By Jordan Lavin for RateHub.ca
Buying a new car is exciting. There’s lots to dream about, especially if you’ve been driving an older car on its last legs, or no car at all. You might be looking forward to heated seats, leather trim, or even something as simple as power locks or a car that starts when you want it to.
Dreaming about a new car is fun, but the issue of money is always there to spoil the party. Cars can be expensive, and a new car might be the biggest purchase you ever make other than your home.
That’s why most people use financing to get the car they want. With a small down payment and a little paperwork, you can borrow the money you need to buy the car you want. But depending on your situation, this option can be expensive. Dealer financing on a brand-new car can range from 1 to 4 per cent interest, and a bank loan for a used car can go up to 12% and above.
More and more people are stretching car loans over longer periods of time, as well. It’s not unusual for a new car to be financed over 8 years. But even with a relatively competitive interest rate of 2.99%, an 8-year car loan for $25,000 will cost $3,140 in interest. That bumps your total payments to $28,140.
There is an easy way to avoid that interest expense, however. Saving up for your new car purchase, rather than relying solely on a loan, can help you reduce or eliminate the cost of borrowing.
Let’s look at a couple of examples, assuming you want to buy a car with an all-in price of $25,000.
As we saw above, a loan with no down payment amortized over 8 years will cost $3,140 in interest. The payments are $293.13 per month.
But what if you were to save a down payment to help with your purchase?
A $1,000 down payment would reduce your monthly payment to $281 per month and save you $116 in interest over the loan term.
A $5,000 down payment would reduce your monthly payment to $235 per month and save you $628 in interest.
If you were able to save up the full $25,000, you could drive away with no payments and no interest, saving yourself over $3,000.
Coming up with $25,000 cash is easier said than done, however. Let’s look at how to set a realistic savings goal, and some tools you can use to achieve it.
Start by considering your timeline; how much time do you have to save for your new car? If you think your current car will last a year, plan to save over a period of one year. If you can make do with your current vehicle for three years, that’s even better.
The next step is to work out a monthly savings amount. You can base this on your monthly budget, or divide your goal by the number of months you have to save.
For example, if you can afford to save $100 per month for 3 years, you’ll end up with $3,600. And if you need to save $3,600 over 3 years, you’ll need to put away $100 per month.
Once you’ve determined how much to save, open a high interest savings account to help your money grow. These accounts are similar to the savings accounts offered by the big banks, but they pay a much higher rate of interest. Some of the big banks’ savings accounts pay as little as 0.05% interest (one twentieth of one per cent), but the best savings account rate in Canada is currently 2.3%.
The difference in interest rates is quite significant. If you were to save $100 per month for three years, a savings account with a low rate of 0.05% would grow to be worth $3,603. Invested in a high-interest savings account, the same deposits would grow to be worth $3,731. That’s $128 in free money!
Another tool you might want to use to save for a car purchase is a guaranteed investment certificate (GIC). These are low-risk investments that lock-in your money in exchange for a guaranteed rate of return. They’re especially useful if you have trouble keeping money in your savings account, because the money you deposit can’t be withdrawn.
You do need to have the money saved up before you deposit it, but the best GIC rate for a 1-year term currently pays 2.75% interest, which is significantly higher than any savings account.
The last way to save for a new car is to save on a new car. Just as you can save significantly on interest by making a down payment, you can save significantly by reducing the purchase price of the vehicle. There are a few ways to get a lower price for a new car. One is to make sacrifices in terms of features. Another is to comparison shop for cars online to get the best price for the car you want.
Buying a new car doesn’t have to be a strain on your budget if you make smart choices. By comparing cars online and finding the best price, you can save a lot of money. By planning ahead and saving up for a bigger down payment, you can reduce your monthly payments and potentially save thousands of dollars in interest over the lifetime of your car loan. Every dollar counts, so the sooner you start saving the better. Tools like high interest savings accounts and GICs are there to help.