You’ve just graduated college, were hired at your first real job, and are finally making a decent, steady paycheck. After saving a portion of your check and depositing some into a retirement account, you still have a good amount of cash left over even after your monthly expenses such as student loan payments, miscellaneous bills, and rent (if you aren’t still living at home). With expenses and savings taken care of, you think now might be a good time to upgrade the mid-2000’s beater you’ve been driving around since college to something more… shiny. However, before making such a purchase you must determine how you are going to pay for it. This guide will outline everything detailing how millennials should buy their first car.
Before you think about ways to pay for your new (or new to you) car, the first step you should take is to ask yourself this simple question – do you really need it? If you are making the purchase from more of a want standpoint, then you should reevaluate the situation. If you are unsure if you can afford a new vehicle, do a cost/cash flow analysis making sure to ask yourself questions like will it be more economical to get a new car instead of having to keep shelling out money for repairs and maintenance costs of your current vehicle? Keep in mind, if you buy a new car your insurance rates will most likely increase too.
Additionally, before making such a large purchase think of some future goals that you would like to see materialize. If you are still living at home and have plans of moving out soon, you might want to save up all you can until you are able to afford a place of your own. Also, do you have an emergency fund set aside that will cover at least three months of living expenses?
Choosing the Right Vehicle
There are so many different options out there when it comes to cars and this article isn’t going to tell you which make and model to get (sorry). Before thinking about any car specifics though, you should imagine where you want to see yourself in two years. It is understandable that a lot can happen between then and now, but if the type of car you currently want will suit your future lifestyle, then go for it. Example: if you currently live in a more rural area but want to move to a big city within the next two years, does it really make sense to purchase a new car considering the need for personal transportation in cities is much less?
Whether to buy a new car or a used car is another decision you will have to think about – but it all comes down to personal preference. You can buy a newer vehicle off of a three-year, low mileage lease for a great deal. There are also many options out there for vehicles under $10,000 which can be very appealing for those trying to save up to move out on their own, or someone who needs a newer vehicle but is prioritizing paying down their student debt.
How to Make the Purchase
Finally, you have decided that you do in fact need a new vehicle. Now comes the point where you have to decide how you are going to pay for it.
Lease: the most popular option.
According to research conducted by Edmunds, over the last five years the popularity of auto leases has increased by 41.7%. The most significant driving force behind that number are millennials and their need for vehicles.
Leases are a pretty simple concept: you pay a monthly amount to a car dealer for the use of a new vehicle (some leases require a cash payment of several thousand dollars which is due at signing). The terms of the lease can differ depending on your needs such as length and the amount of annual miles you, the lessee, is allowed to drive. The length of the lease can range from 2-4 years, the most common being 36, 39, and 48 month leases. Something else factored into the lease agreement is the amount of miles given annually to drive. This can be anywhere from 10,000 to 18,000 miles and are usually in increments of 2,000.
Leases are very attractive to those who are able to afford the payment which will probably range from $200 (think econobox cars) to $350 (well optioned mid-sized sedans). There are leases where you can pay as low as $99 a month, but these are not usually for the safest, most stylish/luxurious vehicles. Additionally, when you are leasing a car, maintenance and some damages will be covered.
Unfortunately, there are some drawbacks to leasing a new car. In its most basic form, a lease is an agreement to rent the use of a car for a specified amount of time – you do not own the car at the end of the lease and are simply paying off the car’s depreciation. The amount of money that you have been paying could have been used to pay down the principal of a loan to purchase the car outright. Additionally, if you go over your allotted miles, you are going to have to pay the dealer anywhere from $0.10 to $0.25 a mile! An extra 1,000 miles a year could end up costing you in the end – better estimate your daily usage and keep tabs on it throughout the life of the lease.
Finance: if you can afford it, why not?
Financing a car is another option someone who is purchasing a new car has. Similar to a lease, you will be paying a predetermined monthly amount to a dealer but instead you are paying off the car completely. You will have to pay interest on this, but some dealers offer no-interest financing for a portion of the repayment term.
There are several advantages to financing that leasing does not offer. The first is that once the principal has been paid off, the car is yours to keep. You will have the ability to sell it or trade it once this occurs. Also, you will be able to drive an unlimited amount of miles. (Even though that sounds like a great thing, there are several caveats: more miles on the odometer will decrease the trade-in value and the resale value, and factory drivetrain warranties only last a specific number of months or miles.) You can also customize the vehicle to your heart’s content – remember, nothing shouts professionalism more than some flame decals.
The main advantage of leases is that if you choose wisely, you can be driving around a brand new car for under $200 a month. If you decided to finance the same car you will probably end up paying double that amount for a term that is twice as long. That is the largest downfall of financing a car – the monthly payment.
Besides the larger monthly payment, you are also going to have the same car for at least 5-6 years, depending on the financing period (unless you decide to buy it out or end the finance agreement early) which is another downfall. Considering rapid technology advancements, at the end of your finance period you may be driving around outdated technology. Just compare the technology in your car to the newest smart phone; do you really want to be carrying around a 6-year-old iPhone?
Auto Loans: similar to financing.
If you decide against financing from the dealership but decide financing a car is the right choice for you, there are still options available. One of the most popular ways is getting an auto loan from a bank or credit union. The process behind financing with a dealer and using an auto loan differs slightly, but the results are the same: after a period of paying down the value of a new car, with interest, the vehicle is yours to keep.
To start this process, shop around for the most attractive rates and terms. Visit local banks and credit unions and see what they have to offer. Once you have been pre-approved for a loan, which shows the dealer that you have already found a lender who has agreed to loan you money for your purchase, you will be in a better negotiating position once you are on the lot. After you have decided on a car, the institution who you are getting the loan through will give you a certified or cashier’s check to make the purchase.
The benefits and disadvantages of paying for a new car with an auto loan are the same as financing the purchase of a car through a dealer. The only real difference is that when financing a car you are in a direct contract with the dealer or a subsidiary of the auto manufacturer that provides financing services (for example GM Financial, a global provider of auto financing, is the financial services arm of General Motors). When getting an auto loan, you make payments to the bank after they have decided to lend you money to make the purchase.
Cash is king.
If you decide not to lease, and do not think that financing or getting a loan is for you, than the only other option would be paying with cash up front.
The main advantage of purchasing a car with this method is that you will not have any interest charges. For those who have the cash and want the absolute lowest cost then buying a car with cash from the dealer is suitable. When you pay with cash you will also know exactly how much you’re paying, opposed to those who finance or lease and only look at their monthly payment. Additionally, when you borrow money to purchase a car, the bank will have a lien on it, and most times the bank will require you have a certain level of insurance coverage on the car as long as you owe money to the bank. If you own the car outright, you’ll be able to choose exactly how much coverage to purchase.
There are several factors that might make you not want to pay cash, the first being interest rates. If you are currently holding the cash you would purchase the car with in a relatively liquid investment account giving you a very reasonable return of 5%, it might make more sense to get an auto loan if its interest rate is less than your account’s return. If the funds are held in a savings, checking, or money market account, it would not make sense because the interest you will be receiving (most likely less than 1.25%) will be less than the loan interest amount.
If you purchase your car outright you will also be giving up the ability to make other large purchases, and might have to deplete your emergency fund. If you pay for your car over the course of 3 to 5 years instead with the help of dealer financing or an auto loan, you will have more cash on hand in case you need it.
Lastly, you will have greater selection of vehicles to choose from if you don’t pay with cash up front. For example, if you walk into a dealership knowing that you have a maximum of $25,000 to spend, and see a car you would really want that suits all your needs for $30,000, you are out of luck. However, that extra 5 grand could easily be added to your monthly lease, finance, or auto loan payment over the course of the term (it would probably increase your monthly bill by $30 if leasing or $60-$80 if financing).
If you are in the market for a new vehicle but don’t have the funds to make a purchase that could have bought a new house in the 1970’s, buying a used vehicle is definitely up your alley. The great thing with buying a used car is that there are so many options to choose from. There are used cars from used car dealerships, used cars from new car dealerships, or used cars from private parties. You can buy a heavily used used car for super cheap, a two-year old car with high miles for a great deal, or a car off of a lease with full maintenance records that might still be covered under warranty – the possibilities are endless. Take note now that there is some risk with buying a used car. You will typically have to spend money for repairs, depending on the amount of miles on the car you purchase, so budget accordingly.
After you have gone through the process of deciding that you do need a new vehicle and realizing a used car is your best option, you will need to do some research. Checking the reliability of the car is super important as you don’t want to spend money on something that you will have to keep repairing during your ownership. ConsumerReports has a lot of information on their website that can help you with this research. Additionally, check if there are any recalls on your vehicle. If you purchase a car that has an outstanding recall, you will probably be able to get it cheaper from the dealer and get it fixed by the manufacturer for free. This is a free online resource that checks if there are any recalls on your vehicle, just type in the VIN (Vehicle Identification Number) and hit search.
Just as you have to determine how you are going to pay for a new car, you need to decide how to purchase a used car as well. Some used car dealerships offer attractive rates on financing used cars directly from them. If you do not want to go that route, you could apply for a used auto loan. The rates and terms for used auto loans depend on the year of the vehicle you decide to purchase, and usually have higher rates and smaller terms for older, used cars. Additionally, used auto loans don’t usually cover the entire cost of the car. In most cases you will have to put down 20% with the bank or credit union lending you the balance.
Because you can buy a decent used car for a highly discounted price, purchasing with cash in full is very attractive. You don’t need to deal with interest payments, the opportunity cost of having a large amount earning interest in an account, or dipping into your emergency fund.
The last step before handing over a check and signing on the dotted line is to make sure to test drive the vehicle, take it to your trusted mechanic to check over, and check the Carfax, a comprehensive vehicle history report that shows maintenance, service, and accident information. The Carfax will also show the title status – something that is important to know as you should shy away from vehicles with rebuilt or salvage titles. Visit this site for more detail about title statuses.
Beep beep’m beep beep yeah!
Purchasing a car, new or used, is no simple feat. First, you must determine if you actually need a new car or just want it, and then decide which make/model/year to get. Next, you must figure out how to pay for it which involves cash flow analysis to see how much you can afford. The car buying process involves asking yourself many questions and should really be thought about. Hopefully this article gave you some insight on how to buy a car, and will help you with your next purchase. Comment with any questions!
For more financial advice for millennials, check out our financial planning site page.