Buying a Car – How to Break the Cycle of Constant Vehicle Debt

First, let’s understand the difference between indebtedness and making payments to a vehicle fund. Indebtedness means you are making payments into someone else’s pocket and paying interest over and above the purchase price. Making regular monthly payments into a vehicle fund (a separate account at your financial institution) is simply enriching yourself and allowing you to have more choices. 

The best advice I ever received regarding vehicle purchases was to buy a good used car and make it last at least twice as long as it took you to pay it off. By doing this you are amortizing the cost of the vehicle over a longer period. Let’s see this is action:

Let’s say you buy a vehicle for a total of $35,000 financed by a loan from your local credit union, which right now might be 5.45% for 60 months or five years. Your monthly payment is $667.73.

If you have taken care of the vehicle and can make it last another 5 years, the total cost per month over the life of the vehicle is cut in half to $333.86. The longer you hold the car, the lower the amortized cost. Of course, this only works if you buy a reliable brand in the first place.

Once you pay off your car, you can keep making the same payment into a separate bank account you keep for a rainy day. One day you WILL have to replace that car, so you may as well plan for it by saving once you pay off the car. You may be able to build up enough to buy the next car for cash. At the very least, you will likely have a substantial down payment on the next vehicle.

If you don’t have the cash, get the loan before you go car shopping.

The Pandemic pushed up used car prices because manufacturers could not find computer chips to make new cars. With production ramping up again, used car prices have eased off. Before you go looking for a car, whether new or used, determine how much you are willing to spend, how much you can contribute to a down payment, and how much you may be able to pay per month if you plan to finance the vehicle. Ideally, get pre-approved for an affordable loan before you even set foot on a dealer lot. (See Beware of Yo-Yo Financing sidebar.)

Ideally, you want to have a 20% down payment in hand and a sterling credit report. If your credit report is not so great, your banker or credit union may have good ideas of how to get around that obstacle. What you don’t want is be at the mercy of high interest dealer financing or an unreasonably long loan term. Auto loans may have terms as short as 24 or 36 months, but the bulk of loans have terms of 48 or 60 months. Some dealers may offer loan terms that last 72, 84, or 96 months, but these are less than ideal. You will be paying more for the car because every payment has interest tacked onto it. You really don’t want your loan payments to last longer than the car’s lifespan. 

You don’t have to settle for dealer financing. Your local bank or credit union may offer affordable auto loans. Having a discussion with a lender in advance of the car shopping experience will help you focus on what you can afford, and you can avoid high pressure sales tactics, because you will be well informed.

Beware of Yo-yo Financing

Ideally, you do want to go car shopping with a pre-approval for a loan. Or better yet, a checkbook for the account that now holds your carefully accumulated car fund. This will help you focus your search on a vehicle you can afford. It will also allow you to refuse some of the dealer upgrade packages you may be pressured to accept. I don’t mean manufacturer’s features, but the so-called upgrades dealers tack on such as adding “racing stripes” or “extra rustproofing.”

Securing your financing ahead of time will also protect you from practices such as spot delivery, also called yo-yo financing. If you are old enough, you may remember dealerships offering 0% financing for qualified borrowers. That phrase “qualified borrowers” is very important. Cars are not the only thing dealerships sell. They also sell auto loans to financing companies. In order for the dealership to sell your loan to a financing company your credit credentials must pass muster.

Whenever you buy a car, there is a great deal of paperwork to sign. If you are getting dealer financing, you want to be sure that one of the documents you are asked to sign is a bona fide financing agreement, and not full of contingency clauses. Check for weasel language that lets the dealership revoke or modify your purchase agreement if you do not qualify for the offered financing.

Car dealerships may make a deal with you that includes a credit for your trade in against the price for the car you are buying and a fixed loan rate with a monthly payment of X for Y many months. This becomes your Retail Installment Sales Contract, but somewhere in the fine print you may notice “conditions” that makes them both the seller and creditor. They usually prefer to sell the creditor role to a financing company, but if your credit does not measure up to the financing company’s expectations, the whole deal you made for your trade-in and new monthly payment may completely collapse. You may get a call to come back to the dealership like a yo-yo spinning back into the hand that just threw it. The dealer may try to renegotiate the entire deal.

This practice is illegal in North Carolina according to the North Carolina Consumer’s council. However, that doesn’t mean some dealers won’t try some version of this scam if they find themselves holding a loan they cannot sell. So read your paperwork carefully before signing, keep whatever you sign, and if you find yourself rejected for the loan application after the fact, contact the NC Attorney General’s Office.

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