Many of us live on credit. We borrow money to buy things we need or want. The trick is managing that debt, which often requires some difficult choices. If you've borrowed on a line of credit, you need to pay it off so you can either eliminate that payment or use that credit to buy something else. If you want or need a new car, you must decide whether to add to your debt or defer the purchase. Adding to your total debt may affect your credit score and impact your ability to buy other things you need.
Assess Your Need
Assess your need for a new car. If you need one for work, you may have no choice, but explore options. A lease might get you a car at a lower payment, enabling you to continue to pay down your line of credit and not affect your credit score. Check out your line of credit options, too. If your home mortgage and line of credit balances are both low, you might consider buying a car with the line of credit rather than a car loan.
Know Your Debt Ratio
Calculate your debt-to-income ratio. Add up your existing house payments, utility bills, monthly credit card charges and other regular payments and balance that against your income to see what adding a car loan would do. Your ratio should be under 36 percent; if the new car will push it past that point, reconsider the purchase.
Check Your Score
Check your credit score at myFICO.com. Total amount owed makes up about 30 percent of your score, while new credit accounts for 10 percent. If you take out a new loan to buy a car, you could be affecting 40 percent of your score. That could change your ability to borrow money for a new mortgage, major purchases for your home or something else you need to put on credit. If you pay off your line of credit, it will improve your score by reducing the amount you owe and adding a positive to your payment history, which is about 35 percent of the score.
Compare interest rates. At the time of publication, rates on car loans ranged from about 3 percent on a three-year loan to about 4 percent on a 5-year loan. Home equity lines of credit had interest rates of from about 4 1/2 to 5 1/2 percent, depending on the amount of the line. Car loans require monthly payments on both principal and interest; credit line payments can vary and often require only interest payments each month. Translate those figures into monthly costs for each type of loan. Try to pay off the highest interest first.
Balance the cost of a car against the amount you owe on the line of credit. If the line of credit is low and you can pay it off quickly, you may be wise to defer buying a car until the credit line is paid off. You can expect to pay from $10,000 to $25,000 or more for a car, depending on the type of car and whether it is new or used.
Calculate the Loans
Use online calculators to help you decide. Bankrate.com, Cars.com, E-Loan and most banks have free online services that let you calculate loan costs. You can enter specific options and see what interest rates, total loan costs and other factors will be. That will help you figure out the best way to use your money.
- Lending Tree: Calculating Your Debt-to-Income Ratio
- Federal Trade Commission: Buying A New Car
- Cars Direct: Managing Your Auto Loan
- Wall Street Journal: How to Finance an Auto Purchase.
- Chase: Using your Home Equity for a New Car
- American Debt Advisor: What Debts Should I Pay Off First?
- Quizzle: Which Debt Should You Pay off First?
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