years. That means your shiny new car is worth less than half of what it cost before the new car smell has even worn off.
Sales Tax: The more expensive your car, the more in sales tax you'll pay.
Registration Fees: Some states base the rate of your car's registration fees on its value and model year.
Insurance: The more your car is worth, the more it will cost to insure it.
When people think of used cars they think of some 20-year-old jalopy, but you can buy a used, excuse me, "pre-owned," car that's just one year old. There are plenty of good reasons to buy a used car:
Less Expensive: Duh!
No Loan: This won't be true of everyone, but some people will be able to buy a used car without taking out a loan. That means they won't have to pay interest.
Cheaper Insurance: Because your car is worth less than a new one, the cost to insure it will be less.
It's not all roses though:
A Lemon: If you only have a couple of thousand dollars to spend you may end up having to buy a car from a private seller rather than a dealer, leaving you little protection or recourse if the car turns out to be a lemon.
Repairs: If your car isn't still under warranty you'll be out of pocket for repairs, and an older car may require more repairs than a new one.
Fewer Features: Depending on the year, make, and model, a used car won't come with all the fancy tech gizmos and safety features of newer ones.
Fewer Choices: You're limited to what's available in your area, so you may not get the color or features you wanted.
Unless you have more money than you know what to do with (in which case you are not likely to be reading this) you should always buy a used car rather than a new one.
The rate of depreciation on brand new cars is just too high to justify the additional cost. It's an old joke that a car loses half its value the second it's driven off the dealer's lot, but it's not that far from the truth.
If your only choice was a brand new car and a twenty-year-old car, we might feel differently. You'd be giving up a lot, and the used car could end up costing you thousands of additional dollars down the road in repairs and rental or cab (or Uber or Lyft) expenses if the car was in the shop a lot.
But those aren't the only two choices anymore. If you want the savings of a used car but the security of a new car, you can get the best of both worlds with a certified pre-owned car.
A CPO car is a late model car that has low mileage and no record of significant damage. Each car goes through a detailed inspection and reconditioning process. They also come with manufacturer backed warranties and often a bunch of nice perks like free maintenance, roadside assistance, and loaner cars should your car need to be in the shop for repairs or maintenance.
If a CPO car is out of your budget you can still get a reliable used car. Research what used cars are considered reliable, do a background check on the car, and take it to a trustworthy mechanic for an inspection by a professional.
We wish you and your new to you car many happy years together. Happy driving!