After housing costs and taxes, cars will be one of the most significant expenses over the lives of many people. So it stands to reason that this is a very important area of finance. As with other major decisions in life, there are persistent financial knowledge gaps that need to be filled when it comes to evaluating car costs before deciding on loans or leases. For many people, car purchase decisions are made on one variable: the monthly payment, and that can set you up for significant consequences. The monthly payment is only one factor, and making such an impactful choice based solely on the monthly costs can put your entire financial future at risk.

Buying a car can also feel overwhelming. Personal vehicles are much more complex than they used to be, and buying decisions are more complicated than ever. One hundred years ago, the car radio hadn’t been invented. Today, many cars have some self-driving features. When we get overwhelmed, we tend to look for mental shortcuts when it comes to making a decision. But that can cost you a lot more than you think. While you may not be able to do much about the vehicle you’re currently driving if you’re still paying it off, you can use some of the tips below to learn from your current situation, and make the most out of your car financing in the future.

The 36-month rule 🗓️

Try to avoid taking out a car loan over a period longer than 36 months. With car prices today, you may find yourself unable to go below 48 months, but any longer than that is not a good idea. When you have to take out a loan for 60, 72, 84 months or more, you have to do that because you can’t afford that car. The 36-month rule may sound completely unrealistic, especially considering some car loans offer a term of up to 96 months (that’s eight years). But have you ever tried shopping for a car using the 36-month rule? If you haven’t, you’re missing out on a chance to avoid overspending on a car and, ultimately, you could save money on interest too.

Are you thinking, but if I pay off a car in 36 months, the payment will be huge? That’s how you know how much car you can afford. If the payment seems huge, the purchase price is too high for you. So adjust your price range to suit a manageable payment within that 36-month term. Many people are chronically over-borrowing when they make car purchases, and they’re pleasantly surprised when they change that behaviour. 

Sometimes we use the fear of unexpected maintenance costs as a reason to spend more. But, spending more on a new car doesn’t mean that it won’t have any maintenance costs before you’ve paid it off, or before you’ve moved on to your next car. In reality, taking on longer loan terms actually increases the risk that  you’ve still got a car payment when major repair costs start rolling in. Paying off a car in 36 months or less can help you adjust your expectations, and result in several years without car payments in between cars. If you can achieve these car payment breaks, you can afford to save for the next one, while being prepared for the maintenance costs of your current car. 

Lease a car you can afford to buy 🏦

Leasing usually seems like a good way to go if you look at monthly payments alone. After all, you can get a much nicer car for the money each month. But that’s just an illusion that results in a never-ending car payment cycle. And more expensive cars often have more expensive maintenance. For instance, something as basic as an oil change can cost more on a higher end model. 

If you have a good reason to lease, like you’re using that car mainly for work so you can write off some of the costs, a lease may make sense. Apply the same 36-month rule to your lease decisions as well. Except, you’re not necessarily going to take a 36-month lease. You can take a longer or shorter lease depending on your needs, but you want to lease a car you could afford to buy in 36 months or less. Then you can save the difference between the lease payment you're making, and the loan payment you would have had if you’d purchased the car over 36 months. Before you know it, you have a cash cushion saved up for your next car. 

The metal to manor ratio 🚙 🏡

Another financial health indicator of car debt is to compare it to your total housing costs. You want to ensure your total car payments don't exceed your total housing costs. Ideally, you want your car loans or lease payments not to exceed 50% of your mortgage payment or rent. 

This test of car debt reasonableness is most effective for those earlier in their lives with a mortgage. If your mortgage is nearly paid off, a better rule of thumb would be to keep car loan payments within 5% to 7% of your net take-home pay. 

Avoid trading a car with an outstanding loan ⚠️  

Car debt can be one of the most dangerous debts you can take on. It’s not because the interest rates are really high, like credit cards. Car debt is so dangerous because cars typically lose their value so quickly. In fact, cars lose about 10% of their value in the first month, according to CARFAX. That depreciation number often doubles to 20% within the first year of ownership. So you can end up owing more than they are worth. When you roll one car’s outstanding loan balance into a new car loan, it means you owe even more than that new car will be worth. This choice can trap you in a cycle of debt. Avoid financing the balance of your current car into your new car loan at all costs. This is yet another reason we need to focus on taking on shorter car loan terms. 

Read the fine print 🔍 

Before signing, read all car loan documents and check that the numbers make sense, no matter how boring or confusing the documents seem. You should be able to make sense of the total costs and added costs. Watch for life insurance or other types of insurance that are added onto a car loan. In particular, watch for insurance premiums that are added as a lump sum to the loan amount. This means you’re paying interest on the insurance premium, which makes the insurance ridiculously, and unnecessarily costly. Speak with your advisor or financial institution to see if your existing insurance will cover the car loan, or if you qualify to purchase new insurance. If you’re still in good health, you may find it’s cheaper to insure all debts via one personal policy that you own. 

Ask for an amortization schedule of your car loan. Watch for front-end loaded interest. This is where the lender collects all of their interest from the early loan payments, leaving the principal unchanged for months, or even years. This type of loan can be particularly risky if you decide to trade in a car that you still owe money on. You could have been paying for that vehicle for 18 months, and not made so much as a dent in the original balance because all of the payments have been taken as interest first. If you have a very short loan term, like 36 months, this sort of issue is limited because the total interest cost is lower since the loan was paid off more quickly. No matter how short or long your current car loan is, you can ask for these details even after the fact. If there is one thing you should definitely do after reading this post, it’s to review your amortization schedule, or go ask for it from your lender.

Don’t forget about maintenance 🛠️

This is a big issue for many people, and you increase the risk of maintenance being unaffordable when you borrow up to your maximum car payment over a longer term. You need to estimate some regular maintenance costs, but you also need a cushion for unplanned maintenance. Cars break, people run into them, or they get damaged just driving around in some cases. Cutting corners on recommended maintenance can void your warranty, or increase the risk of an even more expensive vehicular catastrophe. So make sure you understand the financial implications of proper maintenance before you sign on the dotted line.  

You can usually get an estimate of the current recommended services for your vehicle over the term of your loan or lease. Ask for the difference between recommended and required services. For example, some manufacturers may recommend maintenance that is unlikely to be needed within the timeframe based on your driver behaviour. There are no stupid questions, but the unasked ones can be expensive. 


Here's a personal example. My dealership recommended rotors be serviced after only the first 8,000 kms of driving. I’m exceptionally easy on breaks; I can often get three years or more out of a set, with very little machining or adjustments. So servicing the rotors at 8,000 kms would be completely ridiculous for me, and it was recommended, not required. Someone who’s much harder on breaks may need that service though.

Financial consequences of car purchases 🤦

When you’re approved for a car loan or lease, the dealership financing process isn’t necessarily taking into account many aspects of your personal financial situation, like a mortgage underwriter would, for example. The issue with this is that you could inadvertently borrow too much and not realize it because you qualified. If your car debt is too high, or your payments are really high over a longer period of time, that could result in getting declined for other types of credit. This could put you in a precarious financial situation if you wanted to upgrade your home, or needed to refinance various debts into your mortgage to improve your financial comfort level, for instance. 

Planning to put off other goals 🗺️

You may decide that a nicer or more expensive car is more important to you than other financial goals. If you decide that’s the case, you may need to adjust other goals and consider your comfort level with those adjustments before you make the car purchase. Are you really going to put off a family vacation for the next seven years in order to have a more expensive car? If so, then make sure that’s what you actually do. 

With car prices on the rise, these tips may seem harder to follow. But those rising prices are exactly why we all need to rethink how we make car buying and leasing decisions. Don’t let a quick monthly payment decision permanently alter the life you could get with the money you have.

Check our Financial Capability Series presentation: Car loans & leases here.

About CacheFlo

CacheFlo is a financial education company that builds eLearning and tools to help financial professionals and individuals make behaviour-based changes, which allow them to get more life from their money. We want to make it easier for people to predict the impact of their financial choices before they make them.

About the Certified Cash Flow Specialist (CCS) program

CCS professionals go through enhanced cash flow-based training to develop the skill set to deliver behaviour-based cash flow advice. They start the financial planning process with a cash flow plan to genuinely help their clients get more life from their money.

About the Financial Capability Program (FCP)

The FCP combines quick and practical lessons with tools, including Winton, which helps people make financial changes they can stick to. Users can apply what they've learned to their financial situation, thus bridging the knowing-doing gap. The goal of the FCP is to help people get more life from their money.