I’m currently in the market for a new-to-me car. Unfortunately, I won’t be able to pay cash for my new set of wheels and will need to find an auto loan to cover the cost.
Finding financing at a high-pressure dealership makes me feel uneasy, so I know I have to do a lot of the research on my own before I start shopping.
When we purchased our last car, we took the best deal that the dealership could give us but we could have saved hundreds of dollars if we had done the legwork of finding a loan on our own.
We are hoping to avoid that financial disaster this time around.
Choosing the right car loan can be a complicated process. You want to find something that offers affordable payments and low interest rates.
However, you have several options for different types of loans and a plethora of lenders to choose from. How do you ensure that you are getting the best deal on a new car and its accompanying loan?
If you’re like me and you happen to be in the market for a new ride, here is what you need to know about your loan before you go to the dealership.
Should You Lease or Buy?
I constantly hear advertisements on the radio for the low rates that dealerships around me charge for a lease. It seems like I can get into a new car for a fraction of the cost when comparing leasing versus buying.
This comparison can make leasing feel like a tempting offer, but I’ve always found that I prefer to own the vehicle at some point in the future when my loan is paid off.
I like knowing that I have equity in my car that could come in handy for other financial decisions such as using the car for collateral for a personal loan.
Cons of Leasing
Leasing a vehicle does give you the option to purchase at the end of your lease, but it is typically cheaper to purchase a car outright and own it for as long as possible.
A lease comes with additional fees that you have to consider including a lease initiation fee.
There is less flexibility in setting up a car lease and you cannot make many customizations to the car, if you are allowed to make any at all.
If you do a lot of driving, you need to make sure that you estimate the number of miles you drive accordingly.
A lease sets a maximum number of miles that you can drive each year with higher numbers equaling a higher lease payment.
Exceeding the agreed-upon number of miles will result in extra fees at the end of the lease.
The downsides to leasing include:
- No equity in the vehicle
- More expensive to purchase the car at the end of the lease compared to buying a car outright
- No customizing the car
- Maximum mileage limits
- Extra fees for wear and tear or excess mileage
Pros of Leasing
However, that does not necessarily mean that leasing is always a bad option. Some people may choose to lease based purely off the monthly payments.
A lease typically has lower monthly payments than a car loan, allowing you to either pocket the difference or to opt for a more luxurious vehicle than you would be able to purchase outright.
Some people also like the idea of always having a new vehicle. Every few years, you can return the car you are leasing in exchange for a new ride.
You can skip the haggling and negotiating associated with trading in a used car.
All you have to deal with are the end-of-lease fees that you might have incurred such as those for abnormal wear and tear or excess mileage.
You may also like the security of knowing that the maintenance on their car is taken care of for the duration of the lease. This can save you money on out of pocket repairs such as the need for new brakes or new tires.
In short, the advantages of leasing include:
- Lower monthly payments
- A new car every few years
- No negotiations
- Free maintenance and repairs
Types of Auto Loans
Before you ever set foot in a dealership, you should know exactly what financing options are available to you.
Most car salespeople are going to try to sell you on the most common types of auto loans, but these may not be what is best for your unique financial situation.
Understanding all of your options is important to help you make a wise decision about what works best for your budget.
The first time I bought a car from a dealership and had to use financing, I felt like I had to go with the auto loan that the lender offered me. I had no idea that there were other options out there.
The way they explained it to me, I thought that there was only one type of loan available. If I had known the difference, I may have chosen differently and opted to seek financing elsewhere.
It could have saved me hundreds of dollars in interest and kept me from the potential of having my car repossessed by the lender if I were to have defaulted on payments.
Learn from my mistakes and come prepared when you go to shop for your next car.
Secured Auto Loans
Most people are already familiar with the concept of a secured auto loan.
This means that the lender is guaranteed that you will repay the money you have borrowed by placing a lien on the car.
This means that the lender has every right to repossess the vehicle if you begin to default on the payments. Once the loan is paid off in full, the lender no longer has any claim to the vehicle.
This type of auto loan tends to be the least risky for lenders which is great news for you.
Because they are taking less risk to lend you the cash for your car, these loans often come with the lowest interest rates (depending on your credit).
This is the type of auto loan I have on my car because it saved me the most in interest.
Unsecured Auto Loans
An unsecured auto loan is the exact opposite.
They do not secure the loan by placing a lien on the asset – in this case, your car. If you default on your payments, the lender does not have the right to repossess the car.
In most cases, you will also find that unsecured auto loans are subject to higher interest rates because they are riskier for the lender.
Keep in mind that this is not tacit permission to skip a few payments.
The lender still has the right to seek a judgment on your credit report which can lower your score and make you less likely to qualify for other types of loans in the future.
They can also submit your information to debt collection agencies for further action.
One of the benefits of choosing an unsecured auto loan is that you can borrow more than the value of the car.
While you should still ensure that you can afford what you borrow (and remember that you are paying interest on it), this can be helpful if the car needs some immediate repair work that you can’t afford to pay for out of pocket.
Simple Interest Auto Loans
Simple interest loans are one of the most flexible options for an auto loan. The outstanding balance accrues interest periodically, often on a daily basis.
You are required to make monthly payments just as with other types of auto loans. However, the benefit here is that you can speed up your payoff date and save money on interest by doing so.
This could save you hundreds of dollars.
Precomputed Interest Loans
Precomputed interest loans are a bit different than simple interest auto loans.
You will make a monthly payment based off of the total amount of interest that you will pay over the course of the loan, as well as a share of the principal.
Making extra payments does not reduce the interest that you will incur on this type of loan.
They can be great if you do not plan to pay off your loan early, but it is always nice to have the option to save hundreds with an early payoff.
Tips for Getting a Loan You Can Afford
Once you know what type of loan is best suited to your financial situation, you need to make sure that you are in a good place to get a loan that you can afford.
Here are a few tips to help you figure out what you can afford and get the best deal.
Understand Your Credit Score
Your credit score gives lenders a quick glimpse into your overall financial health and the likelihood that you will repay the money that they loan to you.
This three-digit number ranges from 300 to 850 with higher scores indicating better creditworthiness. It is based on important items like:
- Payment history
- Total amount of money you owe
- Length of your credit history
- Types of credit
- New lines of credit recently opened
A higher score typically gives you the best interest rates because it demonstrates that you are a responsible borrower.
Make sure that you know your credit score before shopping around for a new auto loan. You might be able to check your credit score through your credit card company.
Many of these cards will offer your score as a free service, and you might find it listed on a previous statement. If not, you can always pay a small sum to gain access to this information about yourself on myFICO.com.
Take some time to clear up anything that is inaccurate on your credit report.
You might also want to consider paying down some debt to boost your overall credit score. Doing this now can save you hundreds of dollars in interest fees if you can qualify for better rates based on your credit score.
When I bought my first car using an auto loan, I had barely any credit. I always paid my bills on time, but the length of my credit history was relatively short.
The lines of credit that I did have were relatively new. This meant that my score was lower than I would have liked. While I still qualified for an auto loan, I lost hundreds of dollars because I was subject to higher interest rates.
I wish I had been able to wait and boost my credit score to maximize my savings at the dealership.
So, if you can afford to wait, definitely do so if you want to save the most money with a low credit score loan.
Figure Out Financing First
Whether you have excellent credit or bad credit, the best thing you can do is shop around for a loan before you shop for a car. Look at online lenders as well as local credit unions and banks.
Apply for several loans to see who is willing to give you the best interest rates.
I found the best interest rate on my latest loan from a local credit union.
The good news is that you have some time to shop around for a new car loan. Lenders want to see that you are being financially savvy.
Normally, applying for a new line of credit or a loan will hurt your credit score because lenders are doing what is known as a hard credit pull.
When you shop for a new loan, you usually have a two-week window to apply with multiple lenders to see who offers the most competitive rates and attractive deals.
As long as you are applying during this window, multiple credit inquiries will only count as one.
You can always allow the dealer to check for you as well since they are typically brokering for multiple lenders.
The dealership may still be able to find competitive rates for you. However, you don’t necessarily have to rely on them.
Shopping in advance helps you to know where the best deals are before you sign on the dotted line.
Put Down More Money
Nobody wants to owe more money than their car is worth. The truth is that your car begins to lose value the second you drive it off the lot.
Each year, it is likely to lose about 15 to 20 percent of its overall value. I know it was tempting for me to finance the entirety of my car, but fronting a down payment should be a consideration when purchasing a new car.
This allows me to sell my car if I need to and ensures that my sale price will cover the remaining principal on my loan.
Many experts recommend putting down at least 20 percent on the car before you set up your financing.
You should also make sure to have enough money set aside to cover taxes, fees, and any extras you opt for such as extended warranties.
On my latest car purchase, I spent about $600 in taxes and fees. This can be quite a chunk of change, so make sure that you are prepared to cover it.
Your trade-in can also count toward your down payment. If you already have a car that you own free and clear, the value of it can be used to offset the cost of your new vehicle.
You might even be able to negotiate a higher trade-in value for your car as part of the deal with your salesperson.
Make sure to know what your car is worth before heading to the dealership. You might make more money through a private sale than by trading in at the dealership.
Finance for Four Years or Less
If you have any experience working with salespeople, they always ask you about your monthly budget.
They aren’t interested in how much you want to spend on the car so much as they are interested in how much you can spend monthly.
This is an important question to ask, but they might be trying to trick you into buying a more expensive car and losing hundreds of dollars in interest.
A longer loan term can significantly lower your monthly payments, but it comes with a higher interest rate. Some dealers will offer you six- or seven-year loan terms.
Not only is the interest rate higher, it also means that you will be paying out more money over the duration of the loan.
Most experts recommend that you keep your auto loan to four years or less whenever possible.
This allows you to take advantage of lower interest rates, helps you to own your car faster, and prevents you from paying more in interest accumulated over the extra years of your auto loan.
Keep Payments at Less than Ten Percent of Your Income
How much car can you really afford? While most people would love to ride off the lot with a brand new car, the reality is that a used one might fit better into your budget.
Take a look at your monthly income and try to opt for a payment that takes up less than ten percent of your total income.
Remember that this payment should be calculated after you put down a 20 percent down payment and opt for a shorter lease term that will come with a lower interest rate!
When is the Right Time to Get a Car Loan?
I spent a lot of time trying to figure out when the ideal time was for me to make the switch to a new car. I wanted to make sure that I was in the best financial spot to make a big purchase like a car.
Not only did I want to be financially secure, but I wanted to make sure I was getting the best deal on a new ride.
I worked on my credit score, got my trade-in valued, and saved up some money for a hefty down payment in addition to covering incidentals like taxes and administration fees.
Researching what loans were available to me helped me to rest assured that I wasn’t going to paying more than I needed to in order to finance my new car.
There is no right or wrong time to get a car loan, but it does depend on your overall financial health.
If you have a good credit score, a decent down payment, and can afford the payments on a shorter loan term, then now might be the right time for you to purchase.
Take a moment to look at your overall financial stability before adding more debt to your plate.
Remember that the dealership can help to guide you in the right direction.
However, it might pay off for you to do some research on your own before you start shopping for a new set of wheels. Take some time to research lenders on your own to ensure that you are getting the best deal and the right type of auto loan to suit your needs.