A client recently e-mailed me the below question…
Q: My daughter recently got a job (hooray) and I’m considering buying her a car as a gift to say congratulations. I know you’ve warned me before about the financial pitfalls of buying a new car. I remember you saying that a brand-new car looks and smells good, but it’s never worth the price, because the moment you drive it off the lot, the vehicle starts to depreciate (typically by 20 – 30 percent by the end of the first year and, in 5 years, it can lose 60 percent or more of its initial value). I want to get my daughter this gift so how can I be smarter about the purchase? What are the important things to consider?
Here’s my answer below. I hope it helps you too.
Congratulations to your daughter. I wish her well as she begins her career. It’s a kind gesture that you’re thinking of doing and I hope she appreciates it. Buying a car entails some major financial implications therefore it is important to consider a few financial factors before making that big purchase. Here are my top 3 financial considerations before deciding to buy a car:
The most important factor that affects your bottom line when it comes to purchasing your car is your affordability based on income — especially if you’re buying a brand-new ride. Car payments can be hefty, and if you’re not sure about what you can foot out of pocket each month, it can spell trouble down the line.
It’s a good idea to pay as large a down payment as possible to try and reduce the ongoing monthly payments. I recommend a down payment of at least 20 percent of the vehicle’s total cost (if possible).
Before you head to the dealership, think hard about how much you can realistically budget for your car payment each month, in addition to how much you can set aside for insurance and routine maintenance and repairs. Banks generally recommend that the price of your car should not be more than 30% of your annual gross salary, and your monthly costs should be no more than 10%.
Other rules of thumb are that people earning roughly between R10, 000 and R20, 000 a month should limit themselves to buying second-hand cars, those earning up to R50, 000 should look at smaller new cars, while those earnings more could look at something a little more luxurious. Only those who earn over R150, 000 a month should consider 4X4s or sports cars.
Remember that if you need a balloon payment to make the monthly installments affordable, you’re buying a car you actually can’t afford.
A solid credit score is crucial to your car budget, since it directly affects your interest rates when financing your vehicle. Scoring a good interest rate can save you hundreds — if not thousands — of Rands. If you have bad credit, or you have a credit score that needs some improvement, be wary of dealership salespeople who may try to talk you into a longer financing term. You’ll end up paying significantly more interest over the course of the term, which can negatively impact your future finances.
If you’re not purchasing your car outright, you’ll have to finance it in some way. It might seem strange to shop for loans before you go car shopping, but it’ll give you a better idea of what kind of interest rate and loan amount you can expect once the time comes to secure a financing option. Compare rates from your bank or credit provider to see who offers the best option for you. If possible, it’s smart to get pre-approved for financing before you walk into the dealership — that way, you know the cards are stacked in your favour.