Be Careful, when your Spending on Your Car

It's always a good idea to start the car-buying process with a preliminary budget planning session to help you determine how much car or truck your money can buy—and how much money you feel comfortable about spending—on what is typically the largest consumer purchase after a house.
Experts told MSN Autos it's all too easy to buy or lease a car you really can't afford—even if you're normally a levelheaded consumer. By overextending yourself for the sake of a new car you face more than just giving up vacations and nights out. You could be putting your financial security at risk.

Control Your Emotions
" Don't overbuy," advises Bob Litwin, Director of Creditor Community Relations for the Houston branch of the Consumer Credit Counseling Service (CCCS), part of the nonprofit National Foundation for Consumer Credit, headquartered in Silver Spring, Maryland. "All too often, emotions overrule logic and people get into trouble. If you can't afford it, don't buy the car."

One way many consumers get into trouble is by not understanding the difference between qualifying for a loan and being able to afford one.

What It Means to "Qualify"
Qualifying for a loan simply means you have satisfied the bank's or other lender's concerns about your financial means to repay it. Lending institutions all use mathematical formulas to determine your repayment capabilities. However, Keith Peterson, economist for the Washington, D.C.-based Credit Union National Association (CUNA), the largest organization of credit unions in the country, told MSN Autos that some lenders use an applicant's credit report as the basis for their figuring, while others use an applicant's debt-to-income ratio.

The two methods can produce different results. "Qualifications based on your credit report will present you with an idea of the amount you're willing to pay, while qualification based on debt-to-income ratio will tell you what you're able to pay," Peterson said.

Obtaining Your Credit Report
You can obtain a copy of your credit report from any or all of the three national credit reporting agencies that gather the information. If your installment debts consist entirely of amounts owed to large lenders—major credit card companies, banks, automobile manufacturers' finance companies—chances are you only need to obtain a report from a single agency.

But if you owe money or have recently paid off credit obligations to smaller creditors you should obtain credit reports from all three companies, advised Shari Storm, spokesperson for the Seattle branch of CCCS. The reason, said Storm, is that "creditors pay money to the reporting agencies to list your credit information. Most large companies report to all three agencies, but smaller companies may only report to one or two of them."

The three national credit-reporting agencies are:

Experian (formerly TRW)
P.O. Box 9600
Allen, Texas 75013
800-311-4769
http://www.experian.com

Trans Union Corporation
P.O. Box 1000
Chester, Pa. 19022
800-888-4213
http://www.tuc.com

Equifax Information Service Center
P.O. Box 105873
Atlanta, GA 30348
800/685-1111
http://www.equifax.com

All three agencies charge a fee of up to $8.50 plus sales tax per report. If you have recently been denied credit, you can obtain reports free of charge.

"If you're going to apply for credit, or get a loan for a car, it's a good idea to look at a copy of your credit report. That way you can see for yourself that there are no mistakes and that everything is accurate and current," added Storm.

Determining Your Debt-to-Income Ratio
You can also figure your own debt-to-income ratio, to gauge your ability to repay a loan.

Add up all your monthly installment payments such as car payments and credit card payments (do not include regular living expenses like rent, mortgage, or utilities).
Divide the total by your monthly take-home pay, after taxes and other withholdings have been subtracted.
The resulting percentage is your debt-to-income ratio.
The CCCS recommends keeping your debt-to-income ratio below 15 percent. If your figuring shows a ratio already higher than that, CCCS recommends that you shouldn't attempt car payments at all until you pay off at least some of your credit bills.

If your ratio is lower than 20 percent, a lender probably will grant you a car loan, but you should do more figuring to determine if you really can afford it.

The Whole Picture
Ownership costs for a vehicle—things like insurance premiums, gasoline, and maintenance expenses—don't show up in either your credit report or your debt-to-income ratio, but they do affect your monthly bottom line just as much as other regular, unavoidable expenses such as rent or mortgage, utilities, and even grocery bills. And it is these that can spell the difference between comfortably affording a new car and being "car poor"—owning a vehicle that crimps your overall finances.

To determine a complete picture of your finances:

Total your monthly living expenses—those mentioned above, plus any other amounts you pay each month apart from installment loans and credit card debts.
Total also any annual expenses you have—such as insurance premiums, retirement funding, automobile registration fees, or yearly dues—and divide the amount by 12.
Add the two amounts determined above to your monthly installment credit expenses determined earlier.
Subtract the grand total from your monthly take-home pay.
By this process you determine all your expenses (not just those that interest potential lenders) and subtract them from your available income. The amount remaining is the sum you can afford to spend each month and still maintain your current habits.

Got Cash?
Of course, if you have plenty of available funds in the form of savings or securities you don't mind converting, paying out-of-pocket for a vehicle is virtually always less expensive than financing the purchase. The only time it isn't, according to advice published by the Federal Trade Commission's Bureau of Consumer Protection and confirmed by FTC senior attorney Carole Reynolds, is "when you can invest your cash at an interest rate higher than the loan rate."

Even then, you still must come up with monthly payments while your invested cash is locked up earning interest. When you pay with available funds there are no monthly payments! Just make sure when using money you have on hand that you are not exposing yourself to financial hardship should your income take an unexpected nosedive in the future.

The Bank Loan vs. Your Calculations
By obtaining a copy of your credit report and by determining you current debt-to-income ratio you can get an accurate idea of how much credit you'll be allowed by most lenders. But it's important to remember that just because a lending institution determines that you're qualified to borrow more than you'd calculated on your own doesn't necessarily mean you should discard your limit and accept theirs. You know the details of your expenses and budget better than anyone else, so be careful about accepting higher limits too quickly. When in doubt, it's better to be conservative and stick with your own calculations and even gut feelings. After all, a new car should complement your lifestyle, not compromise it.