Transportation is the second largest expense in most American households, behind only housing. That’s why getting a car purchase right is so important.

You might spend 30% of your income on housing. But at least your home can become an asset to build your wealth.

A new car, on the other hand, loses 20% of its value as soon as you drive off the lot and up to a full 30% of its value in its first year. This means you could be sinking 15-20% of your income into something that only loses value.

What is Depreciation?

Don’t used cars lose value too? That’s true, but the pace of depreciation is not nearly as severe.

Think of it this way. If you buy a new car for $20,000, it loses 20% ($4,000) the moment you drive away. Then your brand new car’s value is already reduced to $16,000.

By the end of the first year, it’s depreciated to about $14,000. Then you sell it a few years later for $10,000. You have lost $10,000—half of your total investment.

Alternatively, you could buy the same model car when it was one or two years old. You might buy the car for $15,000 and still sell it a few years later for $10,000, but you would only have lost $5,000.

Of course, there are always exceptions. Some cars do keep their value better than others. Some people just don’t like the idea of inheriting someone else’s problems by taking on a used vehicle.

There are pros and cons to both new and used vehicles. Ultimately, it comes down to your preferences and circumstances.

Over the shoulder of a man inside a car driving down the road.

Mandatory Costs of a Car Purchase

Whether buying new from a dealer or used from an individual, there are some costs that all car owners must pay.

They include:

  • car registration
  • taxes
  • title
  • and license fees.

Taxes and fees will vary depending on where you live. Look up your state laws as well as your city and county regulations.

Dealerships usually bundle these charges into the total amount of your financing.

If you buy from an individual seller, you will have to make a trip to the DMV to pay taxes and fees yourself. Make sure to put some extra money aside.

Insurance requirements vary from state to state as well. Start by looking up your state’s minimum mandatory coverage. But keep in mind that your actual insurance rates will depend on your demographics, driving history, and the type of vehicle you choose.

All car owners must consider not only the cost of buying a car, but also the cost of owning a specific make and model. You might be able to afford the monthly payments on an expensive sports car. Then find out that the insurance premiums are almost as much as the loan payments.

Taxes and registration fees are usually higher on newer cars and decrease as the car gets older.

Insurance rates also tend to go down the older a car gets—unless it’s a desirable make and model.

Across the board, cars are becoming more efficient and easier to maintain. Some vehicles cost more for parts and labor. All these factors and your geographic location contribute to the resale value.

Nearly 90% of American households own at least one car. It is the primary mode of transportation for most of us whether we are commuting to and from work or running errands on the weekends.

Reliable transportation is something many of us take for granted. If you’ve ever had to live without your car for a while, you know how valuable it really is. This is probably why we are willing to pay 15-20% of our income on transportation. We depend on it so much.

As an asset, your car is only worth what you could get if you sold it. Your old clunker might have sentimental value.

But if no one is willing to buy it, then it essentially is worth what you could get for the scrap metal at the junk yard.

That being said, you might be able to get a couple hundred dollars for it as a trade-in at the dealer. Every bit helps to bring the total amount of your loan down.

When researching potential cars to buy from a dealer or independent seller, you should familiarize yourself with the market price.

This includes what others in your area are paying for the makes/models you want. There are several online guides that use real sales data and other tools to help you compare specific vehicles, including:

Regardless of whether you buy new or used, you also will want to weigh the pros and cons of buying from a dealer vs. buying from an independent seller.

Costs of Buying From a Dealer

Buying a new or used car from a dealership tends to be easier than buying from an individual. They have the infrastructure in place to make sure you are in compliance with the law. You don’t have to worry about whether you’ve set aside enough for taxes and registration.

They often have their own financing divisions. Even if you decided to buy a car on whim, you could submit a loan application right there. You’ll be the proud owner of a new car just like that! But all that convenience doesn’t always mean you’re getting the best deal.

A car dealer is like any merchant. Just like your grocer, their job is to order, transport, prepare, display, advertise, and sell the merchandise.

They add a markup to the wholesale cost that they pay to the manufacturer. This covers their expenses for delivering the product to you and makes it easier for you to buy. Here are some typical cost of buying from a dealer:

Dealer Fees

Common fees include a documentation (or doc) fee to cover the costs of doing paperwork. Some states put limits on how much a dealer can charge in doc fees, while other states do not. It’s worth an internet search for your state and “car dealer doc fee limits” to find out.

Other fees can be a little questionable. Read the contract carefully and don’t be afraid to ask.

For example, why do you need to pay shipping fees if the car was already sitting on the lot? What exactly are “dealer prep” fees? If the dealer can’t explain to you what it’s for or if it seems excessive, you can push back.

Down Payment or Trade-in

Many dealers don’t require a down payment at all. But the more you can put down, the less you will need to borrow.

Typical down payments range from 5-20% of the total car cost. If you have a trade-in, the dealer will assess the market value of the car. They will apply that amount to your new vehicle purchase. But don’t expect this assessment to be very generous!

Sticker Price

By law, dealers are required to display the manufacturer’s suggested retail price (MSRP) on the vehicle.

This is the price the auto maker says the car is worth. However, this price can vary widely depending on your location.

You also can find out the car’s dealer invoice price. This is how much the dealer typically pays for it. Keep in mind that this doesn’t include the dealer’s markup for advertising, storing, preparing, and financing the car.

Extra Features

It’s an old trick to advertise the price of a base model vehicle while showing you the best version. Most popular car models come in a variety of styles with varying add-ons.

They include things like leather seats, 16” alloy wheels and automatic on/off windshield wipers, etc.

These extras can add thousands of dollars to the sticker price.

Warranties

New cars must carry manufacturer warranties for at least three years or 36,000 miles. The dealer often will extend the warranty for longer. If your car’s manufacturer covers major parts and functions for three years, your dealer might extend the policy to seven years for an added fee.

These types of warranties usually don’t cover wear and tear to things like tires, windshield wipers, or brake pads. But they cover major mechanical parts and functions.

There are a wide range of warranties available. Don’t sign up for the longest, most expensive one right away!

Ask yourself how long you plan to have the car and how much driving you intend to do. Is your plan to keep the car forever and drive it until it no longer runs? You might consider a long-range, all-inclusive warranty. But be realistic about how much that will add to your total loan amount.

Maintenance and Care Packages

Believe it or not, most dealers don’t make the majority of their money on selling new cars. The average dealer markup on new cars is less than 10%. This is quite low compared to other retail sectors. It leaves dealers very little room for negotiation on new car prices.

Most dealers make more profit on used cars and parts and service. They may offer a bundled maintenance package that covers oil changes and tune-ups. This entices you to use them for your car care costs in the future.

If you’re ready to buy from a dealership or if you just want to play around with some scenarios, try an affordability calculator.

Hand holding a car key up in the air.

Buying from an Individual Seller

Buying from an individual instead of a dealer is a whole different ballgame. You might pay more at a dealership for a used car, but you also have an added layer of protection.

As a business, the dealer is regulated by federal regulations and the laws of your city, county, and state. This means that there are checks and balances to protect you against fraud.

When dealing with an individual seller, you take on more responsibility. You must assesses the vehicle’s value and decide whether you’re getting a good deal. This could mean added costs, including:

Mechanic Check-up(s)

Always get the car checked out by your own mechanic. Even if the seller says the car is in great condition, still get an objective expert opinion.

Car Purchase Paperwork

In addition to having the title signed over to you, it’s also a good idea to have each party sign a bill of sale. This includes the vehicle identification number (VIN), the date, the price of the sale, your name and the name of the seller.

You can find sample templates online by searching for “vehicle bill of sale.” Make sure they take their license plates. If you are selling a car, make sure you don’t leave your plates. License plates are linked to the owner, not the vehicle.

Vehicle Identification Number Reports

Before buying privately, always request a check of the vehicle identification number. Some sellers will provide this report while others might make you order it yourself.

Each car’s VIN is unique. If the car was stolen or had major damage, these events should show up in the VIN report.

Extra Cleaning

You may find the used car of your dreams, but the upholstery is covered in pet hair or the carpet is caked with mud.

When buying from a private seller, you miss out on the deep cleaning that dealerships give. You might want to negotiate with the seller to get it done before they hand over the keys.

Fixes, Upgrades, and Body Work

Once you get the assessment from your mechanic of what needs to be fixed, you can ask the seller to reduce the price. You can also ask them to complete these fixes before you give them payment. They might say no, but at least you can ask.

Your Added Time and Effort

When buying from an individual, you have to be your own detective and advocate to make sure you aren’t getting swindled.

Request ownership and maintenance records. Test drive the car. Look for any obvious signs of body damage. Some damages can be hard to spot unless you’re really looking. For example, how would you know if the car has been in a flood?

Check for signs of:

  • Mildew, debris, or silt
  • Rust
  • Water stains
  • Dampness or moldy odors
  • Moisture on inside of instrument panels

These are the types of damages that might not be immediately obvious. They could turn out to be real problems later on.

Research Lemon Laws

Lemon laws are regulations that protect consumers from buying “lemon” vehicles. This means cars that look good now will soon become damaged or inoperable. Because cars are such big purchases, they are attractive targets for fraud.

These protections are important safeguards. They keep manufacturers from selling defective vehicles. They discourage dishonest salespeople from taking thousands of dollars for cars that will break down on the way home from the lot.

To qualify for lemon law protection, the car had to have some kind of warranty. Some states have a mandatory 30-day warranty on all used car purchases. But you’ll have to research your state’s specific rules.

If you bought a new car and you think it’s a lemon, the manufacturer has a reasonable time to fix the issue. This means that you’ll likely have to have the car serviced at the dealer, not a private mechanic.

Lemon laws also only tend to apply only to the first year or two of owning a new car. The longer you drive it, the harder it is to prove that the car was defective when you got it. It’s tough to show that you didn’t cause the damage through wear and tear.

Make an Informed Car Purchase

Most people will own about 13 cars in their lifetime, costing an average of $30,000 each, according to the National Automobile Dealers Association. That’s a lot of your lifetime earnings going toward transportation!

Whether you buy new or used, from a dealer or an individual, be sure you’re not getting in over your head. Do your research to find the real market value of the vehicle before you buy. Consider not only your monthly payments, but the cost of owning, insuring, and maintaining it.

When you have a vehicle you can afford, you can balance transportation costs against your other financial goals to make sure you’re not throwing money away.