Tips for navigating an unprecedented market

This story is part of CNBC’s 2023 College Money Guide, a series to help students and recent graduates understand their money and start their adult lives on a solid financial path.

Buying your first car as an adult is always a little daunting. But trying to buy in this current car market, with vehicle prices and interest rates in the stratosphere, can seem almost impossible.

“It is, in many ways, unprecedented,” said Joseph Yoon, a consumer information analyst at Edmunds. “You have a combination of terrible inventory, the highest interest rates since the Great Recession, and no discounts or incentives because of the inventory situation and outsized demand.”

To put this market into perspective: The average new car transaction is about $48,000 right now, up 37% over the past five years, according to Edmunds data. The average used car price has increased 45% to $29,000 in that same time period.

According to Bankrate, the average interest rate on a car loan is 6.5% for a new car and 7% to 8% for a used car. That’s about 4.5% of a new car and 5% of a used car five years ago.

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There are signs that the market may be starting to cool, but it’s still a tough time to buy.

“Things are looking up a little bit for buyers,” said Matt Degen, publisher of Kelley Blue Book. “Prices have come down a bit for both new and used cars, but they’re still near all-time highs.”

Both Yoon and Degen cautioned that buyers should still expect to pay more than sticker price, and that there aren’t many incentives right now. And that’s hard if you’re buying your first car on a limited income and don’t have an existing vehicle to trade in and lower the cost a bit.

This makes it even more important to do your research to find out how much the car you want is worth so you can get the best possible deal. Using sites like KBB.com or Edmunds.com is a good place to start.

Here are three steps to make sure you get good value.

When shopping for a car, Yoon said the most important factor is “really knowing your budget.”

“Go online, run every payment calculator you can find, and really familiarize yourself with how the numbers are going to shake out each month,” Yoon said.

The average monthly car payment is now more than $730, up from $527 five years ago, according to Edmunds.

But the cost of owning a car is much more than the price you pay for it. It also includes:

• Interest on your car loan (unless you can pay it all in cash)
• insurance
• Gas (or electric to charge)
• Maintenance and repair costs

When you add insurance, which varies from state to state and is higher for younger and less experienced drivers, that will add another $100 or more to the monthly cost. For a 20-year-old driver, for example, the average minimum coverage is $110 a month and the average total coverage is $360 a month (about double the global average), according to Bankrate.

“If you’re 23, that [insurance] The number may surprise you,” Yoon said. “Know how much you can comfortably spend.”

Yoon suggests calling around to get quotes from several auto insurance companies to try to find the best rate. If you still haven’t decided which model of vehicle you’re buying, ask agents for quotes on each one you’re considering.

With car prices so high, many people finance the purchase by taking out an auto loan. If you go this route, be sure to run the numbers carefully.

The amount of time it takes you to pay off the loan affects the rate, as does your credit score. If you have a lower credit score, this can increase your interest rate even more. So you first want to make sure you take the steps to improve your score to get the best deal possible.

Buy a loan before you go into the dealership. Many people think that the only way to finance a car is through the dealership, but that’s not true.

“We recommend getting pre-approved for a loan from your bank or credit union before you set foot in a dealership,” Degen said. “Then you won’t be at the mercy of the dealership’s finance department.”

Try to pay as big a down payment as you can afford. This will lower your total loan amount and your monthly payment.

“With interest rates so high, the only thing you can control is reducing the amount of the loan you get,” Yoon said.

Think about how the monthly payment on that loan and all the other costs associated with owning a car will fit into your overall budget. Make sure you can still pay your bills and save money for emergency expenses. You never want to overdo it.

And don’t just consider your current debt, but what you might have in the future, Degen said. Chances are you’ll have this car for 10 years or more, so you want to make sure you’re not stretching your budget too far with your car payment.

There’s a common guideline in car buying called the 4/20/10 rule: Put 20% down, sign a loan for no more than four years, and make sure your monthly payment doesn’t exceed 10% of your salary.

In a market like this, you might be tempted to go a little overboard, thinking, “Oh, I’ll get a raise and then I’ll have more money and it will work.” But if the last few years have taught us anything, it’s how unpredictable the economy can be. So, make sure you can afford it right now; don’t count money you haven’t earned yet. Nothing is guaranteed.

“Your next raise might come later than you expected,” Yoon said. “Don’t take this for granted.”

Should you buy a new or used car?

“That depends on your personal budget and situation,” Degen said. “A new car brings benefits like a factory warranty and the knowledge that no one has abused the car before you.

“But new cars are expensive and finding models in the lower price range can be a challenge,” he added. “A used car is cheaper but has its own unknowns.”

And between the high prices and interest rates, you’ll be paying a lot for this used car.

A bank may not even give you a loan for a used car if it’s too old; they would see it as too high a risk. And, if you’re financing an older car, think about how old that car will be when you finish paying off the loan. Degen points out that you can run the risk of being underwater, where your car is worth less than what you’re paying on the loan, and that’s not a place you want to be.

Another option is to consider a certified pre-owned vehicle. “These bring the best of both worlds: it’s a used car but it’s been serviced and combed by mechanics and comes with the same warranty as a new car,” said Degan. “They are a bit more expensive than a used car of the same make and model, but a wise choice.”

What about the rent? Leasing can, when the time is right, be a great option for getting a new car while paying less than you would on a new car and having the option to trade it in later.

But Yoon said now is not a good time to rent. A good lease depends on two things: incentives and low interest rates, and right now you don’t have either.

“You’d have to put a much bigger down payment on that deal” to make it worthwhile, Yoon said. “And if you’re going to do that, you might as well put it toward a new car loan.”

Beyond making sure a car fits your budget, and whether you’re looking to buy a new or used car, here are some other questions first-time buyers navigating this market should ask themselves:

1. Am I willing to compromise? Consider an older or smaller car than you originally wanted, this will save you some money. Although do your research to find out which brands are reliable.
2. Do I know someone selling a vehicle? Consider having someone in your network sell their old car instead of going to a dealership. “You’re more likely to get a deal,” Yoon said. But it is important that you know and trust them.
3. Am I OK with not having the latest technology and security features? If you’re buying an older model to save some money, understand that they may not have rear cameras, Apple Car Play, or other features of some of the newer models.
4. How does this feel when driving? When you test drive the car, make sure it feels good to you personally.
5. Is this car in good condition? If you’re buying a used car, ask a local mechanic (perhaps someone your family knows or has worked with before) to do a pre-inspection on the car to make sure there are no problems. That might cost $150 to $200, but Yoon said it’s worth it.

There are signs of improvement in the auto market, but Yoon said wait a little longer if you can.

“If you don’t absolutely need a car right away, you should wait as long as possible for it,” Yoon said.

What could move the needle in this auto market is the Federal Reserve’s latest interest rate hike. That will raise auto loan rates, which could deter more buyers, Yoon said, prompting dealers and manufacturers to start offering discounts to lure them back.

“We’re all waiting for the dominoes to start falling on the discount front,” Yoon said. “As soon as someone starts doing it aggressively, others will follow.”

They’re seeing signs of that, Yoon said, but for now it’s limited to one or two models here and there. He said you might see more noticeable discounts in the fall, hopefully even sooner.

And finally, don’t feel pressured to sign anything. Take the time to compare and make sure what you’re buying fits your budget.

Remember, “It’s your hard-earned money,” Yoon said. “It’s a lot of money and you should feel comfortable spending it.”

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