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People will purchase a car that appeals to them and then find a way to make the payments work for their budget. But that’s a poor strategy, an expert says.AdrianHancu/iStockPhoto / Getty Images

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Big car loans are becoming a growing concern in a client’s budget. According to data from J.D. Power, the average monthly car loan payment ballooned to $781 this summer and continues to trend upward with both the average new and used vehicle prices rising to $68,000 and $39,000, respectively in October.

“These loans are just a fact of life for most people,” notes Hannah McVean, certified financial planner at Objective Financial Partners Inc. in Squamish, B.C. “It’s not practical for most to avoid car ownership. Most of our cities and towns are not designed to be walkable and most people live a significant distance from where they work.”

Scott Terrio, manager of consumer insolvency at Hoyes, Michalos and Associates in Toronto, has seen car payments larger than a family’s monthly grocery bill.

“The average person is spending about a third of their income on cars by the time they add in insurance, maintenance and gas and that’s devastating for people’s finances,” he says.

Here are four crucial mistakes buyers may be making with their vehicle purchases.

1. Not knowing the total cost

Clients might know the manufacturer’s suggested retail price and see the sticker price on the vehicle. After discussing financing with the dealer, they’ll learn about the required payments, amortized over a specific period. But to fit the client’s budget, dealers may amortize over a very long period.

“That loan amortization could be up to eight years and that means paying a significantly higher portion in interest,” says Harry Sale, financial advisor at Raymond James Ltd. in Toronto.

Many clients also fail to factor in insurance, maintenance and potential repair costs in addition to the car payment, Mr. Sale adds.

When clients come to see Mr. Terrio about their financial situation and the discussion turns to cars, he says many have difficulty understanding what they pay monthly for their cars.

“Everybody tells me the amount they pay but they’ve lost track of the overall cost,” he says. “The car industry doesn’t want people knowing what they’re paying per month. If they can get them to see a smaller number either weekly or biweekly, then it’s a little lie about what they’re actually paying per month.”

Mr. Terrio finds that, generally, people will purchase a car that appeals to them and then find a way to make the payments work for their budget. But he says that’s a poor strategy for those already living paycheque to paycheque.

Instead, he suggests they work out what they can actually afford for a vehicle ahead of time, and ask the dealership to find a car within that set budget.

“They should bring you different options, including older used vehicles,” he says.

2. Buying more car than you need and can afford

Mr. Sale acknowledges that for some clients, the right car is extremely important to them.

“Sometimes, they just want that particular car. It’s a statement. It could be their dream car,” he says.

“The best approach here is reviewing other areas of their finances that they can cut to allow them to purchase that car within their budget.”

It’s a personal decision but it needs to be on side with their financial plan first, he adds.

Ms. McVean says this issue often goes deeper and speaks to the human nature of why clients act the way they do.

“At one point, there was reduced stock of cars, so they were unable to buy a car for that reason,” she says. “Decisions can be made based on emotion and perceived scarcity of resources.”

Still, Mr. Terrio questions the practicality of some car buyers. He notes that big trucks and SUVs, which cost considerably more than mid-sized vehicles, are driving up average car loans.

Using his own neighbourhood as an example, he’s observed people not even using their big trucks for their true intention of moving objects, carrying work tools or even using the flatbed.

“They’re lured by the sheer size,” he says. “When people are complaining about inflation and the cost of living, this is an obvious area to cut back.”

3. Underestimating credit scores and not shopping around

Before purchasing a car, Mr. Sale says a client’s credit score should be in the best shape possible. Clients who have impeccable credit scores will receive better deals on financing vehicles.

“The higher the credit score, the less likely, in the lender’s eyes, that you are to default and you are considered less of a risk,” Mr. Sale says. “Receiving a lower interest rate can lead to lower interest payments and, hopefully, helps with paying it off more quickly.”

Mr. Sale says a credit score reflects most accurately if a hard credit check has not been completed within the past six months.

Still, he advises clients to compare multiple lenders to receive better rates and terms.

“Don’t just settle with what the dealership might be offering,” he says. “Explore different lenders and different payment plans, too.”

4. Thinking of returning the car when times get tough

If a client falls on hard times and doesn’t want the car anymore, it’s not just a matter of returning it to the dealership. They are still on the hook for the loan. There will likely be penalties for breaking the agreement, Mr. Sale says.

Sometimes, if the current value of the car is greater than when the client purchased it, they can sell privately, make a profit and pay off the loan. But that’s in more exceptional cases, he adds.

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