My Child’s First Car Buying and Loan Experience - Key Components of a Car Loan
Car buying is one of the most stressful purchases people make. Owning a car is often a necessity for most households as it makes it more efficient to get to a job to earn an income for all the other expenses in your life. I know this is not always the case depending on where you live and your personal situation. But none the less, it is a big purchase with lots to consider.
I made the same deal with my children as my father made with me - for your first car, you work and save, then we will find you a good reliable car; you will pay half and I will match your half. For most of my children, this was a 10–15-year-old, medium-high mileage, still reliable, kind of a beater, first car. It ranged between $3,000 to $6,000 - some children were better savers than others.
In 2019, at age sixteen and a half, one of my children bought a 11-year-old Honda Civic with about 113,000 miles for $5,000. Although she also had to pay an additional $1,500 or so in sales tax, registration, and a good tune-up. She had the car until age 22 and it got her through high school and college. During the next 4-5 years, she continued to save a lot in preparation for her next car. She had planned to wait until fall, but with the uncertain economy and looming tariffs, we decided to shop for a new-used vehicle now.
Well, this past week, she experienced the car buying and loan experience for the first time. It was nerve racking for her but an opportunity to learn a lot of financial lessons. She was out-of-state, but was lucky enough to have an uncle living in the area to go with her to the dealership. In addition, she received a lot of advice and feedback from her dad, step-dad, and I back home.
Among many, the main lessons she learned that I want to remind you all are the main components of a loan. However, do not forget to account for other costs of ownership such as increases to insurance and regular maintenance. Newer vehicles will likely have higher insurance rates. Also, if you have a loan on a vehicle, you will be required to carry full coverage; where on your first old beater car that you paid cash for, you might have only had liability coverage.
Let us discuss the components of the car loan:
Total Price: This is the overall cost of the car, including the selling price, fees, and sales tax.
Down Payment: The amount you pay upfront, which reduces the total price. The remaining balance is the amount financed.
Amount financed: The original loan amount you borrow—also known as the principal.
Formula: Total Price – Down Payment = Amount Financed
Interest Rate (APR): The annual percentage rate that applies to the amount financed, typically recalculated monthly.
Term: The length of time (usually in months) you will be making payments. Your loan term determines how long you will pay until it is paid off—unless you make extra payments.
Payment Amount: Your monthly payment, which includes both principal and interest.
Total Interest Paid: The total amount of interest you will pay over the entire loan term.
Total of Payments: The sum of your amount financed (principal) plus the total interest paid over the loan term.
Most of the time, people (and the dealer) are only focused on the payment amount. But it is also very important to understand the key relationships between the components of a loan and how they impact each other. Make sure you take the time to look at the different options and truly understand them to make the best decision for your situation.
Key Relationships:
Increase your down payment: Reduces the amount financed, your monthly payment, total interest, and total payments.
Decrease your down payment: Increases the amount financed, your monthly payment, total interest, and total payments.
Increase your loan term: Lowers your monthly payment, but increases the total interest and total of payments.
Decrease your loan term: Raises your monthly payment, but reduces the total interest and total of payments.
Increase your interest rate: Raises your monthly payment, total interest paid, and total of payments.
Decrease your interest rate: Lowers your monthly payment, total interest paid, and total of payments.
This is a lot to understand, I know. It can especially be overwhelming while at a car dealership when they are throwing all kinds of other options at you and playing with your high emotions. I recommend understanding the components of a loan and key relationships prior to going shopping. Also, have a clear understanding of your budget, all costs involved in buying, financing, and owning a car. Do your research and online shopping before going to a dealer or private seller. If buying from a private seller, and some lower end dealers, I recommend you invest the approximate $200 to get a pre-purchase inspection done by a reputable dealer. And always remember, it is okay (and usually best) to walk away and sleep on it.
Oh, I want to quickly touch on trading in your old vehicle. I know you may want to take the easy way out and just trade in your old vehicle towards your new vehicle, but this is usually never the best deal for you. For example, in our situation, the dealer offered her $2,078 for her old car, which also helps reduce sales tax you pay on your new car, so this would have been $2,250 total. However, I advanced her $3,000 on her down payment and convinced her to have a friend follow her back to Utah (an 8-hour drive) with it the next day. After spending an hour cleaning it up and listing it on the local classifieds, we were able to resell it within 4 hours for $4,200 – more than double what the dealer offered. After paying me back the $3,000 down payment advance, she has another $1,200 to put towards her loan. I could have sold it for a little more, but I was happy to take less than listed for the next teenager buying it for her first car.
Lastly, I want to say how proud I am of my daughter for how she handled her first big purchase – a car purchase. She got a 1-year-old Toyota Rav4, the car she really wanted (minus a couple higher-end features she decided were not worth the extra cost at this time in her life). This is her first small loan (she was able to put 88% down!) and the loan is in her own name (no co-signer). Although she has been “adulting” the past few years away at college, working part-time, paying for rent and groceries; this is another big step! Mom is proud!