Before You Get an Auto Loan
How to Get a Great Deal
For a successful auto purchase, you've got to get several things right: choose the right car, get a good price, and fund the purchase in the most affordable way. If you're going to borrow for your purchase, the choices you make on your auto loan are extremely important.
An auto loan helps you buy a car that costs more than you can afford with cash. Unless you have a substantial amount of savings, you’ll probably borrow and pay off your vehicle with flat monthly payments. If you borrow wisely, you enjoy two important benefits:
- You’ll spend less (perhaps thousands of dollars less) on your vehicle
- You’ll have the flexibility to change vehicles and fund other goals within a few short years
Start planning for your loan long before you ever start looking at cars. Getting your ducks in a row ahead of time improves the chances that you’ll get a loan (and a car) that fits with your lifestyle. Plus, when it’s time to make a deal, you’ll be ready to proceed with confidence.
Key to a Great Auto Loan
Manage Your Credit
Your credit (in combination with your income) determines whether or not you will be approved for a loan. Your credit is your history of borrowing from other lenders – have you borrowed before, and did you repay those loans on time? With a good credit score, you’ll get a lower interest rate, which means you’ll pay less for your vehicle (both in terms of the total interest costs, and the monthly payment, which is based on your interest rate).
- Check your credit: review your credit reports before you apply for auto loans or visit a dealership. All US consumers are entitled to a free credit report under federal law, so exercise your rights. Make sure that your credit looks as good as it possibly can. Your lenders will largely make their lending decision on your credit score. Read through the report carefully and fix any errors that will drag down your score – they’re more common than you think.
Know How Much You Can Spend
Get a clear idea of how much you can spend (down payment and monthly payments) before you start looking at cars. If you fall in love with a vehicle before you know whether or not it's in your budget, some salespeople can make it appear as if the car is affordable with fancy math and long-term loans.
- Your down payment is an up-front payment – the larger your down payment, the smaller your loan (and the resulting monthly payments). It hurts to write a big check up front, but you’ll enjoy more flexibility later if you do so.
- Your monthly payments are the regular payments that you’ll make for years to come. Keep these at a comfortable level because you never know if things will change. Your income could fall, or you might face unexpected expenses in the coming years. If you spend as much as you can today, you’re putting your future at risk.
Look at the Big Picture
Understand how loans work, and you’re better equipped to make smart decisions about your loan. When car buyers lose perspective, they commonly fall into two dangerous traps:
- Focusing on the monthly payment (as opposed to the purchase price and total cost including interest)
- Tunnel vision (the need to buy a certain car or certain features, even if those don’t fit your finances)
It’s tempting to focus on the monthly payment when deciding how much you can afford. Some auto dealers encourage this. Unfortunately, the monthly payment is easy to change: just make the loan last longer. Stretching out a loan for more years (for example, going with a seven-year auto loan instead of a four-year loan) makes for lower payments – but it also results in dramatically higher interest costs. What’s more, you’ve got a better chance of getting upside-down on your loan (when you owe more on the vehicle than it is worth).
Making a small down payment feels good today, but that means you’re borrowing more (which, again, makes it easy to get upside-down). Make sure you’re buying a car that you can truly afford and avoid taking on a loan that will come back to haunt you.
Tip: unless you pay cash, it’s best to put down at least 20% for a down payment and get a loan for five years or less.
It is simple, but it is often overlooked. The most important point here is that you don’t have to get your auto loan from the dealership. Check with a credit union, bank, online lender, or P2P lending source. In most cases, your car dealer won’t have the best auto loan (but in some cases the dealer's offer can't be beat). By consulting with an alternate lender before you step onto the lot, you’ll be armed with knowledge of what’s available to you – and that gives you bargaining power.
Avoid Prepayment Penalties
Things change in life and flexibility is important. Your auto loan should also be flexible. Find a lender that will allow you to make extra payments or pay off the loan entirely without any penalties. It’s important to read the fine print – some “penalties” aren’t called “penalties,” and old-fashioned prepayment penalties have been outlawed in some states (so lenders have to find other ways to discourage payment).
Lenders sometimes ask about life and disability insurance when you buy a car. They’re not asking out of kindness – they’d like to sell additional insurance with your loan. Credit insurance helps to cover your loan payments, but it’s rarely a good deal to get credit insurance with your lender. Evaluate your existing life and disability policies that you own as an individual or that you get through your employer.
Again, gather information before you go shopping for a car, as you’ll want these details available. Plus, it’s just wise to know how you and your family are protected if something happens. If you feel like you need coverage, compare offers from several different sources, including an individual insurance agent that is not affiliated with your lender.
When you borrow money to buy a car, your lender is already protected: they can repossess the vehicle if you stop making payments – so focus on protecting yourself and your loved ones.