The Denver Post recently reported that U.S. consumer borrowing increased in November 2013. According to the Federal Reserve, borrowing jumped to $12.3 billion. This impressive figure was said to have been boosted by gains in student and auto loans. The report also indicated that auto sales were strong at the end of the year.
Borrowing for auto purchases may be high, but the amount you borrow for your car need not be. If you need financing to get a ride, you should take some steps to ensure that you are not borrowing too much. If you take too much loan, you may struggle to repay. Keep your car payments manageable by doing the following:
Offer a down payment
You have the option to buy a car without putting down anything, but you shouldn’t take it. If you finance the entire purchase, you are guaranteed to have an upside down loan. At some point, the vehicle you are driving will be worth less than your loan’s remaining balance. Avoid having negative equity by giving a down payment. Putting money down also helps you get a better rate and a better deal overall.
Remember the 20/4/10 rule
Before buying a vehicle, keep these numbers in mind: 20/4/10. 20 refers to the down payment, 4 is the ideal loan term and 10 represents percentage of your gross income.
Dealers accept a down payment that is 5 percent of the purchase price, and this is what most car buyers give. However, the ideal amount according to experts is 20 percent. If you can give a bigger deposit, that’s better. A generous DP is more likely to result in a lower interest rate.
These days, many auto loans are 6 to 8 years long. When you finance a car, don’t prolong your repayment period. Your loan term shouldn’t be more than 4 years.
Meanwhile, the overall amount you spend on your car (loan payments plus auto insurance) should be no more than 10 percent of your gross income. To make things easier, just compute 20 percent of your take-home pay. The result is your limit when it comes to car payments and other car-related expenses. You should only spend this amount or less.
Keep your loan term short
4 years may be the suggested loan term, but it would be better for you to borrow for a shorter period of time. A longer repayment period comes with more interest, so you will be spending more than you need to. If you need to extend the loan term to afford the monthly payment, it only means one thing: you are buying a vehicle that is too expensive. When choosing a vehicle, consider your needs instead of wants so you can get reliable transportation without compromising your financial health.
Consider buying used
Think nothing beats the smell of a brand new car? Think again. Not having to deal with depreciation beats that awesome smell, which doesn’t even last a long time. Cars lose value fast—a brand new vehicle loses 9 percent of its value after it is driven off the lot. In 5 years, it loses 60 percent of its market value. If you opt for a preowned vehicle, depreciation wouldn’t be your problem.
Another thing that wouldn’t be your problem? A huge car debt. Used cars cost less, so you will be borrowing less to buy them.