Over the past few years, however, it’s become increasingly affordable to buy a car, with recent data showing cars were actually at their most affordable in 37 years in 2014.
A report from CommSec estimates that someone earning the average wage would have to work for around 26 weeks to buy a new Ford Falcon XT auto sedan without any finance. The organisation says this timeframe is down from around 30 weeks just two years ago.
But very few people would actually save up for 26 weeks before buying a new car. Would you, for instance, wait half a year to get a new car if your current one was on its last legs?
Basically, car affordability is one thing, but car financing is another. How do you pay for something now when you will not have all the money for it until later on in the year?
The most common answer is car loans, which have boomed over the past couple of years. There are now more car loan providers than ever before, and a wide range of introductory rates and deals to go with them.
Car loans are now, however, the only option – and with car affordability so good right now, it’s more likely for people to look beyond the norm when financing this kind of purchase. Unfortunately, there are some options that are worse than others. Here we take a look at the five most dangerous ways to pay for a car so that you can avoid falling into any of these traps.
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- Adding it onto your mortgage
- Using a high interest credit card
- Borrowing money from family
- Using all your savings
- Signing up for the first finance offered to you
Adding it onto your mortgage
Using your mortgage to pay for a car sounds good enough on paper. For one thing, it means you will have one less debt to deal with month-to-month, and the bigger repayment required should be easier to manage as a result.
It’s also a relatively simple thing to do: providing your home loan has an overdraft facility, it’s just a matter of filling out an application and waiting for your home loan provider to get back to you. You’ll also have the same interest rate, which could mean you save on car loan interest in the short term.
But adding even a few thousand to a home loan is a risky proposition. While it means less interest on the car, it means a lot more interest on your home loan in the long run.
MoneySmart says it is best to avoid longer-term loans for financing things that should only take a year or two to pay off.
“Even if the interest rate is lower on the new loan, paying off a short-term debt (like a credit card or personal loan) over a very long term means you will still pay more in interest and fees in the long run.”
With mortgages, in particular, the repayments are usually fixed, which could make it hard if you want to increase your payments at any time. So while this option could make sense for the car, it is often not so great for your house or your long-term financial situation.
Using a high interest credit card
If you want a used car, there’s a good chance your credit card could cover it. According to data from both the Reserve Bank of Australia and MasterCard, the average credit card limit is over $9000 and rising, which means a good proportion of cardholders have limits that could easily buy a decent used car.
The main appeal with this option is convenience – you can buy the car when you want it without needing to apply for new finance or read any more terms and conditions. Plus, if you have a rewards credit card, the points could be a huge incentive for this type of purchase.
But using a credit card to pay for a car has several big problems, starting with the fact that it means you will not be able to use your card until you have paid off some of the balance. Beyond that, there is the interest rate to think about.
Let’s say you bought a used car for $8000 on a credit card with an interest rate of 18% (around the average for 2014) and planned to pay $200 off the balance each month. Using a credit card calculator, we can see that it would take you five years and one month to pay down the debt and cost you an extra $4014 in interest – with the total debt worth $12,014.
That’s not to say using a credit card is never a good idea, however. With a low rate card, you could find the interest much more affordable – the same goes for a card with a good introductory rate that could help you get ahead with payments. But really, the only way to keep this finance option viable for your car is to make the monthly repayments as big as possible (or make more frequent repayments) so that you clear the debt in a short amount of time.
Borrowing money from family
Mixing finances and family can be a recipe for disaster. While your parents, grandparents, siblings or other family members might be happy to lend you a few grand to get you on the road (interest free), it often puts a huge strain on relationships.
In an article for Business Insider, personal finance writer Luke Landes says borrowing money from family or friends changes the dynamic from personal to professional.
“When you take a personal relationship and turn it into a business relationship, there is a significant risk that your personal relationship will be destroyed,” he writes.
“If you cherish your personal relationships, you should try to avoid borrowing money completely. Even if you pay the loan back in full and on time, it can change the nature of your relationship forever.”
Landes actually recounts a story of borrowing money from his father to finance a new car purchase when he was younger, and offers some insights into how to go about it is an appropriate and fair way. But it is usually best to borrow from a third-party to avoid damaging relationships over money.
Using all your savings
The benefit of using savings to pay for a car is that it means you will not have to worry about interest rates, loan terms or other financing factors. But while savings might seem like the best way to pay for a new car, it could leave you high and dry a few months down the line.
If you used all of your savings on a car, for example, and then got a bill for car repairs a few months later, you would have to find another way to pay for the additional cost. The same goes for using you savings on your car and then getting a huge medical bill, or having to turn down an overseas trip due to lack of savings.
Basically, the risk with this strategy is that you could end up with less access to money after using all your savings to buy your car. But if you really want to pay for your car with your own money, then you could develop a savings plan to get you there.
“Work out how much you need to buy your car and develop a savings plan to help you get there,” MoneySmart recommends on its page about saving for a car. The organisation adds that you should “give yourself a realistic timeframe to save as much as you can to put towards your car.”
Signing up for the first finance offered to you
Whether it is a loan from the car dealership or a pre-approval from the bank, signing up to the first deal you see is a big mistake. The problem is that it could be a great loan or the worst car loan possible for your circumstances and you would never know.
If you have nothing to compare it to, how do you know if a loan is good or bad? That’s why it’s so important to look at a few car finance options, compare them and make an informed decision about which deal with be the best for your personal circumstances.
“Just as important as getting the best price on a car is getting the best credit deal,” MoneySmart says.
“By shopping around for credit before you go shopping for a car, you can find a loan that suits your budget and circumstances.”
This process could save you hundreds of dollars every year and thousands over the life of the loan, so it is worth taking a bit of time to compare car loans based on what you want and what you can afford.
Buying a car is one of the biggest purchases you will ever make, second only to property. But while people could choose to rent instead of buying a house, a car is often essential for getting around – especially in a country with such vast distances between places.
When it comes to cars, however, the way you decide to pay for it can have just as much of an impact on it’s affordability as the make and model. There is a wide range of ways you can finance a car purchase, but as the examples above show, they are not created equal.
But taking the time to consider all of these options means you will be able to figure out the best way for you to finance a car purchase. And whether it is through a car loan, personal loan, or one of the options above, making sure it fits with your lifestyle should be a priority.
That’s where a budget can help. Budgeting for your car means that you will be able to factor in any repayments for the finance, as well as other costs such as license and registration fees, petrol, services and insurance. That way you will be able to make your car and your finances really work for you.