Don't Fall for the Most Common Mistake People Make When Financing a Car

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Andrew Koole
Updated on Apr 27, 2022 · 3 min read
Car financing can be trickier than it looks at first glance. When
buying a car
, you might be tempted by the low-interest percentages and long-term agreements
offered by dealers
But lowering your monthly payments by spreading them over a longer period of time is often a big mistake. It can cost you much more money in the long run. And one factor most people don’t notice can make any long-term financing agreement problematic: the rate of the vehicle’s depreciation.
Buying a new car is a huge financial commitment | Twenty20

The danger in car depreciation

Every new car depreciates in value once it’s purchased and driven off the dealership lot. Financing a car that depreciates is inevitable. The problem occurs when the value of your car depreciates faster than you are paying it off. If you end up owing more on your loan than what your vehicle is worth, an accident that totals your car could put you in a serious financial predicament. That’s because your insurance policy will most likely only cover the value the car is worth at the time of the accident, leaving you with to cover the difference. Depending on the vehicle’s rate of depreciation and the length of your financing agreement, that could be a lot of money.

Car financing advice

Does Refinancing a Car Hurt Your Credit Score?
If you need to take out a loan for your vehicle, Chuck Bell from
Consumer Reports
suggests following the 20-4-10 rule: "Make a 20 percent down payment, take a 48-month loan, and spend no more than 10 percent of your budget on all vehicle expenses, including maintenance and insurance." Before you even decide what vehicle to buy, it’s a good idea to make a budget and decide how much you can afford. How much is 10% of your monthly budget? Enough to cover all your vehicle expenses—not just your loan payment. Putting down 20% on your car right from the beginning means your loan can be that much smaller, bringing any interest costs down with it. A smaller loan means smaller monthly payments. Starting with a smaller loan will be easier for you to pay it off over less time, avoid the financial fiasco described earlier. Taking out a 48-month (four-year) loan will allow you to avoid having your vehicle’s depreciation catch up with the amount you still owe.

Other auto financing options

While following the 20-4-10 rule is normally ideal, there are situations where choosing a longer financing agreement could make sense for you. You might be trying to free up cash for investments, or maybe you need a car and know you can only afford small payments every month. If that’s the case, it’s wise to add
gap insurance
to your policy. Gap insurance is meant to cover the difference (or gap) between what you owe on a financed or leased vehicle and what your vehicle is worth. It kicks in if your vehicle is totaled in an accident and you owe more than what the vehicle is worth. You can find
cheap car insurance
that includes gap insurance with
. Jerry does the insurance shopping for you by comparing prices from up to 45 companies. We help you find the best deals and the coverage you’re looking for.

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