Avoid the Monthly Payment Mistake

Capital One

Originally published on November 15, 2017 

Article QuickTakes

• Don't get too fixated on monthly budgeting
• Negotiate the total price of your car first
• Be realistic about what you can afford

Among the many potholes car buyers can encounter on their journey to a new vehicle, The Monthly Payment Mistake may be the deepest.

Fall into this crater, and you could pay thousands more than you should for your new car.

The good news is it’s relatively easy to navigate around this dip in the road, with a bit of budget planning, some savvy negotiating, and a healthy dose of reality.

What’s wrong with focusing on monthly payments?

It’s natural to structure your budget around what you can afford per month. Most of our biggest bills – mortgage, credit cards, car, electric – come due that way.

But there are several reasons not to fixate on monthly payments when it comes to car buying.

1. Monthly numbers obscure the real cost of the car: Walk into a car dealership shopping for a monthly payment of $500 and you will get it. But it will come at a cost – a longer loan, with a higher interest rate is one possibility. There may even be some additional “packages” wrapped into that monthly figure, because once you have monthly payment tunnel vision, it’s easy to lose sight of what you are actually paying (or overpaying) for a car.
   
   ONE $500 MONTHLY PAYMENT, THREE VERY DIFFERENT CAR PURCHASES
   
2. You’ll own your car for years, not months: The average monthly payment for a new car in 2020 is $576, and the average loan length is just under 72 months (6 years) according to Experian. Yet 46% of Americans say they don't have $400 saved for an emergency, a Federal Reserve study says. That’s a clear indication The Monthly Payment Mistake is still gobbling up its share of car buyers. Don’t designate your last dime for a car payment, particularly one that will last five or six years.
3. You could end up owing more than your car is worth: To keep monthly payments manageable, some buyers take loans of 72 months or longer, according to the Consumer Financial Protection Bureau. But new cars lose their value (or depreciate) quickly – nearly 20% the first year and as much as 60% after five years. If they trade-in the car before the loan is paid off, they’ll likely owe more than the car is worth. That’s called being upside-down on a loan, and nobody likes the view from that precarious position.

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What should I do instead?

1. Always negotiate the price of the car first: You can bet one of the salesperson’s first questions will be: “How much are you hoping to pay per month?” It’s their job to try to find out, because once they know your number they can structure the deal around it -- even if it means a longer loan that will cost you much more in interest. Expect them to circle back to it several times during your discussions. But as you steer clear of this financial pothole, they’ll know you’re an educated buyer. Simply let the salesperson know you’re only interested in discussing the best price for the car, based on your research. You will talk financing, trade-in, and down payment later.
2. Calculate monthly payments back from the total cost:  Once you’ve gotten close to the price you want, figure out your monthly payment using an online calculator. Say you found the car you want, and it costs $30,000. Financing that amount over 48 months with a 4.5% interest rate will cost about $684 per month. At 60 months, it would be about $559. You could extend the loan to 72 or even 84 months – but that would be driving straight into The Monthly Payment Mistake.
   
   FINANCING A $30,000 LOAN OVER THE LONG (AND LONGER) TERM
   
   Instead, try to keep negotiating a lower price for the vehicle, or …
3. Be honest with yourself about what you can afford: Financial experts suggest that your car should cost no more than 15% of your net household income. If you negotiate a great price for a car, but the payment is still too high, it’s probably time to adjust your expectations. Shop for a more affordable vehicle, and by focusing on the total price first, rather than the monthly payment, you’ll be in for a smoother ride.