According to Consumer Reports, loan interest represents 11 percent of the five-year cost of owning a new vehicle (based on a five-year loan with 15 percent down and interest at 6 percent). You only sign a few of these loans in the course of your lifetime. You need a solid game plan because lenders have completed far more of these transactions than you have. Here are strategies that level the playing field.
42.1 Ditch the Car
You don’t have to worry about auto loans if you never own a car in the first place (see Chapter 44).
42.2 Don’t Borrow
□ 42.2.1 Pay Cash
On a four-year loan for $15,000 at eight percent, you pay $2,577 in interest plus applicable fees. To run the numbers for any loan you’re considering, visit these auto loan calculators:
□ 42.2.2 Go Car Free Temporarily
A medium sized sedan costs about $9,000 per year to own and operate. Go without a car for eighteen months (see Chapter 44), and you save enough to buy your next vehicle outright.
42.3 Read a Reliable Guide
Car loans are complex beasts. Educate yourself with one or more of these guides:
42.4 Favor Small Loans
If borrow you must, try these methods to minimize loan costs.
□ 42.4.1 Buy a Used Car
And slash your finance costs (see Chapter 43).
□ 42.4.2 Buy a Cheaper Car
Usually, small cars cost less than larger ones.
□ 42.4.3 Get More Money for Your Trade-In
To limit the amount you borrow, get as much as possible for your current vehicle. Sales to private parties yield the highest returns, but they also take the most time and effort.
□ 42.4.4 Increase the Down Payment
The more you pay upfront, the less you pay in interest.
□ 42.4.5 Shorten the Loan’s Term
This increases the size of your monthly payments, but the sooner you repay, the lower your interest rate.
□ 42.4.6 Maintain a High Credit Score
Those with higher scores qualify for lower interest rates, so pay all bills and loan installments on time. Also, make sure your credit report is accurate. For a FREE copy, visit AnnualCreditReport.com.
42.5 Use House Money
When you borrow on your home to finance a vehicle, you save twice. First, unlike interest on car loans, mortgage interest is deductible. Second, interest rates for home mortgages undercut car loan rates.
But you won’t receive any savings unless you first convince a lender to increase the size of your home’s mortgage. If you have ample equity and a high credit rating, your chances for approval are good. These tactics guide you through the process.
□ 42.5.1 Weigh the Risks
If real estate values drop, you could go “underwater” (own a house worth less than its mortgage).
□ 42.5.2 Use a Car Loan vs. Home Equity Calculator
Access online tools to figure how much you can save.
□ 42.5.3 Refinance Your Home
One way to tap your home’s equity is to refinance for an amount that pays off the old mortgage and leaves enough left over to pay for a car. If you take this path, you embark upon one of the most complicated transactions of your life. This is one instance where you have to educate yourself to avoid disaster. The Federal Reserve Board publishes “A Consumer’s Guide to Mortgage Refinancing.”
□ 42.5.4 Apply for a HELOC
Home Equity Lines of Credit work well for car financing because: (1) your borrowing minimum is low (about $5,000); and (2) you can tap a HELOC without the bank’s renewed permission. HELOCs are complicated, so read “What You Should Know About Home Equity Lines of Credit.”
CODA: AVOID SECOND MORTGAGES
Generally, these have long terms (10 or 20 years) and you have to borrow large amounts (usually, at least $40,000). Such requirements make this a poor choice for auto financing.
42.6 Shop Around
Sources of auto loans include local banks, online banks, credit unions, and car dealerships. Follow these steps to find the best deals.
□ 42.6.1 Line Up Financing First
Secure a loan before you shop. If the dealer pitches a loan to you, say you’ve already arranged one, but would entertain better offers. Never let the dealer mix price negotiations with loan discussions, as in “if you finance with us, I’ll drop $600 off the car’s price.” This increases the risk that you overpay for the car, for the loan, or for both.
□ 42.6.2 Price Interest Rates at Internet Comparison Sites
When shopping, the main consideration is the annual percentage rate (APR), which varies daily depending upon market conditions. The lower the APR, the better. On a four-year car loan of $15,000, a rate of five percent instead of eight percent saves about $1,000. Review the latest offers at these sites:
□ 42.6.3 Visit Your Local Consumer Credit Union
They often offer the best deals on car loans.
□ 42.6.4 Use a Comparison Shopping Checklist for Auto Loans
Under the Truth in Lending Act, lenders must disclose such key terms as the APR, monthly payment amounts, total finance charges, and late payment fees. As you shop, use the Comparison Shopping Checklist below to keep all the offers straight.
42.7 Avoid Pitfalls
□ 42.7.1 Avoid Bells and Whistles
The lender may try to sell you coverage that pays off the balance owed if your car is destroyed or stolen (guaranteed auto protection), if you die or become disabled (credit insurance), or if you lose your job (unemployment insurance). Decline all extras.
□ 42.7.2 Retain the Right to Pay Off Early Without Penalty
Make sure that the repayment schedule spreads interest out evenly over the life of the loan. This is called “simple interest,” and that precise phrase should appear somewhere in the documents. If it’s missing, then interest is likely front-loaded, which means that if you repay early, the payoff amount will be higher because the first payments were allocated to pay interest instead of principal.
□ 42.7.3 Don’t Refinance Auto Loans
You may see ads about refinancing auto loans. You probably can do better if you pay off your loan early with a home loan (see 42.4) or your savings (and these pile up fast with SLN!).
□ 42.7.4 Avoid Leases
Leases save on interest costs, but you save more if you buy a used car instead. Run the numbers yourself with these online calculators.
□ 42.7.5 Avoid Long Term Loans
Don’t sign loans that last more than 72 months. These look attractive because of their low monthly payments. But they also carry rates that are one or two points higher than loans for shorter terms, and you pay hundreds more in interest over the loan’s life.
□ 42.7.6 Read Before You Sign
Before you sign final papers, read them carefully and confirm that their language matches each of the key terms outlined in the Comparison Shopping Checklist below.
COMPARISON SHOPPING CHECKLIST FOR AUTO LOANS
Lender 1 Lender 2 Lender 3
Total amount financed
Annual Percentage Rate (APR)
Is the interest rate variable? (This is
rare for auto loans.) If so:
(a) When do rates change?
(b) How often can they change?
(c) How much can they change?
Fees, including credit check fee,
loan origination fees, application
Total finance charges
Length of contract in months
Total payments in dollars
Penalty for late payments?
Any penalty for paying loan off early?
“Simple interest” or front-loaded
Does loan include extras like credit
insurance, guaranteed auto protection,
or extended service contracts?