Buying a Car Without Getting Hooked: The 20/4/10 Rule

"What monthly payment are you comfortable with?"

It's the first thing most car dealers ask, and it sounds friendly. You might think, "Ralph, isn't he just being helpful?" Nope. That's the moment the hook gets set.

I know because I've bought something like 100 cars in 26 years. I've made every mistake in this post myself, some of them more than once.

Why the Payment Question Is a Trap

Picture a $30,000 car financed at 7% for 60 months. The payment is about $594.

You tell the salesman you're comfortable with $500. He already knows what the car costs, so he knows exactly how far to stretch. He stretches the loan to 72 months and says, "I can't quite get to 500, but I can get you to 512."

You feel like you won. You didn't.

The longer loan moved your interest from about $5,640 to about $6,830. That's roughly $1,200 more, and all he did was change the term.

How Do I Know What Payment Is Right?

Get preapproved before you set foot on the lot.

The dealer isn't only selling you a car. He's selling you a loan. Call your credit union or your bank, and they'll look at your income and debts and tell you what you can afford.

Then when the salesman asks about payments, say, "I've already got the financing figured out." Watch his shoulders drop.

My youngest son had $40,000 to spend on a truck, all in, with tax and tags. The dealer got him excited about four-wheel drive and an extended cab at $42,750. He walked out with a $39,000 truck he could actually afford.

When the finance manager steps in, ask, "Can you beat my credit union's rate?" Either they try, or they admit they can't.

Don't Roll Negative Equity Into the New Loan

Say you buy a $30,000 car. It loses about 20% the day you drive off the lot, so it's worth $24,000. If you also owed $4,000 more than your trade-in was worth, your new loan is $34,000 on a $24,000 car.

Lenders see that risk and charge more. Instead of 7%, you might pay 9.5%.

I've had loans with three cars rolled into them. It was a boneheaded move, and I've stopped. Last time I leased, which means no negative equity to carry. A lease isn't right for everyone, but quitting the rollover was right for me.

Call Your Insurance Agent First

Before you buy, ask your agent what the new car will do to your premium. If you've been carrying only collision on an older car, a $30,000 vehicle can push that number up a lot. Get the quote before you sign, not after.

The 20/4/10 Rule

This is the first time I've put this into words, and it's the rule I'm going to live by. Three numbers: 20, 4, and 10.

20% down. The car loses about 20% on day one, so this keeps you from driving off the lot upside down. On a $30,000 car, that's $6,000.

4 years maximum. That's 48 months. Dealers are pitching 84-month loans now, and you pay interest on every one of those months.

10% of gross. Your payment should be no more than 10% of your monthly income before taxes. At $6,000 a month, that's $600.

Run it on the same $30,000 car: $6,000 down, $24,000 financed at 7% over 48 months comes to about $575 a month. That's under the $600 ceiling, so the car passes.

Write your three numbers down before you shop: your down payment, 48 months, and your payment ceiling.

Which One Got You?

Be honest. Have you told a dealer your payment number? Rolled an old loan into a new one? I've done the negative equity one more times than I'd like to admit.

No Shame on the Car Lot

These folks are trained to pick up on every word you say. You didn't make these mistakes because you're silly. The cards are stacked against you.

Know what you can afford. Get the number before the dealer does. Then buy the car.

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