February 28, 2016 - 2:15 pm
It’s a great time of year — tax refund time. Most folks can expect somewhere, on average, in the neighborhood of about $2,500 when it comes to the IRS returning them some money.
A lot of people are going to take those refunds and plunk the money down on a new-to-them used car. That begs the question: Should you use your tax refund to buy a car? Here’s the qualified answer: maybe.
After all, there are no hard and fast rules when it comes to using a tax refund because there are different answers depending on your circumstances.
The first thing to consider is if you absolutely must have a new set of wheels right now. Why? This time of year is almost like the holidays for used car dealers. People love to buy big ticket items when their tax refunds arrive.
That affects the market. Used car prices might increase slightly. Or, used car dealers might be less willing to deal. How to put this gently? Don’t be a rube and let any used car seller know you just received a tax refund. That leaves a seller with little incentive to deal.
It’s wise if you can wait a couple months. The supply of used cars is good right now because the new car market is so strong. That means you should be able to find the used car you want in the middle of April.
Some might think the middle of April would be a prime time for buying a used car because that’s the tax filing deadline. It’s not because usually the people who wait to file around April 15 owe the government money. By then the used car market has started to cool down.
Something else to consider is how much of your tax refund you should spend. It might be smart to estimate how much money you are going to need for your new-to-you car after you buy it and work backwards from there. For example, say it’s going to cost you $500 to register it and pay for additional insurance. (Odds are good you’re going to be paying more in insurance.) Well, if you have a $2,500 refund, you really only have $2,000 to spend.
Don’t make the mistake many people do of rolling all of their costs into the financing. It’s absurd to pay for your registration costs over 48 months.
Another thing to think about is how much car you can afford, not how much monthly payment you can afford. I’ve been covering the used car industry for almost eight years now. One of the mistakes people make (and it’s true for buying new cars, too) is buying based on monthly payment. You can end up with a ridiculously long loan that way.
What’s a good rule of thumb? You should not take out a loan of more than 48 months for a used car or 60 months for a new car. Longer loans leave you with little equity in the vehicle. That poses a problem if something happens to the car before it’s paid off.
By the way, don’t be afraid to splurge a little bit with your refund if your finances can swing it. Consider it a reward for good financial behavior and take a step up.