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There's nothing quite like that new (or new-to-you) car smell. The thrill of buying a new car can overwhelm even the most financially minded folks. If you're considering purchasing a new-to-you car but aren't sure if it's the right time, there are a few factors to keep in mind.
First, determine if a new car is a want or a need. You need to get to school or work, and you need a vehicle that won't leave you stranded on the side of the road. You don't need a brand-new model of a specific car, leather seats, or a 200-horsepower engine. If you can afford those features, then great -- but they aren't a need.
Once you've figured out how much of the new car purchase is a want or a need, consider these other factors. If they apply, consider spending time getting a handle on your budget before making a purchase.
1. Your debt-to-income ratio is above 35%
Debt-to-income ratio (DTI) is a metric that compares the amount you pay each month toward debt to your gross monthly income. Lenders use this metric to calculate whether you can afford payments on a loan.
Here's an example:
- Monthly debt payments: $1,500
- Monthly gross income: $5,000
To get the ratio, we divide 1,500 by 5,000, which is 0.3, and then multiply that by 100 to get the percentage. With those numbers, your DTI is 30%, which is decent, as lenders view anything below 35% as favorable.
2. Your income is unpredictable or unstable
If you're hearing rumors of layoffs, you work in an industry that isn't growing, or have any other reason to believe your income might change soon, now is not the time to buy a new car unless you absolutely must.
Even if you have the cash to buy a new car outright, you're better off saving it in a high-yield savings account for emergencies. And speaking of emergency funds, make sure you have one of those, too.
3. You don't have enough savings to cover a $1,000 expense
According to Forbes, 1 in 4 Americans have less than $1,000 in savings. That means nearly 25% of Americans can't easily cover bigger emergencies like a trip to the emergency room or a rental car after a car accident. If you don't have the funds to cover at least a $1,000 emergency, work on your savings before buying a new car.
4. You can't afford a 20% down payment
Ideally, you should be able to put 20% down on your car. This comes from the car buying guideline called the 20/4/10 rule, which says you should be able to put 20% down, finance the car for no more than four years, and keep your car-related expenses below 10% of your income.
While it's just a rule of thumb, following it can help you avoid negative equity and ensure you can afford other (pretty important) expenses like a mortgage or food.
5. Your only financing options have interest rates above 10%
A lot of factors impact your interest rate, including your debt-to-income ratio and your credit score. If you've shopped around and all the lenders are offering you interest rates above 10%, that's likely because they see you as a higher risk.
The average interest rate for a new car if you have a credit score between 660 and 689 is 9.678%, while the average used-car interest rate for someone with a credit score between 660 and 689 is 10.488%. If your interest rates are higher, it likely means you have debt, possibly some missed payments, or have defaulted on loans in the past.
Higher interest rates also lead to higher car payments, so you can save quite a bit by spending time getting your credit score up before making a car purchase.
Final thoughts
If you currently have a car that gets you from point A to point B and any of the above factors are true, it's a good idea to put off buying a car for now. Find ways to pay down your debt and use budgeting tools to get on firmer financial footing. When you're ready, make sure to shop around for cheaper car insurance to lower your expenses.
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