5 Financial Moves to Make before Financing a New Vehicle

Sep 10, 2014

The time has finally come; you are sick of driving your old, beat-up car and are in the market to purchase a new vehicle. There is nothing wrong with replacing an older car, especially one that is run-down and unreliable.

New car payments can range in price, but the average car payment ranges from $400- 500 per month.  Think of all the things you can do with $500! Before making the decision to buy a brand-new car accompanied with expensive car payments each month, consider these 5 smart financial moves you should make before taking the plunge.

1. Establish your emergency fund

This is one of the first steps to gaining financial independence after graduating college or entering the work force. Single wage-earners with one salary are recommended to have at least 6 months worth of expenses in an emergency savings fund. Expenses include anything from your monthly rent payment, your insurance premiums, and your food and transportation expenses. Your emergency fund acts as a safety net in case you were to suddenly lose your job and no longer be producing an income.   

2.  Pay off debt

Another important financial move to make, before purchasing a new car, would be to pay down any existing debt you may have that may be accompanied by a high interest rate. When making the decision to pay down debt, it is wise to start paying off the debt carrying the highest interest rate first, and go from there. Usually credit cards bear larger rates, with student loan interest following close behind. It is important to make a conscious decision to keep debt down by at least making the minimum payments each month- before even thinking about financing a new vehicle.

3.  Begin contributing to your future retirement

Although your future retirement may seem far off and distant, consider establishing an individual retirement account or contributing to any employer sponsored retirement plans that may be available to you. It may seem like you have more important things to spend your money on now, but take time value of money into consideration:

Savings$100 (monthly)
Interest Rate5%
Time30 years
Future Savings  =$83,000

As you can see, time value of money and compound interest are powerful. The sooner you begin saving for you retirement, the more that time value of money will be able to benefit you.

4.  Consider saving first rather than financing

In the above scenario, we looked at the positive effect that time value of money can have on your retirement savings, and why it is so important to get started saving early for retirement. Now, consider the effect that time value of money might have on your car purchase.

Buying a Car Today 
Purchase Price$25,000 (in cash)
Ultimate Cost of Car$25,000
Financing a Car Today 
Purchase Price$25,000
Interest Rate3.0%
Time5 years
Ultimate Cost of Car$29,000

In this scenario, putting money aside ahead of time to buy your new or used car could end up saving you $4,000 on the total price of your car. Consider saving money to buy your car with cash rather than financing a car with costly monthly payments, which will ultimately cost you more money in the end.

5.  Buy certified pre-owned

Finally, when you have established your emergency fund, paid off debt accompanied by a high interest rate, contributed towards your retirement, and considered saving for your car rather than financing, it now is an appropriate time to start shopping for a new car. Before buying a brand-new, off-the-lot car that depreciates as soon as you drive it home, consider purchasing a certified pre-owned car that will cost less but will also come with a warranty.

There are some situations in which purchasing a new car is unavoidable. However, if you find yourself in a situation where you are able to drive your existing car for a little while longer, it would be wise to consider these 5 practical financial moves before making your big purchase.

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