How the Buying Process Works

Here are some things you should know:

Avoid being upside down- be able to afford the payment on a loan no longer than 4 years!

If you get a loan to finance a vehicle, remember the "Rule of 3 to 4." Since you have already done your research, you will know what you want to pay for the vehicle and how much you can afford in a monthly payment. It is best to finance a vehicle for no more than 3 years, but avoid ever financing a vehicle for longer than 4 years. This is a maximum of 48 months. The reason for this is to prevent you from being "upside down" in your vehicle. Being upside down means owing more for your vehicle than it is worth. If you cannot afford the payments on a new vehicle financed for 48 months, then you should look for a less expensive vehicle to meet your needs.

To understand the term "upside down" you first need to understand depreciation. Depreciation is the decline in an object's value over time. A vehicle loses about 15 to 20 percent of its value each year, and it tends to lose more than this amount the first year. For example, a brand new $20,000 car is worth about $15,000 at the end of the first year. The primary reason for the large drop in value is that when you purchase the new vehicle from a dealer, you are paying retail price. Once you drive the car off the lot, if you were to sell it, it would only bring its wholesale price. Also, the money spent on taxes and licensing is gone for good. At the end of the second year, the same vehicle is worth only about $12,750 (85% of the value at the end of the first year).

Now, let's say you financed a $20,000 car by obtaining a loan for 5 years. At the end of two years, you may still owe $15,000 on the car. In this situation, your car's value would be $2,250 less than what you owe on it. This is known as being upside down. Dealers who advertise that they can put you in a new car "even if you're upside down on your current vehicle," simply take the excess loan amount ($2,250 in this example) and roll it into the new loan. Now, after two years you would be "double upside down" on the second vehicle! It looks like this:

Vehicle price/value new:	$20,000	Amountof Loan: $20,000
Value after year 1:	$15,000
Value after year 2:	$12,750	Amount of Loan: $15,000--$2,250 more than value (upside down)

2nd Vehicle price/value:	$25,000	Amount of Loan: $27,250 (value plus $2,250)
Value after year 1:	$18,750	Amount of Loan: $24,750--$6,000 more than value: (double upside down)

So, "double upside down" is when, despite being upside down, you finance another new vehicle and the amount of negative equity from the first vehicle loan is rolled into the new loan. Since the new car loses a great deal of its value in the first year of ownership, you will not only be upside down on the new vehicle, but your loan on this vehicle includes the "upside down" amount from your prior vehicle. This is known as "double upside down." This can continue to become triple, or quadruple "upside down" so that you owe much more than what your vehicle is worth because of continuing to refinance before you have equity in a vehicle. To avoid becoming upside down, do not finance a vehicle for over 48 months, 36 months is even better. If you can't afford the payments, look for a less expensive vehicle.

When you are upside down (have negative equity because you owe more than the value) on a vehicle and it is declared a total loss because of an accident, the insurance company will only pay the vehicle's value, in this case less than the debt owed on the vehicle. The amount the insurance does not cover is called a "deficiency balance." If you do not have gap insurance, you will be responsible for paying any deficiency balance.

Vehicle financing basics.
Financing is more expensive than paying cash because you are purchasing on credit, which includes interest and other possible loan costs. Used vehicle loans normally have higher annual percentage rates (APRs) and shorter loan periods than new vehicle loans. Be cautious about advertisements that offer financing to first-time buyers or people with bad credit. These offers often require a big down payment and a high APR or a loan term that is too long. If you cannot get any other financing, then: (1) be sure that the used vehicle will be reliable transportation for you for the length of the loan and beyond (pay a good mechanic to inspect the vehicle before you buy and ask him or her about this); and (2) be sure that the payment will fit comfortably into your spending plan.

*If you are not paying cash for your car, please also visit our Auto Financing section.

The vehicle purchase process in 5 Steps.

First step: Decide whether you want a new or used car.

Second step: Decide from whom you will buy: A dealership, a car superstore, over the Internet or a private seller.

Third step: Decide what to do with your current vehicle. If you are not going to keep it, then you can sell it yourself or trade it in when you purchase the new vehicle. Selling it yourself will usually get you more money, but there are other factors to consider such as the time it will take you to market and show the car, dealing with potential buyers, collecting funds, money spent on advertising, etc.

Trading in your vehicle is the other option. The first and most important thing when trading-in your vehicle is – negotiate the price of the vehicle you are buying before you discuss a trade-in price! If a dealer asks you whether you are trading-in, simply say you want to focus on the car you're buying first. Vehicle salespeople can be pushy. Stand your ground and remember that it's your money. Always negotiate; the worst that can happen is that they say no. Because you have done your research, you will know when to use the power of walking away.

If you still owe money on the loan of your trade-in, remember that you, not the dealership, are responsible for paying off the loan. Also remember that you can't sell a vehicle without paying any loan against it in full. If you're using the vehicle for a trade-in, only the amount of the trade-in above the amount you owe on the vehicle will go towards the price of the new vehicle. For example, if you still owe $10,000 and the dealership offers you $12,000 for the trade-in, the $2,000 difference is the actual amount you are getting toward the purchase of your new vehicle.

Results if you are "upside down" on a vehicle:
If you owe more on your vehicle than you can get for the trade (you are upside down on the loan), then instead of lowering the amount of your new vehicle loan, you will have the difference added to your new loan! For example, if you still owe $10,000 and the dealership gives you only $8,000 in trade, the other $2,000 will be added to the price of the vehicle you're buying! In this situation, if you finance for longer than three years, you could be "double upside down" on your new purchase. It would be better to keep the existing vehicle, at least until it's worth what you owe on it. Otherwise, you will be paying for the new car and for the negative value of the old car you don't even own any more.

Last but not least, before you take your trade-in to the dealership, have it professionally detailed. This usually increases the value you receive for your trade-in.

Fourth Step: Get your insurance quote before you sign a contract! One true story will show you why. Sue had a car that was paid for. Because money was tight, she carried only liability insurance, which cost her $62 per month. Her vehicle broke down and she had to finance a used car. All commercial lenders and leasing companies require full insurance coverage on any vehicle they are financing. Sue called her insurance company from the car dealer's office, but they were unable to give her a quote at the time. Sue signed the contract to finance the car for payments of $142 per month. She later discovered that a traffic violation she thought was off her driving record was still there. Her insurance payment ended up being $351 per month, more than double her car payment! She couldn't afford this and when the insurance lapsed for non-payment, the car dealer repossessed her vehicle. Don't let this happen to you. Get your insurance quote before you sign!

Fifth Step: Decide whether to purchase vehicle options, extra packages and/or extended warranties. There are many vehicle feature options to consider and salesmen often use them to increase the price of the vehicle (and their profit) by selling you additional features you may not want or need (see "Wants" in Needs vs. Wants). Examples of such options include: automatic transmission, a more powerful engine, anti-lock brakes, four-wheel drive, CD/AM/FM stereo, cruise control, power windows, power door locks, remote-adjustable mirrors, sunroof, tilt steering column and alloy wheels. The point here is to research the prices for these options before you go to the dealership, know what you can afford and what such options are truly worth to you.

Extras are another source of extra profit for the salesman. Typically, the value of a vehicle is not increased very much compared to the cost of extras like fabric protection and paint sealant. Most vehicles already come with these items and if you really want extra protection, you can do it yourself for very little money.

Extended warranties may cost hundreds of dollars and are worth considering only if you plan to own the car a long time. The manufacturers' warranty that comes with a new vehicle is usually sufficient, offering bumper-to-bumper coverage of three years or 36,000 miles and even longer coverage on the power train. If you are intent on buying an extended warranty, purchase one from the auto manufacturer; avoid buying any "third party" warranties.

If you are purchasing a used vehicle from a dealer, the dealer is subject to the Federal Trade Commission's Used Car Rule. The Used Car Rule is in effect in all states except Maine and Wisconsin (these states have their own similar laws). Under this rule, the dealer must provide a disclosure document—a "Buyer's Guide"-- that gives consumers the following important purchasing and warranty information:

For a list of Buying Quick Tips, click here.