This post will discuss the most common mistakes to avoid when buying a car. But first, our disclosure:
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Let’s face it. Cars are the biggest wealth destroyers in America.
Cars can cost tens of thousands of dollars to buy and thousands more to finance, and their depreciation rivals that of timeshares. Then there are fuel, insurance, maintenance, and repairs. These “hidden costs” add thousands of dollars more to the cost of owning a car.
Whether you love cars or not, the last thing anyone should do is jeopardize their financial well-being for a car. So, if you’re looking to buy a car, here’s a list of the biggest car-buying mistakes to avoid to safeguard your money while getting a good deal. I hope you enjoy the ride and save money along the way!
Car Buying Mistake #1: Not Being Able To Say “No”
Car salespeople and finance managers know it is hard for most people to say “No.” This is especially true after a long, high-pressure negotiation when buying a car. Negotiating is uncomfortable and can wear you down. The next thing you know, you are saying “Yes” to get your butt out of the dealership. It does not matter if you did most of the negotiations online; once you step into the finance manager’s office to close the deal, it’s game on.
There’s a reason the finance manager pushes for expensive add-ons and extended warranties. By then, they know you’re tired and more likely to agree to things you wouldn’t usually consider. It happened to me when I bought my last car.
I got a good deal on a car, only to undo it in the finance manager’s office by opting for the extended warranty. I was under pressure to get back home to relieve a babysitter. It was a stupid money decision made in the heat of the moment.
The key takeaway is that you can save a lot of money by using the power of “no.”
When buying a car, don’t be pressured into a deal or add additional services you do not need. Don’t let the finance manager push you around. Never be afraid to say “no,” and don’t be scared to walk away. There is always another deal to be had in the car-buying sea.
If you want to learn to negotiate using the power of “No,” check out “Never Split the Difference: Negotiating As If Your Life Depended On It” by Chris Voss. He was one of the FBI’s top negotiators, and his book will teach you how to negotiate at work and at the car dealership.
Car Buying Mistake #2: Shopping By Monthly Payments
Focusing only on the monthly car loan payments might cost you big time when buying a car. It could lead you to extend your loan terms to 72 months or even longer to reduce your monthly payments. But here’s the thing: while it might seem like a good deal, it isn’t. Let’s take a look at an example to see why.
Lower Monthly Payments = More Interest Paid
Peter Payments is in the market for a car. He settles on one that costs $20,000, which he will finance using a car loan.
Peter Payments steps into the finance manager’s office at the dealership and is presented with two car loan options:
Option 1: 36-month car loan at a 7% interest rate for a monthly car payment of $617
Option 2: 72-month car loan at a 7% interest rate for a monthly car payment of $341
What does Peter Payments do?
Peter Payments can’t resist Option 2 and its low monthly car payments, but is it the most affordable choice?
Option 2 will result in Peter paying $4,550 in interest over the life of the loan, bringing the total cost of the car to $24,550 ($20,000 + $4,550 = $24,550).
Option 1, at 36 months, will result in only $2,232 in interest, bringing the total cost of the car to $22,232 ($20,000 + $2,232 = $22,232).
So, although the monthly payment on the 72-month loan is almost half that of the 36-month loan, choosing the longer loan will cost Peter Payments over $2,000 more for the same car!
We are not done yet! There’s another potential car-buying pitfall to watch out for when you base your decision solely on monthly payments.
Shopping Monthly Payments = Too Much Car
Let’s look at a different scenario: Peter Payments visits a dealership and is welcomed by a salesperson who inquires, “What is your monthly budget for a car?”
The correct answer is to say you do not shop by monthly payments. However, Peter Payments blurts out $600 and then tries to backtrack by saying his number is based on a 36-month car loan. Why, Peter?! WHY?!!!
It’s too late! The damage is done. Now, like a tiger, the salesman jumps into action.
He first shows Peter a $20,000 car, which is within his monthly budget and loan terms. The salesman gives it a lackluster review, hinting there might be other options. That’s when he steers Peter to a nicer vehicle with more features, but the price is $30,000.
A $30,000 car loan with a 7% interest rate over 36 months will lead to monthly payments of over $900! That’s way more than Peter wants to spend. What is Peter Payments to do?
The salesman is more than happy to provide the solution.
The salesman suggests to Peter that he can reduce the monthly payments to $500 by extending the loan terms to 72 months. Peter is ecstatic. He planned on $600 monthly car payments, not $500.
Poor Peter Payments! He made a common mistake many people make when buying a car: by focusing on the monthly payments, the car salesman took him for a ride. Let’s see how bad it is.
True Cost of Peter’s Decision
As we saw earlier, if Peter Payments takes out a 36-month car loan on a $20,000 car at 7% interest, he’ll have monthly payments of $617 for a total purchase price of $22,232, including interest.
By opting for the 72-month car loan on a $30,000 car at the same interest rate, Peter will have smaller monthly payments of $500. However, he is spending $10,000 more on a car while doubling the loan terms, resulting in $6,825 of interest over the life of the loan.
When you add the interest to the $30,000 purchase price, Peter will pay $36,826 for the car. That’s nearly a $15,000 difference between the two cars ($36,826 – $22,232 = $14,594).
Peter thinks he’s gotten the deal of a lifetime, but he’s been tricked by a slick salesman. Despite exceeding his car budget by almost $15,000, Peter sees it as a good deal because the monthly car loan payment of $500 is less than the $600 he expected to pay.
Don’t be like Peter; before buying, consider the total cost of ownership of the car instead of focusing on the monthly payment.
Car Buying Mistake #3: Confusing A Want With A Need
It’s amazing how people can justify overspending on something they want by overestimating its necessity. I’ve watched enough episodes of “Financial Audit” with Caleb Hammer and “I Will Teach You To Be Rich” with Ramit Sethi to see how widespread this mistake is.
It’s incredible how often guests come on “Financial Audit” and “I Will Teach You To Be Rich” and are found to have monthly car payments of $700, $800, and even $1,000. These monthly payments are on a 72-month or even 84-month auto loan. Yes, you read that correctly. Many guests on these shows pay over $700 monthly for 6 to 7 years for a car!
How do these guests get themselves trapped in these loans? They confuse a “Want” with a “Need.” Funny enough, this mistake frequently involves pickup trucks.
Pickup Trucks, Kids, And SUVs
The number of guests on these two shows throwing away their future and financial independence for a pickup truck is startling. When pressed by the hosts, they have no good reason for needing the vehicle. They “need” it for the few times they work around their house or haul furniture back from Ikea.
Then there are new parents. What do many of them do soon after their first child arrives? They run out and buy a monster four-wheel-drive SUV with an equally monstrous price tag. They “need” the extra safety and space to haul around their tiny ten-pound baby, which won’t reach adult size for another 18 years.
You cannot possibly expect them to drive little Billy around in a Toyota Camry. Only a giant Toyota Grand Highlander will do!
Not upgrading my car out of false necessity allowed me to continue to save and invest despite the additional expense of daycare. I did not buy a new car until my sedan was almost ready for the scrap yard, allowing me to pay off my new minivan in under three years.
When buying a car, try not to justify a want by turning it into a needless need. I did fine hauling kids around in an older sedan in the harsh New England winters.
Car Buying Mistake #4: Not Factoring In Hidden Costs
In addition to the monthly loan payment, the cost of insurance, gas, maintenance, and repairs can add another $500 or more each month to the cost of owning a car. It’s easy to overlook these hidden expenses when buying a car, which is a costly mistake.
Ramit Sethi, the author of the bestselling book “I Will Teach You to Be Rich,” refers to hidden costs as phantom costs. This is one of his biggest pet peeves, and for a good reason: people often overlook phantom costs. Rarely do people take the time to research the actual cost of owning a specific vehicle beyond the sticker price.
Before buying a car, research the hidden fees. The make and model of a vehicle directly impact your insurance rates, as well as repair and maintenance costs. A Toyota RAV 4 may cost over two hundred dollars more yearly to insure than a Honda CR-V. Maintenance and repairs on a BMW are much more expensive than those on a Toyota.
Don’t forget about taxes!
The more expensive the car, the more you pay in sales tax when buying a car. Then there are excise taxes.
If you live in a state or town that imposes an annual excise tax on your vehicle, you might be in for a rude awakening. The amount of this tax depends on the value of your car, taking into account its make, model, and year. In my first year of owning my new minivan, I received a $600 excise tax bill. $600 for a minivan! That tax bill hit me like a ton of bricks,
Don’t let these hidden fees hit you like a ton of bricks. Do your research before buying a car and budget for them accordingly.
Car Buying Mistake #5: Not Shopping For A Car Loan
If you need to take out a loan to buy a car, shop around for the best interest rate. Don’t simply go to the dealership and let the finance manager set the rates, as they might not offer the most competitive loan rates. Even a small difference in interest rates can significantly affect the overall cost of owning your car.
When you shop around for a car loan, you gain bargaining power. Having an interest rate from another bank or credit union may help you get better rates at the dealership. Dealerships earn a lot of money from the loans they finance, so they may be willing to offer you lower rates than what another bank has offered to avoid losing out on the financing deal.
Car Buying Mistake #6: Rolling An Existing Car Loan
If you’re trading in your car with an outstanding balance, dealers will be more than happy to roll the existing balance into your new vehicle loan. That is a bad idea with a capital “B.” It might possibly be the biggest and costliest car-buying mistake someone can make.
Rolling over your car loan involves adding the remaining balance from your existing loan to your new loan. By rolling over an existing loan, you’ll owe more than your new car is worth, leading to higher monthly payments.
Cars are one of the worst depreciating assets you can own. The moment you drive your new car off the lot, it’s worth less than what you paid a second ago. Owing more than something is worth is known as being upside-down or underwater on a loan. The technical term is negative equity. You exacerbate this issue when you roll over a loan, and it can quickly spiral out of control.
When you repeatedly roll over a loan, the balance grows, making it challenging to pay off. Before you know it, you are rolling over larger and larger balances into new car loans that stretch over 72 or even 84 months.
Regardless of how far you extend the loan terms, there may come a time when you can no longer afford the monthly payments. At that point, you are so far underwater on the car that selling it for a cheaper car won’t make much difference in what you still owe.
Paying off your loan and keeping a car for as long as possible is one of the few ways to offset the depreciation of a car and keep your head above water.
Car Buying Mistake #7: Not Considering Cash
There is no denying that buying a car with cash is the best option. Buying a car outright can avoid monthly payments, interest, and overspending. While it may not be feasible for everyone or lead to getting your dream car, its benefits cannot be overlooked.
It may seem challenging, but buying cars with cash will allow you to build wealth like never before.
While new college graduates were rushing out to buy new cars, I drove a manual 5-speed pickup truck with roll-up windows, plywood for a tailgate, and no power steering. No, I wasn’t living in the countryside but in traffic-heavy Boston! My pickup wasn’t fancy, but it was indestructible, lasting almost 200,000 miles.
Not having a car payment allowed me to save a fully funded emergency fund and max out a Roth IRA within a few years of graduating college. It also allowed me to upgrade to a 7-year-old Ford Taurus that I bought in cash and drove for another eight years.
I didn’t take out my first auto loan to buy a new car until I was in my thirties, and I’ve only ever financed two cars. Both times, I had enough money to pay in cash, but I didn’t want to use up all my savings for a car. That was a bad financial decision that I won’t make again!
The bottom line is that if you can, buying a car in cash is the best option. It prevents you from overspending on a car, stopping you from taking out a 72-month car loan for a car you cannot afford. Most importantly, buying a reliable car in cash will save you a ton of money!
What if you cannot pay in cash?
The 20/4/10 Cay Buying Rule
If you cannot pay for a car in cash, there are ways to minimize the impact of owning a car on your wallet. The key is to minimize the total cost of ownership while limiting the length of the car loan. Following the 20/4/10 rule is one way to accomplish this goal.
According to the 20/4/10 car buying rule, you should make a down payment of at least 20%, finance it for no more than 4 years, and make sure that your total monthly vehicle expenses (loan payments, insurance, fuel, maintenance, and repairs) do not exceed 10% of your gross income.
Don’t skimp on the 20% down payment. Putting down 20% helps you stay ahead of the car’s depreciation. That is key if you sell the car before paying off the 4-year loan.
You can take this further and follow Brian Preston’s advice from the “Money Guy Show” and use the 20/3/8 rule. That means putting at least 20% down, taking out a loan for no longer than 3 years, and keeping car expenses to 8% or less of your gross income.
No matter what rule you choose, both will stop runaway car expenses from turning your finances into roadkill.
Car Buying Mistake #8: Always Buying New
The 20/4/10 rule or 20/3/8 may not help you buy your dream car, but they are excellent guidelines. Following these rules often means purchasing a reliable 3 to 5-year-old used car. Buying a used car can be one of the smartest money decisions.
New cars lose about 20% of their value in the first year and 15% each year after that for the first five years. Buying a used car allows you to take advantage of lower prices while avoiding depreciation. Even buying a one-year-old car can save you 20%.
This doesn’t mean you should never buy a new car. However, for most people, purchasing a used car maximizes their buying power while keeping car costs in check. The more money you save on car expenses, the more you can put toward other things that matter to you.
In over 30 years of driving, I have only purchased two new cars. All the others have been used. This has saved me a tremendous amount of money.
My first new car was an anomaly. I was planning on buying a used car, but it was one of the few times the numbers did not make sense.
Three years after the Great Recession, the world was struggling to recover from the damage. Car sales were down, and the Fed cut interest rates to 0%. Car manufacturers offered big cash incentives on new cars and rock-bottom interest rates. It was during this time that I purchased a brand-new car for $19,000, taxes and registration included.
I have a little regret about my second new car purchase. Although I got a good deal and paid it off in three years, I realized I could have saved much more if I had bought a slightly older used car instead.
Car Buying Mistake #9: Frequently Trading In Your Car
It’s a big mistake to trade in your car for a new one every few years.
When you trade in your cars frequently, you always buy them at their highest price point and own them during the worst years for depreciation. It’s like buying a stock at $100 and selling it three years later at $50, then taking out a loan to purchase it again at $100 and repeating this cycle every three years.
If you trade frequently, leasing might be a better option. However, I don’t recommend it. Leasing has significant drawbacks compared to buying. Instead, I encourage you to keep your car as long as possible, as that is the only way to come out ahead with a depreciating asset.
As a car ages, it will require more frequent and expensive repairs. However, don’t use a $800 repair as an excuse to buy a $30,000 new car. I drive my cars until they stop working or repairing them no longer makes financial sense.
The $19,000 car we bought a few years after the Great Recession remains one of our primary vehicles. Before buying my second new vehicle, I was driving a 15-year-old car. I eventually donated it to charity after the entire exhaust system, from the catalytic converter on the back, needed to be replaced.
I decided to forgo the repair on the 15-year-old car because expensive repairs were becoming more frequent before the exhaust system broke. Replacing the entire exhaust system would have cost $2,000, and the car was not worth $2,000.
The point is that you will see a return on your investment (ROI) in a car after paying off the car loan (or paying in cash) and driving it for a long time.
Car Buying Mistake #10: Worrying About What Other People Think
Last but not least, stop worrying about what other people think about the car you drive. Worrying about what other people think will lead you to overspend when buying a car to impress people you don’t know (or like). Stop trying to keep up with the Joneses; they’re broke!
Our culture and car manufacturers have warped cars into status symbols. The irony is that the car someone drives often has an inverse relationship to their wealth. Why? Because cars destroy wealth.
People who are good with money know you cannot build wealth through depreciating assets like cars. Therefore, they minimize what they spend on their cars so they can maximize their returns through appreciating assets. Thomas J. Stanley, in “The Millionaire Next Door,” shows how most millionaires are our neighbors who live modest lives and drive older cars.
As Morgan Housel said in “The Psychology of Money“:
“But the truth is that wealth is what you don’t see. Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see.”
Morgan Housel, “The Psychology of Money: Timeless lesons on wealth, greed and happiness“
So, who cares what people think about the car you drive? My 2011 Great Recession-era car takes me to the same grocery store as someone cruising in a $50,000 BMW. The difference is that I’m not worrying about car payments.
Conclusion: Mistakes To Avoid When Buying A Car
Cars are one of the biggest wealth destroyers in the United States.
Automobiles are a bad investment because they are depreciating assets and expensive to maintain. Sinking money into a depreciating asset is one of the fastest ways to destroy wealth. However, for most of us, owning a car is necessary, but that does not mean we need to overpay for one.
By following the 20/4/10 or 20/3/8 rule and avoiding common car-buying mistakes, like shopping for monthly payments, you will be well on your way to owning a reliable, safe, and affordable car.
The bottom line is you want your car to work for you instead of you working for your car!
