by Carrie Schwab-Pomerantz, CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
August 24, 2011
I've been on my own for a couple of years and finally feel in control of my money. I've been driving the car my parents helped me buy when I was 17 and really need to upgrade it but I want to go about it in a way that doesn't jeopardize my finances. Any tips?
I'm impressed that you're taking such a responsible attitude toward money at an early age. You won't be sorry. By making thoughtful choices now, your chances of not only staying on top of your finances but also improving them as you go along are just that much better. Making a big purchase such as buying a car shouldn't be done hastily, so you're wise to take your time. There's a lot to consider—from how much car you can afford and how you'll finance it to how you'll handle ongoing costs.
Start with your budget
Whether you plan to save up in advance of buying your car or hope to finance most of it, start by figuring out how much you can put toward this purchase without putting too much of a squeeze on the rest of your life. Take a good look at what you spend on essentials like rent, utilities, food, student loans, etc. and what you spend on extras like going out. Is there anything left over? If so, are you regularly saving that money? If not, you may need to prioritize your spending and make some adjustments before taking on an additional financial obligation.
First, I'd start saving to make sure you have an emergency fund of at least three months living expenses set aside. Then I'd focus on any credit card debt you may have. Get those balances down as low as possible—pay them off if you can.
When these things are in order, look at your budget again and decide how much of a car payment you can handle. To see if you're being realistic, start putting that money aside in a designated car savings account each month. Make it easy on yourself by setting up a monthly automatic transfer from your checking to savings. (That will get you going on a down payment, too!)
Check your credit rating
This would be a good time take a look at your credit rating. Since you say you're in control of your money, I'm assuming you're in control of paying off any debts. But it's always wise to get a free yearly credit report, so go to annualcreditreport.com to see where you are. The better your credit rating, the better chance you have of getting good financing for your car. And if you find there's a problem, you can take some time to clear it up before taking on another debt.
Look at the total cost
Since you already own a car, you're aware of all the other costs that go along with it such as maintenance and insurance. But don't assume that a new car will cost the same. Insurance may be more. Gas mileage may be different. And don't forget that you'll also have to pay for registration and licensing upfront.
If you plan to finance your car, get pre-approved by a bank or credit union. This way you'll know exactly how much you can spend when negotiating with an auto dealer or private seller. Plus, it will help you set your own expectations and narrow your choices. Dealer financing is also an option, but it's often structured so that very little of the principal is paid until the interest is almost completely paid off. As a result, if you want to sell or trade the car in a few years, you might find that you still owe more than the car is worth. Best to be cautious.