How to buy a car

By Holger Reinel | Updated on June 11, 2020


Young couple buying a new car in dealership

Buying a car is like going on a blind date. You won’t entirely know what you’ll get until you get there; the fact is more people get destroyed financially when buying a car than in any other transaction.

The average car payment stands at $500 per month, excluding insurance, and fuel costs. People seem to be buying cars that they cannot afford and empirical data suggests they are overpaying on those purchases.

I have personally negotiated the purchase of 11 new cars and 3 used ones for either myself, family members or close friends. Why?

Because there is a simple formula everyone looking to buy a new car should follow; this formula helps you buy the car you want, and save thousands in the process. Here is a detailed guide with the steps you’ll need to take to buy a new car.

On this guide:

  1. How much should I spend on a new car?
  2. 20/4/10 rule –how much should I spend on a car?
  3. Find out the total cost before looking at the monthly payment
  4. How to choose the right car
  5. Do your research
  6. Negotiate the best price
  7. Do’s and don’ts of purchasing a car

How much should I spend on a car?

The best way to determine how much you can afford to spend on a car is by buying it cash; this way if you have saved $5,000 to buy a car, then you buy a $5,000 car and avoid getting into a long term loan that can cripple your finances.

But let’s face it, only a few people have the cash to walk into a dealership and buy the vehicle they want for cash. For the rest of us, we get a car loan.

Your car loan monthly payment should be an amount that’s small enough to not make an impact to your finances.

For illustration, my monthly car payment currently is $370 per month. The payment gets automatically withdrawn from my bank account on the 9th of every month and the amount represents about 4% of my monthly income which means it has not

How much should I spend on a car?

You should spend no more than 10% of your gross income on your car expenses. That includes your monthly car loan payment, your car insurance, and your fuel consumption spending.

 

For example if your gross income is $60,000 per year, your monthly car payment should be lower than $500 ($60,000 * 10% = $6,000 / 12 = $500)

 

Be sure to leave room to cover the insurance and fuel costs.

20/4/10 car affordability rule

I love the 20/4/10 car affordability rule because it is simple, yet effective. Here is what it means:

  • Put 20% down payment towards the purchase of the car

  • The car loan should be for 4(four) years

  • Total car expenses should not exceed 10% of gross income. That includes monthly car loan payments, plus car insurance, plus fuel costs.

So, if you want to buy a car and the total cost of the car, all in, is $30,000 and your annual gross income is $60,000, that means you need to put a down payment of $6,000 (20% of the total cost), you should finance the car loan for 4 years, and you should spend no more than $500 per month on car expenses.

Why should car expenses not exceed 10% of your gross income?

At MyHomeAnswers, we recommend devoting 50% of your budget to what’s classified as needs; these include things like rent/mortgage, groceries, food, insurance, utilities, and transportation, i.e the car costs.

Car expenses not exceed 10% of your gross income

What happens when you spend more than 10% of your income on car expenses?
Let’s say neighbor Jimmy has an annual income of $50,000 and buys a car for $30,000 with 0% down payment on a five-year loan.

That means Jimmy will need to pay $500 per month, plus car insurance, and fuel costs which would total about 20% of gross income leaving only 30% to cover the rent/mortgage, utilities, food, and home insurance.

Check out our How to make a budget plan article for more details

Read: How Much Should I Spend on a Car?

Find out the total cost of the car before enquiring for the monthly payment

Many buyers what they do is go to the dealership and ask what they can qualify for. That’s like the gazelle waking into the lion’s territory hoping for safe passage.

In fact, one of the most common questions car sales representatives ask is “what monthly paying would you be happy with?” that’s a trick question, you should not answer right away.

The more important question is what is the total cost for the vehicle, all in?

Most car dealerships now push seven-year car loans. Let’s say for instance Joe Tory can afford a monthly payment of $350 for a car loan. If Joe pays $350 per month for four years, that adds up to $16,800 that could go to paying off the car loan.

On a seven-year loan with the same $350 payments per month, the total payments add up to $29,400. So all of a sudden you can afford a more expensive car? What if the car breaks down in year five, and you need to buy another one?

Perhaps you feel you can afford more than 10% because you don’t have other significant expenses, or you feel that getting something you love trumps sacrificing your finances. You should recognize the fact that cars lose value every year that goes by.

Remember, cars depreciate in value every year. You have to be intentional when deciding how much money you put into something that loses you money day after day.

How much value do cars lose in the first five years?

Cars lose 20% of their value in the first 12 months; from there, you can expect a 10% value loss per year. That means in the first five years 60% of the value is gone.

You need to be able to absorb that financial hit without putting a strain on your long-term finances.

If you want to build financial freedom, you should aim to spend as little money as possible on things that go down in value. Cars are at the top of that list of things that go down in value.

Yeah, I know you still want to drive a decent car, right? Me too. After going through a few used cars, I got in the habit of changing a new car every four to five years. I found myself getting into a better vehicle while my monthly payment kept getting lower.

That’s how I discovered the dos and don’ts of car buying. The tricks car salesmen use, and how to get the best deal. However, buying a car is a big purchase; with every big purchase, there is a chance of making a big money mistake.

What to Look For When Choosing the Right Car

It’s interesting to see that people seem to care more about saving money when buying shoes, toys, and grocery shopping but when it comes to buying big-ticket items like a car or a house, they make expensive mistakes that quickly erase previous savings.

Not sure what vehicle you want yet?

Choosing the right car will depend on what you expect to get out of the car. Perhaps you just need a vehicle to drive to and from work, or you may want to make an “I am rich” statement, although keeping up with the Joneses is pointless.

Pay attention to your motivating factors. If your commute to work is 80 miles each day, comfort and reliability are your number one priority, and luxury perhaps the last priority.

  • Weigh the costs of ownership, including insurance, fuel consumption, how fast the vehicle depreciates, and their resale value.

  • Research online the vehicle type, features, reliability, and safety rating.

  • Find out the fuel consumption rating

When I bought my last car, I knew I wanted an SUV but I had a few vehicle options in mind. I wanted an SUV because I need more trunk space to carry ice skating gear for me, my wife and two kids; I also needed to be able to load a couple of bicycles for when we needed to enjoy some summer trail cycling.

So, SUVs were my start point on my research; a jeep was starting to sound like the best option, but I decided not to go for it because there were other more fuel-efficient options.

I also knew my trade-in would cover about $14,000 because I had done an evaluation on the vehicle. The remaining balance would be financed at 0.9% financing for four years with monthly payments which I wanted to keep under $400 per month.

I then found the vehicle that serves my needs and focused on getting the best deal possible.

That’s the proper way people should go about buying their vehicles. Yet what most people do is choose a car they want and then put all resources they can into making the purchase work such as extending the loan term to five years or even worse to seven years financing.

That’s a sure way to keep yourself poor and chained to debt.

Do your research

Typically what people do when they want to buy a car is they go to the dealership first. That’s not what you want to do if you are to get a good deal. To get a good deal, research and preparation mean everything.

Time your purchase

If you want to get good deals you have to pay attention to the best times of the month or even the best times of the year to find good deals. Dealers measure their performance and sales quotas every month, every quarter, and at the end of the calendar year.

So, the best times to buy a car are at the end of every month, at the end of every quarter, and the last two weeks of December.

Check out online for rebate discounts

When a new model comes out the manufacturer may offer discounts incentives on the previous year model.

Find out the Invoice Price and the MSRP (manufacturer suggested retail price)

The invoice price is what the dealer will pay the manufacturer for the vehicle whereas the MSRP or “Sticker Price” is the price to consumers the manufacturer has suggested.

Your goal should be to pay a slightly lower price than the invoice price the dealership pays to the manufacturer.

I can almost hear you through the computer screen wonder how on earth it is possible to pay the dealer less than what the dealer pays the manufacturer.

It’s possible!

Why?

Because car dealerships get volume discounts and other rebates from the manufacturer; that means if you pay the dealer slightly less than what they pay the manufacturer, the dealer still makes money.

The trick is you have to ask!

How to negotiate the best price when buying a car

I love negotiating with car dealerships because they are always motivated to make a sale, which means you have a high chance of getting a better deal simply if you ask.

Let the salesperson know you are ready to make a deal and start the negotiation with a pre-calculated low offer.  It’s important to let the salesperson knows you are serious as a buyer so they can give you all their attention.

The salesperson will most certainly point out the MSRP price and say they don’t make any money when selling at the MSRP. It’s not true, and if you are dealing with an inexperienced salesperson they might even not know that the dealership can afford to sell at a much lower price.

Be willing to walk away

Luckily there are many car dealerships out there willing to make a deal. To steer the negotiation to your terms let the salesperson know that:

  • You are a serious buyer ready to make a deal

  • You do not need a test-drive because you’ve already test-driven the vehicle

  • Assured them you have done the research submitted a fair offer. Request the salesperson to submit it to the sales manager for approval. If not accepted, you will be visiting a different dealership.

Do not allow the monthly payment to be the focus of the negotiation

One of the first questions a car salesperson will ask is what monthly payment you can afford.

When you give them a number it gives the salesperson all the information they need to reverse-engineer a way to sell you the car that makes them the most money while keeping the monthly payment exactly what you asked for. Don’t do it.

Use a price comparison website to get dealerships to compete for your business

The following sites allow you to receive quotes from multiple dealerships across the city. You also get access to MSRP and invoice prices as well as current rebates being offered by the manufacturer.

You can then simply choose the best option or call dealerships and request an even better deal.

Car price comparison website

DOs and DON’Ts of Purchasing a Car

To get maximum savings on the purchase of your next car, there are certain things you should do, and a bunch of things you should avoid.

DOs

  • Do buy a car that will last at least 10 years. Those vehicles tend to hold value better than vehicles that start giving problems right after the warranty has expired soon after year 5.

  • Do your research before visiting the dealership. At the very least you should find out the invoice price, the MSRP and discounts the manufacturing is offering.

  • Do set a budget allocating a pre-calculated amount that you can afford.

  • Do get quotes from multiple dealerships

  • Do negotiate and ask for a better deal

DON’Ts

  • Don’t mention your trade-in until you have agreed on a price for the car you are buying.

  • Don’t buy the add-ons such as extended warranty, rust protection, or special features that get added to the vehicle for an extra price.

  • Don’t focus on just the monthly payment

  • Don’t accept the first offer

Don’t overpay

Overpaying for a car

In Summary

Buying a car is a major purchase. Do it wrong and it will keep you poor for many years. Do the research before so that you go into the negotiation well prepared. If you are not comfortable negotiating, bring a friend or family member to help.

By following the tips and techniques outlined in this article, you’ll be set to get the best price possible on your next car purchase.

If you want to increase your income so you can buy your dream car you should check out our Salary Negotiation Online Course.

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