Buying a car is a huge financial commitment, there’s so much to consider. We already have a blog article about why it probably doesn’t make financial sense to buy a new car if you look at the numbers. Since that article, the numbers have only worsened with the price of petrol and used cars at all time high levels. Numbers aren’t everything though, and whatever reason that resulted in my decision to study marketing instead of accounting is probably the same one that made me decide to buy a car, even after hearing it was such a bad idea. So, if you are like me and you’ve decided to buy a car anyway, there are some things you should know that will help you make your purchase in a financially responsible way. Here are 4 important financial considerations to make when budgeting for a car.
The 20/4/10 Rule of Thumb
This is a rule you can use to help you determine what size car loan you can afford. The rule goes you should aim to make a 20% deposit on a car, with a loan term of 4 years and your monthly car expenses should be no more than 10% of your monthly salary. Once you’ve sat down and worked this out you’ll very quickly be able to see what you can afford. For example, the price of a new entry-level car in 2022 is around R170 000, which means you will want to have a deposit of R34 000. If this deposit seems like too much for you my (non-financial advisor) advice would be to ask yourself if you really need a car right now. This is because I found saving for my deposit really useful, it allowed me to make room in my budget for car expenses without the pressure of a debit order at the end of the month.
The Additional Expenses
You’ll notice earlier that the rule said the ‘monthly car expenses’ and not the ‘loan instalment’ needs to be 10% of your monthly salary. That’s because a car comes with a lot of other expenses that are mostly non-negotiable - petrol, insurance, maintenance costs. No petrol means no travel and its not a good idea to skimp on maintenance or insurance. This will then open you up to other risks; like bankrupting yourself because you got into a fender bender with a Ferrari. Also, nothing has made me question my decision to buy a car like finding out what an annual service costs. Only once you’ve included all of these expenses in your budget can you really tell what you are able to afford.
When applying for a car loan you will get asked if you would like to add a balloon payment to your loan terms. Balloon payments are like deposits that are paid at the end of the loan agreement. That means if you select a balloon payment you won’t have to pay towards that every month through your loan instalment, however, unlike a deposit, you don't already have the money for this balloon payment just sitting in your savings account. Essentially the whole time you are paying off your car you will also have to be saving for this balloon payment, to make sure you can afford to pay for it in the end. So, you might as well not get one and save yourself the unnecessary admin, that’s my (non-financial advisor) advice though.
Credit scores are a three-digit numbers between 0 and 999 that potential lenders will look at to determine how high a risk there is that you won’t be able to pay them back. In general, a really bad credit score will stop you from getting a loan, while an average credit score will get you the loan with a really bad interest rate. For car loans specifically, Auto Trader says that a credit score of 580 will probably get you a car loan, but you’ll want to have a score of at least 740 so that you can get a better than average interest rate. So you should definitely check your credit score before submitting your application to see what kind of interest rate you should expect.
If you have a bad credit score you may also want to consider improving it before taking out your loan to minimise the interest you get charged. I have a secret for those new to the workforce and with no credit score - there are some banks that will give you a car finance deal and a decent interest rate with no credit history 🤫.
After you’ve crunched the numbers on the four concepts mentioned above you’ll know whether or not you are ready to walk into a dealership for more than a test drive.