banktime.com

The title of this post says it all. Can you actually afford the car that you are thinking of buying? Liz Pulliam Weston doesn’t think so. The MSN Money guru recently published an article about car buying, and how we Americans are getting over our heads despite our best intentions. She has determined a “simple formula” for determining how much car you can truly afford. You won’t like the results, but there’s not much doubt that what she’s saying makes perfect sense.

Weston has advised consumers that, unless they can either pay cash for a new car or afford to put at least twenty percent down and finance the remaining balance for four years or less while ensuring that the resulting payment isn’t more than one-tenth of their gross income, they shouldn’t be buying a car. Period. This math essentially means that the average American family can’t afford the average new car. To this, Weston essentially says oh, well. Do you want to own a new car like you feel you should be entitled to do, or do you want to stay financially solvent and make the most out of the money that you do have? The answer should be a total no-brainer.

According to the National Automobile Dealers Association, the average price of a new car last year was a smidge under twenty-nine thousand dollars. Under Weston’s formula, a car buyer would need an annual household income of at least sixty-five thousand dollars to pull that off. That’s assuming that they have the twenty percent down payment in accessible savings and that they are able to get the average American auto purchase interest rate of five and three-quarters percent. In the United States last year, the median household income was fifty thousand dollars. Basically, then… no, the average American family cannot in fact afford an average new car.

Weston takes her crusade a step further, and opined that shelling out ten percent gross income on a new car might still be too extravagant for some households. Depending on how much debt you have personally, you might want to spend a lot less. If you have a higher-than-normal home payment, a lot of student loans, a bunch of credit cards carrying balances, or any other obligations, you might have to abandon your new-car dreams altogether.

Weston warns that new car dealerships will do everything they can to disguise the fact that you can’t actually afford your car. These tactics include streeeeching your loan term to keep your payments low, which makes them seem more affordable. This is malarkey, however, because you are obviously paying a lot more in interest by extending your payment term. You stay in debt longer, and you pretty much guarantee that you will be underwater on your car for as long as you owe money on it, meaning that you owe more on the loan than the vehicle is actually worth. The only party who benefits from this arrangement is your lender. If you borrow twenty-five thousand dollars – the average American car loan – at five and three-quarters percent, the average interest rate, you can very easily track the rapid increase in how much interest you’ll end up paying over the long run. If you take out a normal four year loan, your monthly payment will be five hundred eighty-four dollars, and you will ultimately pay twenty-eight thousand thirty-two dollars over the life of the loan. Adding one year to the loan term drops your monthly payment to four hundred eighty dollars, but ensures that you will pay twenty-eight thousand eight hundred dollars for your car. A six year loan will bring your monthly payment down to four hundred eleven dollars, and make the total cost twenty-nine thousand five hundred ninety-two dollars. A seven year loan, the worst deal of all, will make your payment a neat three hundred sixty-two dollars (over two hundred dollars less per month than the four-year option), but you will pay thirty thousand four hundred twenty-seven dollars over the life of the loan, or over two thousand dollars more.

Lenders are also very crafty in not insisting on a down payment, which they disguise as a deal for the customer. Not having to pay a cash down payment makes a deal sound much more tempting to car buyers, but the truth is that permitting you to finance all or almost all of your purchase means lenders can charge higher interest rates, because the loan is totally unsecured. It also ensures you’re underwater on the loan from the very moment you accept the keys and proudly take it off the lot. This is depreciation at its finest and most brutal. Did you know that a car’s value sinks by at least ten percent from the moment that it is no longer considered new? Some car buyers commit an even graver sin: they roll their previous car payment into the purchase of their next car, ensuring that their loan is even higher and they are even further underwater and needing to drag the new loan out for longer to make it affordable. Edmunds.com estimates that one-fifth of all new car loans incorporate negative equity.

These numbers were actually worse during the most carefree and irresponsible days before the current financial crisis. At the peak of the financial bubble that characterized the beginning of the last decade, thirty percent of all loans incorporated debt from a previous car loan. The percentage hit its current point in 2008, but back then the amount of negative equity in these car loans averaged forty-five hundred dollars. There was a brief, shining instant last summer when it seemed the tide was turning against underwater loans. As credit became almost impossible to attain, auto lenders got a lot more selective about what consumers would be able to access their money, and in August 2009, the amount of negative-equity sales hit a glorious eight percent. Naturally, however, lenders got over their pickiness, and the numbers went up again.

Weston points out that overspending on a new car will ultimately only spell disaster for many people. When car buyers spend too much on a car, it creates a vicious cycle that is hard to escape. The insurance premium is higher, gas tends to cost more (although not always, it must be pointed out), maintenance runs higher, repairs add up, and taxes, which are based on the selling price of a car, skyrocket. Over time, the expert warns, you will pay twice the sticker amount for your car in terms of cumulative costs. That’s to say nothing of the fact that if, God forbid, these car buyers’ vehicle is stolen or totaled in the aftermath of a bad accident, their suffering will begin anew when the check they’ll receive from their insurer is likely to be far less than what they owe. Hopefully these free spenders have incorporated gap insurance into the cost of their vehicle, because otherwise they could very easily end up owing a large chunk of change to the lender of their nonexistent or trashed vehicle while they are still left in the unenviable position of figuring out how they will get around. Plus, when you spend too much money on your car, you cheat yourself by not allowing extra money for your retirement fund, your other debts, or the building of your all-important emergency fund.

Weston claims that the ultimate key to avoiding a big vehicular mistake is realizing that “a new car is not a birthright; it’s a luxury. And luxuries should be paid for in cash.” There is no need to accept a car payment as a fact of life, in the way that many Americans seem to do, she claims. There is nothing – but pride – stopping you from buying a perfectly serviceable used car and paying for it in good old-fashioned cash. She advises an “action plan for vehicle sanity” that goes thusly:

First of all, find out exactly what your current ride is worth. Kelley Blue Book has an online site (kbb.com) where that information can be freely had. Compare this amount to what you owe on your vehicle. Are you underwater? Do you have the cash savings on hand to make up the difference? If the answer to that question is no, get thee to the insurance company and buy gap insurance. Following this assessment, get ready to drive your current car until it is fully paid off and the title is in your hand. At that point, you can start tucking the money that you would have formerly spent on a car payment into a savings fund for your next car. If your old car should happen to have a complete mechanical failure while you are saving up (and hey, these things happen!), you use your savings to get a cheapo used car. You can save a LOT of money on buying a mechanically-sound secondhand car that isn’t pretty, but will give you lots of use with a little TLC and preventative maintenance. Then, once you have saved up the money you need, stop and consider your possibilities. Here’s a big question: do you actually need another car? Cars are expensive, and not everyone needs one. In car-crazy America, that’s a transgressive thought, but it’s totally true! Weston points out that the average American household will sink eight thousand dollars a year into its vehicle(s). What else could you, a newly-awakened thrifty consumer, be doing with that money? If you are a two-car household, considering cutting down to one and filling the void with judicious use of public transportation. It can be done. You have a choice – you just need to break the shackles of popular opinion!