Cars depreciate expeditiously. For this reason alone, it’s not a good idea to pay high interest on an auto loan. What normally happens is that the auto depreciates and the value falls faster than you repay the loan, leaving you upside down or underwater (when you owe more on the loan than the car is worth).
Many people need cars to get to their workplace but don’t have enough cash in their bank account to buy one. So they get a auto loan. Whenever you finance a car, consider the total cost of the car and not just the monthly payments.
Here’s what we recommend:
1. Before going to the car dealer understand your credit score
If there’s ever a time to check and track your credit report and score, it’s before you get a car loan.
Here’s the deal: Unlike mortgages or a credit card, you can usually get a car loan even if you have pretty bad credit—you’ll just pay (a lot) more. The reason? It’s relatively easy for the banks to repossess a car if you don’t pay.
But if you have shaky credit, you’re likely excited to even get a loan, so you’re not going to want to ask if there’s a lower rate available. Dealers know this and they make a lot of money on it.
Free tools like Credit Karma can help you understand your credit score. Once you know your credit score, you can figure out if you can qualify for the best car loan rates.
Dealerships will often advertise very good interest rates on new cars: 2.9 percent, 1.9 percent, sometimes even 0 percent. What they leave in the fine print is that these rates are only available to buyers with the best credit—that may mean a FICO score of 750 or better.
Buyers with credit scores in the low 700s can still get a good interest rate but may not qualify for the best promotions. After that, rates rise quickly. Borrowers with below average credit scores (under 650) may be presented with car loan rates of 10 percent or more.
The lower your credit score, the more important it becomes to shop around and make sure you’re getting the best rate a bank can offer you. Yes, you may have to pay more than someone with good credit, but you may not have to pay the first rate somebody offers.
2. If your credit isn’t perfect, get financing quotes before you go
If you have excellent credit and you know it, you can usually get the best financing rates right from the dealership (who serves as a broker for multiple lenders).
Don’t have stellar credit? Try online lenders. You complete a credit application and are presented with your interest rate and a max amount you can spend on the car. The nice thing is you don’t have to use this loan if the dealer gives you a better deal, but at least you can walk through the door knowing that you have an interest rate to beat.
Most of the time, local banks and credit unions can offer borrowers with average credit the most competitive interest rates on both new and used car loans. Even better, you may be able to use the pre-arranged financing as a bargaining chip with the dealership’s finance and insurance (F&I) manager and score an even lower interest rate.
3. Keep the term as short as you can afford
Shorter loan terms come with lower interest rates but higher monthly payments. And that’s what you want.
When you walk into a dealership and say you want to finance your car, any savvy car salesperson will try to negotiate with you you based upon your monthly payment, not the overall purchase price of the car. By doing so, the sales rep can show you lower and lower payments by extending the the term of your loan, not by reducing the price of the car. Suddenly a $470 car payment becomes a $350 car payment. And yet you’re not paying any less for the car. In fact, you’ll be paying much more in interest.
The longer you take to repay a loan, the more interest you’ll pay. But that’s not all. Many times banks will charge higher interest rates for longer loans, further increasing your cost of credit.
It’s tempting to stretch out an auto loan over five or even six years to get to a more comfortable monthly payment, but this means you’ll pay a lot more in interest and almost certainly be upside down on your car for nearly the life of the loan.
4. Put 20 percent down
In addition to a short loan term, you can avoid a situation in which you owe more money than the car is worth by putting money down.
This may seem like a no-brainer, but many dealerships don’t even require buyers with good credit to make any down payment at all.
Driving off in your new car without putting a penny down is tempting, but it’s risky. If you find yourself suddenly needing to sell your new car, you may not be able to if you owe more on the loan than the car is worth. A larger down payment ensures this doesn’t happen.
5. Pay for taxes, fees, and “extras” with cash
Do not finance the miscellaneous expenses involved in your vehicle purchase such as sales tax, registration fees, documentation fees, and any extras you choose to purchase like extended warranties.
Often, dealers are more than happy to roll some or all of these fees into your financing. Unfortunately, doing that just ensures you’ll be upside down on your car loan, at least for a while, since you’re increasing the amount of your loan but not the value of the car securing the loan.