The dilemma continues. If a vehicle purchase is in the near future for you, should you buy a new or used car?
To reiterate the four considerations, I’m going to cover your budget, the price of the car, the add-ons, and the financing. We covered the budget side in the last piece (Part 1 here: http://www.kaufmanfinancial.com/about/blog/the-dilemma-buy-a-new-or-used-car-part-1 ). So now that you have a general idea of your personal budget and how much of your take home pay you should allocate to a monthly automobile payment (suggested 10-15% of your take home pay), what are some important things to think of when looking at the sticker price of the car?
When you walk up to a car that’s for sale and see a price on the windshield, a whirlwind of questions might run through your head. What makes up that price? Is there room to negotiate from there? How much is the dealer going to make if I buy it at that price? What’s reasonable? Well, an overview may help before you try to answer those questions.
The price you see on the car is what the dealer is trying to sell it for, the sticker price, or MSRP. They buy the car from a manufacturer (if it’s a new car) or maybe elsewhere (if it’s a used car). Either way, you should be able to obtain a copy of the original invoice price (either from the dealer or if it’s a used car, the Kelley Blue Book site can help). The invoice price is what the original buyer bought it for from the manufacturer. If you’re buying a new car, the invoice price is what the dealer who’s trying to sell it to you bought it for. The invoice price may not be of great use if you’re buying a used car but if you’re buying a new car, if you know what the dealer paid for the car, you can get an idea of what they are trying to make as a gross profit margin on the transaction. Typically dealers will mark their sticker price anywhere from 10-15% above what they paid for it (Cars Direct). However, that price can be elevated in the hopes that the buyer will not be savvy in negotiating. To get a deal that is 5% marked up from the invoice price is a reasonable deal but some dealers will go as low as the inventory price (Cars Direct). How do they do that and still make money you might ask?
Some new car dealers will have “BLOWOUT INVENTORY PRICE SALES!” (whacky wavy inflatable arm flailing tube man!) where all buyers get the advantage of buying at inventory price. These car dealers should be out of business then, right? Wrong. The truth is that new car dealers get certain financial incentives from the manufacturer for selling new cars and usually the faster they sell them, the better the incentive. The most common is called the holdback (I won’t explain it here because it will take up too much space in the article but feel free to look it up). Therefore, even if you buy a new car at inventory price, the dealer can still make as much as 10% gross profit on that transaction (Cars Direct). Unbelievable huh? Well, it’s how the business works and knowing how their business works gives you an advantage when you enter their lot. So if you’re buying a new car, why wouldn’t you want to get the dealer as close to inventory price as possible (depending on your negotiating, they may even sell a car to you under inventory price… because they will still make money).
As for used cars, the inventory price may not be that useful. A common way of determining the value of a used car is simply going to Kelley Blue Book (http://www.kbb.com/ ). Kelley Blue Book is great! For used cars, you can look up the suggested retail price or the suggested price from a Certified Pre-Owned Dealer of a car similar to what you’re looking at. The site offers a wealth of information both on used cars and new cars. If you go into a transaction without using the Kelley Blue Book website, that would be a mistake.
So overall, you need to figure out your budget first so that you know exactly how much you should pay a month for a car payment. I found a better way of searching for cars that fall within your car payment range, so check it out (http://www.carsdirect.com/auto-loans/car-loan-calculator/?monthlyPayment=300 ). You will want to enter all the information and the calculator will automatically show you the estimated price of a car that you should be looking at. At that point, you can start looking up cars (either new or used) that you like in your price range. After that, with the information I’ve given you on the price of a car, you can go to a dealer and start talking to them about what they have to offer while keeping the idea of how their business works in the back of your mind. You’re already a leg up on them! There will be two more segments to come, one on the add ons (should be a quick one) and one on financing terms. Stay tuned in the coming weeks!
*I work as a financial planner, not a car salesman. Therefore, I cannot answer specific questions about certain make or models of cars. I am simply a financial advisor. The next two segments will be out in the weeks to come. Again, a picture is coming.
Financial Executive, Member FPA
Kaufman Financial Services
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