Automoblog How Can Buying a Car Affect Your Finances

How Can Buying a Car Affect Your Finances? (2022 Guide)

  • Buying a new car is enjoyable, but it can greatly impact your finances.
  • Consider whether you can afford a new car before springing for your dream model.
  • Car loan payments and auto insurance rates will differ depending on the new vehicle you choose.

Everyone has different reasons for buying a car, from needing to replace an unfixable model to purchasing a new vehicle due to life changes. Before heading to the dealership, keep in mind that buying a car can affect your finances in many significant ways.

Most buyers can’t pay cash for a car, and so they must apply for an auto loan. Consider questions such as what monthly payment you can afford, whether the purchase is a good deal, and if it’s a good time to buy a car. Thinking through your current financial status will help you determine whether purchasing a vehicle is the right move.

Increased Monthly Payments

If you currently don’t own a vehicle or your vehicle is paid off, acquiring a loan on a car will increase your monthly payments. When thinking about a car purchase, it’s best to look at your budget and all expenses. Your budget is typically made up of two types of expenses: variable payments and fixed payments.

Variable payments shift each month and include costs such as your grocery bills and the cost of gasoline. On the other hand, fixed expenses remain the same each month. These include your monthly rent or mortgage payments, home and auto insurance bills, and most car loan payments.

You’ll Have Car Loan Payments

Your monthly car payment includes the balance, which is the price of the car, along with interest and any added fees. Your lender will take your total loan amount and divide it by your payment window to figure out your monthly payment.

If you’re looking to save money on a car loan, shop around for the market’s best rates. Lenders base interest rates on factors like a borrower’s credit score, the duration of the loan, and the total loan amount.

Those who agree to a higher monthly payment with a shorter payment window may receive a lower annual percentage rate (APR). Taking time to improve your credit score can also lead to better interest rates than the ones that come with bad credit car loans.

Auto Insurance Rates May Change

When your car situation changes, so will your auto insurance payment. Insurance is a flat monthly charge that covers certain repair and medical costs after an accident. Whether you’ve bought a car before or not, you’ll need to prepare for potential auto insurance costs.

Insurance companies set premiums using formulas that evaluate your risk while driving a car. They look at your personal driving history, where you will be driving, your current mileage, what the car is used for, and the car model itself.

Spend time shopping around for the best auto insurance providers when you buy a new car. Look for well-rated companies that offer competitive online quotes, and remember to check for better rates every few months.

You’ll Pay for Car Maintenance

Make sure to also plan for car maintenance and protection. This can either be covered by a regular monthly payment through a reputable extended car warranty company, or it can be an unexpected expense that changes each month.

Extended car warranties aren’t just for new models, and they’re often very valuable for older ones. Many pre-owned models are well-suited for a used car warranty due to the frequent repairs that are required.

Your Credit Score Could Dip 

Buying a car can affect your finances, but it could also hit your credit score. If you’re getting a loan, expect your lender to pull a hard credit check – which will likely result in a slight credit dip. The added debt from the loan may reduce your ability to take on additional loans, and lenders may be hesitant to give to borrowers who already have other payments.

Your credit score should return to its previous levels if you always make on-time payments on your car, though. These regular payments show lenders that you’re a reliable borrower who can be trusted with their money.

Fico Score Factors and Percentage of Credit Score

Consider Your Debt-to-Income (DTI) Ratio

Taking on a car loan will also increase your debt-to-income ratio (DTI). This number can be found by dividing your monthly debt payments by your monthly gross income. For example, your DTI will be 40% if your mortgage and auto loan payment add up to $2,000 per month and each month you earn $5,000.

Creditors consider your current DTI when setting interest rates for a loan. The higher your DTI, the higher the likelihood that you’ll miss a payment due to other expenses. Consider how much a monthly payment will affect your DTI before you buy a car or agree to the terms of a loan.

You’ll Need To Pay Taxes on the Car

When most drivers buy a new vehicle, they’ll need to pay a state sales tax on it. This one-time tax isn’t always cheap, so it’s definitely a way that buying a car can affect your finances.

The annual property tax on your vehicle will also likely be higher after you make an upgrade. While this increase probably won’t be too steep, you may want to keep it in mind before going to the dealership.

What Happens if You Default on a Car Loan?

If you can’t make the payments to cover your auto loan debt, then you’ll default on the loan. Defaulting means failing to meet the obligations of the loan, and lenders have multiple options if you fall into this position.

Seek Out a Debt Settlement

In a debt settlement, the debtor will negotiate with the creditor to receive loan forgiveness. The debtor will typically offer a sizable lump-sum payment for the rest of the loan to be wiped away. You may be able to enter into a debt settlement if you cannot pay for your car loan.

Try To Avoid Facing a Collection Agency

Your lender could potentially send your account to collections if you fail to meet your payment obligations. A third-party company could start calling you for payments or the lender could potentially take the car back.

Expect your credit score to take a hit if you have a collection account, as future lenders will view you as a high-risk borrower. Buying a car can negatively affect your finances if you don’t have the money to pay for one, and collection agencies are definitely something to avoid.

Should I Still Purchase a Car?

If you have the money for a vehicle or find a great auto loan rate, it may be worth getting a new car. While buying a car can affect your finances, that’s often outweighed by necessity or by the satisfaction of having a new model.

Only purchase a new vehicle if you’ve got the money to cover the payments, as you’re dealing with a significant financial commitment. Always understand how buying a car can affect your finances before you sign on the line for a new or used vehicle.