Should I Buy a New Car or Pay Down a Line of Credit?

Balancing your debt responsibilities isn't always easy to do, especially when you're considering a new purchase. If you have debts, such as a line of credit, and are considering a new car, you need to carefully evaluate your finances before deciding on what to do. Talk to a financial adviser if you need help planning out your finances to determine if you can afford a new car.

Finances

When you're deciding whether or not to make any new purchase -- be it a car, house or any other significant expense -- you should judge the potential purchase in light of your current financial situation. If you plan on buying a new car with a car loan, for example, you need to take into consideration all your other obligations as well, such as your mortgage payments or rent, credit card payments and any other obligations you have.

Debt-to-Income Ratio

A good way to evaluate how much you can afford to pay for a car is to calculate how much money you earn versus how much money you pay on your debts, known as a debt-to-income ratio, or DTI. To determine your DTI, you need to determine your gross monthly income and compare it to how much you pay in debt each month. For example, if you earn $4,000 a month and pay $800 in total debt payments, your DTI is 20 percent. According to LendingTree, lenders prefer that you keep your DTI to 36 percent or less.

Depreciation

Another factor you should consider when determining if you should buy a new car or pay off a line of credit is the depreciation involved in a new car purchase. According to Bankrate, a new car typically loses much of its value as soon as you buy it, known as depreciation. While cars generally lose about 15 to 20 percent of their value each year, buying a new car and driving it off the lot can cost you more than 20 percent of the car's value.

Other Considerations

You may need a car regardless of your financial obligations. For example, if your current car breaks down, you may need to replace it to keep your job or meet other needs. In these situations, you need to evaluate your financial needs versus the cost of any car you're considering. In many situations, purchasing a used car is usually a better financial option than purchasing a new car as it can cost much less yet still meet your needs.