Money rules of thumb: car edition

Thumbs upToday for public radio’s Marketplace Money we talked to a guy who has a $600 a month car payment. It turns out he bought a car worth more than half his annual pay, and financed it over six years. (The segment airs this weekend, if you want to listen in.)

I no longer try to talk car guys out of their love affairs with wheels. But too often they’re prioritizing car payments over retirement savings and other more important goals.

So here, in my continuing “Rules of thumb” series, are three guidelines regarding cars:

Cars, Part I: “Buy used and drive it for at least 10 years.” I run through the numbers in my book “Deal with Your Debt”—you can save a quarter million dollars over your driving lifetime by holding on to cars for 10 years instead of trading them in every five years, assuming the cars cost about $20,000 each in today’s dollars and you finance them for five years. If you buy used and/or pay cash, you’ll save even more. Not only will you buy half as many cars, but you’ll avoid the 20% or so loss to depreciation that happens as soon as you get the keys. Today’s cars are better built and will last longer than ever before, so buying used isn’t the gamble it used to be.

Cars, Part II: “If you have to borrow, follow the 20/4/10 rule.” Make a 20% down payment so you’re not upside down as soon as you drive off the lot. Limit loans to four years and payments to no more than 10% of your income—less if you have other big debts or a fat house payment.

Cars, Part III: “The real cost to own is about twice the monthly payment.” If you’re trying to decide whether you can really afford the car the salesman is pitching, double the payment, since that’s roughly what you’ll pay for insurance, maintenance, repairs, depreciation and other costs averaged over five years. Some cars are much cheaper to own than others, obviously, but keeping the true cost in mind can help cool your ardor for a too-expensive ride. You can get more precise figures about how much a car will cost over five years by using Edmunds.com’s “True Cost to Own” calculators.

 

 

In case you missed it: car leases, celebrity estate disasters and how to choose your first credit card

Chevy VoltHere’s a column I never thought I’d write: “Sometimes, leasing a car is the right option.”

Most people are way better off financially if they buy cars slightly used and own them for at least 10 years. Even if you want to buy new, you’ll save a fortune (at least $250,000, by my calculations) by not trading your car in every few years. In most cases, leasing just encourages you to overspend on your wheels and ties you to never-ending car payments. Not good.

But there are situations where leasing actually makes sense, and those are outlined in the column.

Plenty of famous people have left seriously messed-up situations when they died. Lawsuits over the estates of Marilyn Monroe and Jimi Hendrix continued decades after they died. A court recently overturned a settlement in the James Brown estate, a situation complicated by the question of whether he was actually married when he died. Jerry Garcia’s estate plan appointed his third wife as a fiduciary for the second wife and the second wife’s children, legally requiring Wife #3 to put Wife #2’s interests ahead of her own…even though Wife #3 was also a beneficiary. Yikes.

I chose five other more recent but equally spectacular cases of celebrity estate disasters in “5 celebrities who messed up their wills.”

Back in June I wrote about “Why young people hate credit cards.” The good news, that people in their 20s and 30s have less credit card debt, is offset by the bad news, which is that credit cards, responsibly used, help build your credit scores and qualify you for better rates on mortgages, auto loans, insurance and more. If you’ve decided you do want some plastic after all, check out Doughroller’s “5 steps to choosing your first credit card.” Just remember that there’s no reason to carry debt to improve your scores, and that you should pay off your balances in full every month.

When “the basics” eat up too much of your income

Dear Liz: My husband and I are recovering from a job loss four years ago. We used up all our savings and home equity. My husband is now employed, but we are struggling to keep ahead even with a salary of about $100,000. I was a stay-at-home mom for the first 10 years of our kids’ lives and now I work two part-time jobs to help with our expenses. We are trying to follow the 50/30/20 budget plan you recommend, but can’t seem to get our “must haves” — which are supposed to be no more than 50% of our after-tax income — down from 80% to 90%. Most of the rest goes for “wants,” such as the kids’ dance classes and soccer teams and for cellphones. We’re not saving anything although we’re trying to whittle down our credit card debt. I have tried several times to refinance our first and second mortgages and home equity line of credit but have found we don’t qualify because too much is owed on our modest three-bedroom, one-bath house, which has gone down significantly in value. We also have two car loans that are worth more than the cars, and the insurance is killing us. Amazingly enough, we have never been late on a payment. We just can’t get ahead. Did I mention that both kids need braces?

Answer: You clearly can’t afford your life, and things will only get worse if you don’t get your spending in line with your income.

Your first step should be to consult with a HUD-approved housing counselor, who can advise you of your mortgage options. You can get referrals from http://www.hud.gov. If your first mortgage is held by Fannie Mae or Freddie Mac, you may be able to refinance it through the federal government’s Home Affordable Refinance Program. Recent changes in the program have helped more underwater homeowners refinance. Even if you’ve been turned down by one lender, you can try with another. One way to search for HARP quotes is through Zillow’s online mortgage quote service at http://www.zillow.com/mortgage-rates/.

The Federal Housing Administration and the Veterans Administration also have streamlined refinancing programs for their underwater loans.

Government programs usually define an “affordable” payment as one that’s 31% or less of your gross income, but that may be too high for many families to comfortably handle. Ideally, your housing costs — including mortgage, property taxes and insurance — would consume no more than about 25% of your gross (pre-tax) income.

If you exhaust your options and can’t get your mortgage payments down to an affordable level, you should consider a short sale of your home. Moving is terribly disruptive and expensive but it’s better than letting a house sink your finances.

Then take a look at your cars. The average annual cost of owning a car is $8,946, according to AAA. You can make the argument that one car is a necessity, but having two is typically more of a convenience than a “must have.” Getting rid of one could dramatically lower your insurance and transportation costs.

Since you’re underwater on both, you’ll need to look at which is cheapest to operate and which is closest to being paid off. If they’re the same, then your choice is easier — you can work toward paying that car off faster so you can sell it. Otherwise, you’ll have to weigh which loan to target first.

Another way to get your budget balanced is to make more money. That may mean asking for more hours at your jobs or looking for opportunities that pay better.

Low car loan rate could have been lower

Dear Liz: I recently bought a new car, and the dealer, after running a credit check, told me my Experian score was 783. I have had only credit cards and no loans. This is my first auto loan. They gave me a 3.5% interest rate and I took it reluctantly. I do not like the rate and the need to pay huge interest over time, and am considering paying off the loan as soon as possible as there are no pre-payment penalties. If I am able to pay off my loan in a couple of months (instead of the original five-year loan term), will this improve or adversely affect my credit score? How will this look in the eyes of future lenders?

Answer: Paying off debt is a good thing, both for your credit scores and your wallet. The leading FICO credit scoring formula likes to see a big gap between your available credit and the amount you’re using. This is particularly true with revolving accounts, such as credit cards, but your scores also get a boost from paying down installment debt, such as auto loans and mortgages.

By the way, a 3.5% rate isn’t bad and wouldn’t cause you to pay “huge” interest. But you probably would have gotten a better rate had you arranged your financing in advance, say with a local credit union. If the dealership then offered you a better deal, you could cancel your application with the credit union. As it was, you left yourself at the mercy of the dealer — not a good idea.

Once you get this loan paid off, consider making the same-sized payments to a savings account so you can pay cash for your next car. If you do decide to finance again, try to keep your loan term to three or four years. That will help ensure you don’t buy more car than you can afford and could prevent you from being “upside down” (owing more than the car is worth) for much of the loan term, as is often the case with longer loans.