When Is A Car Payment Too High?
Too many folks today go in over their heads to purchase the car of their dreams. Many times, this ends up with needing to refinance the vehicle, defaulting on the loan, or the worst case scenario: having a vehicle repossessed. Not only does this affect your credit score, but also the financial system.
How can you avoid payments that are too high for your budget? Here are a few key points to keep in mind:
Step #1: Evaluate Your Monthly Finances
Each month, you’ll have money coming in and payments you need to make to live your everyday life. List out all these payments, and mark out how much you’re spending on necessities, how much you’re spending on entertainment, and how much you set aside for savings and long term investments. These are the three main categories you should remember when budgeting. Your car payment goes under necessities since transport is a necessity. Ideally, you should be able to manage the month by spending 50% of your income on necessities, including your car payment. This means that your car payment should not be over 10-20% of your monthly income.
Step #2: Keep the Term of Loan Low
Some people try to lower the monthly payment by deciding to pay off the car over a longer period of time. Financial experts don’t recommend this, because the value of cars depreciate quickly. If you have a loan term of five years, you’ll pay for a vehicle that’s worth less than half of the price you paid for it initially. This doesn’t even calculate interest, since the longer you pay a loan, the more interest you’ll owe.
Step #3: Interest Rate
The interest rate on a vehicle is dependent on your credit score. A score over 700 is ideal, since the interest rate is fairly low. The best interest rate is 3.68%, which comes with a credit score that’s over 780 points. However, if your score is between 300 and 500 points, you’ll have to pay a 14.41% interest rate for a new car, and 19.98% for a pre-owned vehicle. To avoid paying all that money on interest, consider a few of these alternatives to buying a new car.
You can buy a pre-owned vehicle, which cost a lot less than a new car. Leases allow you to drive a new car without taking official ownership of it, and the monthly payments are much lower. The down payment and the first month’s fee will be the same as when buying a new car, though. Leases are perfect for people with low credit scores, as it can help them build up their score to buy a new vehicle in the future.