Five Worst Money Mistakes to Avoid When Buying a Car

Big Car Payments Can Lead to Credit Card Debt
Many young adults (and quite a few older ones) have such high car payments that they struggle to meet their other financial obligations. The shortage of cash forces them to use their credit cards for day-to-day expenses, getting deeper and deeper into debt. They may not even realize that their car payment is the root of the problem. Here are the top five mistakes to avoid to prevent excessive credit card debt caused by buying too much car.
Not Knowing How Much Car You Can Really Afford
Financial experts recommend spending no more 12 to 15% of your after-tax monthly income for car payments. To calculate how much car you can afford, multiply your monthly net pay (take-home pay after taxes are deducted) times 15% (.15). Your car payment should not exceed this general guideline.
What's the highest car sticker price that much money will buy? To find out, use the "How Much Car Can You Afford?" calculator at Bankrate.com and see the example at the end of this article.
There's more to the cost of a car than just the purchase price - there's the cost of owning your new car. Insurance rates vary widely depending on theft, damage or repair costs for each make and model, as well as other factors, so ask your insurance agent for quotes on several different makes and models. Also consider the costs of repairs and maintenance and the repair record of the car, available from Consumer Reports and other consumer organizations.


Buying New Versus Used Cars
New cars depreciate in value signficantly during the first two years of ownership (30 to 40%). If money is an issue, let someone else pay for the depreciation on the first year or two of your car - buy used. If you're very concerned about warranties or determined to have particular options and specific features, and the rapid loss of value in the first few years of ownership is not a big concern (for example, if you intend to keep the car for 5 to 7 years), buying new may suit you, but go into it with your eyes open.

Not Knowing the True Worth of a Rebate Versus a Low Interest Rate on New Cars
What if your dealer offers a choice between a cash rebate on your new car or a very low interest rate? How do you determine which is the best deal? You may be surprised, so use the quick and easy Rebate/Interest Rate Calculator on Bankrate.com to find out you which deal will save you the most money.

Choosing a Long-term Loan Versus a Short-term Loan
There was a time when the average car loan was 36 months. Now 60 months is more the standard and many dealers are offering 72 months or more. This allows you to buy more car than you can really afford, by stretching the payments out until the car is almost fully depreciated. You also end up with higher interest costs, and you may become upside down on your loan (see #5, below). Try to buy only as much car as you can afford to pay off in 48 months, or even better, 36 months.

Being Upside Down on Your Existing Car Loan
Long-term loans (and quickly depreciating cars) are also the reason people get "upside down" on their loan, where they owe more than the car is worth. If they trade it in or sell it, they have to pay the lender money out of their own pockets or add the old loan balance to their new car payment. If you still owed $3,000 on your old car and you rolled the balance into your new car loan of $17,494 from the example below, your new car payment for 60 months at 6.5% interest would be $409 instead of $292, an additional $117 per month for 60 months, for an additional $7,020. Rather than stretch your payments out over five years or more, buy a cheaper car, or a one- or two-year-old car, and pay it off over a shorter period.
Do you see why people get in trouble with car-buying decisions? Use the tools available to you online (at sites such as Bankrate.com) and educate yourself about the true costs of buying a new car. You'll save a lot of money.

Example: Your annual salary is $30,000 or $2,500 per month before taxes. Check your most recent tax return to deterine your federal tax bracket by dividing the total tax you paid for the year (including taxes you paid with your return, or refunds you received) by your adjusted gross income. Add your state tax bracket to this federal tax bracket to get your total tax bracket, a modest 22% in this example.

Your taxes are $550 ($2,500 salary before taxes x 22%). Your after tax income is $1,950 ($2,500 salary before taxes - $550 taxes). You can afford a maximum car payment of $292 per month ($1,950 monthly salary after taxes x 15%).

If you don't already have a car payment and you won't be making a downpayment, the maximum sticker price you can afford is $14,949 at 6.5% over 60 months.

If you made a $3,000 downpayment or trade-in, the maximum sticker price you could afford would be $17,949. You would finance the remaining $14,949, paying an additional $2,601 in interest over five years, for a total cost of $20,550 for the car (including your $3,000 downpayment).