The decision to buy a new car must be carefully thought out, just like any other major financial decision.

Many people believe a car is a liability and its main function is to get one from point A to point B safely, while others see it as an outward show of their status.

Here are four things to consider in making the decision whether or not a new car is needed.

1. Do you need a new car?

A new, expensive car is considered a status symbol that shows a person has made it in life. But does one really need it? Things to think about before making a decision include:

Change in circumstances: The number of family members may have increased. A four-door hatchback might be sufficient for a family of three or four but it becomes uncomfortable and not safe of the family grows larger.

Cost of repairs: If it costs more or the same as the monthly instalments on a new car to repair, it is worth replacing the old car. A new car likely comes with a warranty on major parts, potentially for up to five years.

Total loss: The car is wrecked in an accident or stolen. Self-explanatory – the car is gone so a new one is needed.

2. What type of car can you afford?

The two main guidelines people use to work out how much they can afford to pay for a car are:

Monthly salary x 12: This is the price someone can afford to pay for a car.

The value of the car to be bought with a loan: The rule of thumb is that the monthly payments do not exceed 15% of the monthly salary and the loan repayment period must not exceed five years.

The best way for someone to estimate their ability to afford a car is to take into account all expenses, such as housing, food, children, savings or investments (minimum of 10% of the monthly salary), insurance or takaful and other needs and look at what is left.

Take that balance and divide it into two. Why two? One half is the amount the individual can afford for monthly loan repayments and the other half is to maintain the car, including fuel, tolls and so on.

This will show exactly how much one can afford to spend on a new car.

3. Financing the purchase

The cheapest way to by a car is to pay cash as there is no interest on a loan to pay. Most people cannot afford to do this, so how do they go about financing the purchase?

Trade in or sell the current vehicle: The current vehicle may still have some resale value. Trading it in for a new car may be the best option, as the salesman may want to close the deal on the new car.

Or, shop around second-hand car lots, forums such as Mudah.my, Carsome or Mytukar to find the best price for the old car to reduce the amount of financing needed.

Use savings: If there is no car to trade in, use savings to finance at least the 10% down payment. It is not advisable to take a personal loan, if the individual needs to do this they probably cannot afford the car in the first place.

Hire-purchase financing from the bank: This is the most common method and the car salesman can help with the application. Things that need to be considered include:

• The tenure of the loan: Five, seven or nine years. The seven-year option is good but try to settle it in four.

Put aside the money that would have been used to pay a five-year loan and invest it (wisely). This should earn more than enough to settle the loan in the fourth year.

• Fixed-term or reducing-balance financing: In a lower interest rate environment, a fixed term is always better to avoid exposure to an increase in interest rates if the overnight policy rate is increased.

Calculate how much interest would be payable for each option to find out the actual cost of the financing.

4. How much to insure the car for

A few things need to be taken into account when insuring a new car. These points are generally relevant for any car.

Protection on the car: If the car is under financing, get coverage based on agreed value. If RM50,000 is owed, get coverage for RM50,000.

Do not go for the market value option, or worse still the minimum value. If something happens to the car (total loss or stolen), one would probably have to top up an additional amount to the lender.

One can opt for additional riders such as windshield coverage or coverage for flooding.

Protection for the owner: In recent years, banks and financial institutions have introduced hire purchase reducing term assurance or takaful products that will pay off the balance of the loan if one dies.

This is a similar concept to the mortgage reducing term assurance or mortgage reducing term takaful offered with housing loans.

If someone has insufficient life coverage, it might be a good idea to take it. But remember, the benefits are only paid if the person dies.

This article first appeared in MyPF Follow MyPF to simplify and grow your personal finances on Facebook and Instagram.