You are post-divorce and your car is on its last legs and you need a new one. What do you do? Do you buy a new or used car with cash? Do you finance a car if you have not saved enough to buy it outright? What about leasing a new car? After reading this article you will know which option is the best for your situation.
Financial experts disagree on how much of your monthly budget car expenses should consume. Most people focus on how high of a monthly payment they can afford when financing or leasing a car. However, it is important to factor in how much you will spend on gas and insurance over the coming years.
The only way to know how much you can afford to spend on a car is to closely examine your monthly income and expenses.
Start with your monthly take-home pay and any other consistent income you might receive like child support or alimony. Then deduct rent (or what you spend each month on your mortgage payment, property tax, HOA fees, homeowner’s insurance, and maintenance), groceries, child expenses, pet food and care, clothing and jewelry, entertainment, travel, personal care, health care insurance and out-of-pocket costs, retirement contributions, student loan payments, and interest payments on credit cards (if you carry a balance). Do not forget to estimate what you might spend on an annual basis for things like gifts, charitable contributions, and emergencies. You can divide that by 12 to get an average monthly amount.
If you have no idea what you spend each month or year, you can look at the annual spending summary for your debit and credit cards (most financial institutions provide a link to annual spending reports on their websites). You can also download each monthly statement and manually enter each item into a spreadsheet. Some of my clients link their multiple accounts to Mint.com which organizes spending data into categories.
In addition to estimating how much you will spend each month on gas and routine car maintenance, you will need to estimate how much you will pay in car insurance.
The more expensive the vehicle, the more expensive it is to insure. If you choose a lower deductible over a higher one, that will also make car insurance more expensive. Hopefully, you have a clean driving record otherwise car insurance will be more expensive. If you plan to add a child or two to your insurance policy that will also make it more expensive, especially if the child is under the age of 25.
Sometimes your credit score can impact whether or not you will receive a favorable rate for insurance.
If you know you will not be able to pay cash for a new or used car, you should find out your credit score before you spend time shopping. A poor credit score could limit the amount of financing that is offered to you. The less you can borrow the more of a down payment you will have to cough up.
By federal law, you’re entitled to a free copy of your credit report every 12 months from each of the three reporting bureaus. Many online services such as Credit Karma also offer free access to your credit score.
Let’s assume that after reviewing your budget, you can spend up to $700 per month on car expenses. If you find that on average you spend $200 per month on gas, insurance, and routine maintenance, then you have $500 to go towards a car payment.
Edmunds describes this scenario:
You could likely finance a new or used car that sells for about $30,000.
I like the Edmunds Affordability Calculator. The calculator allows you enter inputs such as how high a monthly payment you can afford, how many months you wish to make car payment, the interest rate you obtain on a loan, how much you can receive from trading in your current vehicle, and how much cash you can provide as a down payment.
Extending the term of your loan or obtaining a lower interest rate will enable you to purchase a more expensive car. But is your credit score high enough to obtain a low interest rate?
At first glance it may appear that leasing is more affordable than purchasing. Often down payments are reasonable and monthly payments lower with leasing than purchasing. However, leases are for a fixed period of time (generally three years) and after the lease term is over, you do not own the car. When you purchase and finance a car, however, you know that eventually, you will own a car and not have any monthly payments. That feels really good!
Leases have mileage limits where you are financially penalized if you drive over that set amount. In addition, if you have wear and tear that is above normal at the end of the lease the car dealership can charge you extra.
Before you end up with more car than you can afford, make sure to consider all these factors.
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