thoughts

RLFS #1 - Car Purchases

RLFS = Randomly Learn Finance Stuff

Hello and welcome to the first edition of Randomly Learn Finance Stuff, aka RLFS. This series of blog posts are intended to teach you the very basic of different financial areas, decisions, or processes that relate to the American system. I am no financial expert, I am no genius by any means... but I am one of the average American folks who received practically NO information on how to do this from anyone and ended up learning from mistakes.

I want these to be quick and to the point - even if they contain a lot of info. No fancy editing, infographics, just pure information.

Situation: Buying a Car

So in America, having a car in the household is a requirement; not really an option. We all live too far away from things and most cities in America do a horrible job at public transportation, and with what a lot of us make, even Uber gets far too expensive too quickly.

If you've never been to a lot or dealership, what essentially happens is that you get introduced to a vehicle that you'll probably love, they convince you that you need it, and then an absolute WALL of information comes at you. Even if you ask questions about the process, trying to learn all of it in one 3-5 hour sitting just really isn't enough.

Terms You Should Know

However, when you go in, you do need to be prepared to understand what you're getting into. Here's a few quick terms you're going to hear as you head to your desired business to get a vehicle -

Loan - yes, you probably can't drop 40k on a family SUV out of your bank, so you apply for a loan, where basically a bank pays for the car, and you pay the bank back for the car.
APR/APY - AP something basically, and it's interest (also sometimes called rate). Basically the bank has to make money off the 40k they gave to buy the vehicle. So they say "per year" or "per this amount of time" you'll need pay X more. That "more" is basically you paying the bank. You'll pay the bank 44k for the vehicle instead of simply 40k.
Credit - Basically credit is used in America to determine risk. Risk of what? How likely you are to pay back, refinance, or default on it. If you're credit score is bad, banks might not think you can make consistent payments, they make no money, it's too much risk. Good credit means they trust you and are willing to buy the vehicle because they have indicators you likely will pay.
- Consider if you gave out a loan. If you gave someone 40k, and the value of the vehicle just goes down, if that person never paid you, you've not only got a bunch of debt now, but a car to deal with too. That's why credit is a thing.
DTI - While they may not outright say it, they ask for your household income and a few things, like house payment among other things. What they are determining is DTI (Debt to income) ratio - basically using their criteria to determine if you can actually pay for the vehicle in a reasonable fashion.
Down payment - Depending on your credit and DTI, they determine whether you can afford the loan (to their standards of course, not yours or reality). A down payment typically comes in one of two flavors -
- Down payment required - meaning you need to put money down to prove you can afford the vehicle and are serious about it, or because you need to be under a certain amount to get the loan.
- Down payment optional - the more you pay up front on a vehicle, the less the total value is, the less your payment will be.
Warranty - You'll often have several options. What a warranty essentially does is give you a "just in case" security. So if you get a "bumper to bumper" warranty, that means if anything happens to the car, you tell warranty about it, put a little bit of money on it, and they take care of the rest. The catch is that you pay for the warranty in the actual loan.
Term - So your term is basically how long you're going to pay on the vehicle before it's paid off and you're done. The car then becomes yours. The shorter the term, the faster it's paid off but the payment is higher. The longer the term, the lower the payment, but it takes a lot longer to pay off and interest might accrue making you pay more in the end.
Total Value - When they toss final paperwork at you, the most important box to look at is the Total Value. This is the vehicle + warranty + any fees associated with the state, dealer, or whatever. This is the amount you're paying off.
- There's also sometimes a second box, which is Total Value + Interest. It just means in the end, this is what you pay including interest.

Finally, let's talk about "depreciation." A vehicle is worth something today. The more it gets used, the more outdated it becomes, or if it accrues any damage or anything, the value of the vehicle drops. You will almost never buy a vehicle and get rid of it for the same price. Just expect it. It's a part of life. Especially if you buy a brand new car. You'll purchase it for 35k and the second you drive it off the lot, it becomes a used car worth 30k.

Trade-In Process

Most of us don't typically go into a dealer with nothing; we come in with a current car, trying to get a new car. The current car you give them is your trade in. This process is very simple, and here's how it goes.

They usually take your vehicle back and inspect the condition of the vehicle. Is it scratched or damaged? Is there a bad history on it (wrecks, damage, in and out of shops, etc.)? Does it work right? Are there any modifications? After they determine that on your vehicle, they start plugging it into their system that determines the value of the car. There's a little more here, but I'll save it for a little later.

If you outright own the vehicle, whatever value they give it, goes to paying off the new vehicle. If you're buying a 40k car and your trade in is worth 10k, you're now buying the new one for 30k.

If you don't and you're still paying on the vehicle... well then there's an extra step here. They have to take your car and pay off the rest of your loan first. If you have a loan that has 5k left to pay on it, and you're car is worth 15k, you get 10k towards your new vehicle. However, if you still have 15k on your loan and your car is worth 10k, then you get 5k ADDED to your new car loan. Basically your 40k new car becomes a 45k loan immediately.

It's called being upside down; you have pay off the loan regardless if you're paying it directly, or your paying it off with the new car's loan.

Leasing vs Buying

This seems to confuse a lot of people, so I want to take a second to explain the difference from a calculation perspective.

When you buy a vehicle, it's pretty straight forward. They make the price, you take a loan, the bank makes money, eventually you intend to pay it off and the car is yours. Think of like a credit card; you go to the store and buy a new TV, but you still have to pay the credit card. It's the same concept. You buy the car, pay back the bank.

Leasing is a little different, but not really. Basically you still have to take out a loan, you still pay back the bank. The difference here is that you're agreeing to only keep the vehicle for a certain amount of time and keep it's value. So if you lease a 40k vehicle, you won't pay 40k, but instead you'll agree to something like... paying 20k over the course of 3 years and only putting 10k miles on it a year. At the end of a lease, you have two options; trade in the lease for another lease, or turn the lease into a purchase.

Note: With leasing, if you damage the vehicle in any way or rack up more miles than you agreed, you're on the hook for that extra money.

Where Does Everyone Make Money?

This is important to know so you know where you can actually negotiate and get the difference in that payment or value. The reason being is that everyone does need to make money, so there are non-negotiables or limits. Most people think they can walk into a dealership, and somehow get a 40k vehicle for 25k just by "talking them down." Yeah buddy, it doesn't work that.

The dealer has to get the car from somewhere, and they pay what's called "cost" for it. If you're a mom/pop shop, you likely bought the cars off other people, fixed up broken cars you bought, or you bought at an auction. If you're a big brand, you've likely purchased all the parts, paid for a factory to assemble them, and then paid for transportation to the lot. The reason this is important is because this is what the dealer paid, so they need to make more to be profitable. The profit off your vehicle goes towards getting more cars, paying sales/finance/service folks, offering better deals, etc. If they broke even on every car, they'd make no money, there's no way they could operate.

With in mind here, let's talk about it.

A parts seller or factory is going to charge a dealer extra for labor.
A dealer is going to mark up the vehicle to make profit.
The bank is going to charge fees, interest, or something to make money.
Sales folks know their commission comes from the value of the car, so they'll try and keep that price up. Gotta feed the fam y'all.

Negotiation Power

Okay, so now the area where all of you guys will skip to anyway; negotiating the price or payment. Everyone wants some magic way to do it... and there really isn't one.

Let's start with where you CANNOT negotiate -

Rate - it's based on your credit and DTI. You can drop more down payment sometimes to reduce it, but adjusting the rate is often up to the bank; not the dealer.
Original Price - Cars have a list price, and that's where it all starts. To you it may seem like magic how a 45k vehicle is advertised for 38k. The list price didn't change though... the cost did. We'll get there, hold on.

With that out of way, in order to negotiate, you have to understand that it's give and take; not just "give me more off." With the whole process of making money there, you have to operate within those profit areas. Here's some practical ways to negotiate, and what you're actually negotiating.

The Value of your Trade In - May not seem important, but the value of what you're trading in, directly contributes to your loan. When they price the vehicle, they have to make money too. What happens is they buy your car for 15k and sell it for 20k - so they make 5k off your vehicle. That's your in between - convincing them your car is worth 16 or 17k.
1. They are in COMPLETE control over the value here. You have a lot of power. They'd rather sell you a car than have you walk. Keep that in mind.
Discounts - Remember when I mentioned list price? They lower the price because of discounts and rebates, and these are often negotiable and are like a puzzle to piece together. The two or three deals they have on a vehicle, they might be able to trade some in and out for something that lowers it even more. It's always worth asking. Also, things like where you work, Costco/Sam's membership, and other things often offer discounts as well.
Vehicle Features - So... car companies are smart. They know people love things like sunroofs or arial cameras. They'll often ONLY put those features in higher tiered vehicles, that cost a ton more than base or mid models. If you can do without a sunroof or fancy cams, you might be able to shift negotiations to a cheaper vehicle, meaning a better deal. Ask them as well "could I get something cheaper if I took features off?" - there's often a "yes" to that scenario.
Terms - If you hate paying interest, are looking to pay off fast, or looking for a lower payment, the length of term affects that all very directly and significantly. Always ask them to run numbers for multiple scenarios (aka 5 year vs 7 year loan, and have them also show you what a lease looks like).
Different Dealers - Ask the dealer your at directly if what you're looking for is on another lot or at a different place. Despite the idea that well a vehicle has a single worth... the same vehicle may be priced wildly different depending on the dealer and location. If they can't, do a little bit of research on your phone while you're there, most of these places price match.
Warranties - Look, you don't need warranties unless you're just a hazard to society. It's nice to have that cushion, but if you can't afford it, then don't sign up. Tell them no. It'll often save you 25-100$ off a monthly payment. Often after you deny all the things, there's a magical "oh we can give you this for free and because we did that we got the rate down" or something like that.

Your biggest negotiation tool nowadays is honestly just to walk away. I've done it multiple times and it works without question. If you spend 3+ hours in there, interested in buying, they know you will. If you suddenly say "I need to look at this at home" or "yeah I just can't do this," you'll be amazed at how much they'll start knocking off. Again, they'd rather sell you a vehicle than watch you walk, especially in slower times. This alone will eat away their profits, but it'll get you a deal.