Many people — maybe most — shop backwards for their vehicle loans: First they find the car or truck they want, and then they ask the dealer for a good deal on a trade-in and auto loan.
How much sense does that make? Once you want to get your hands on that car, you’re hooked emotionally, and the dealer has little incentive to give high value for your trade-in or a good deal on financing. You’ve lost the opportunity to save perhaps thousands of dollars by comparison shopping on interest rates and terms and maybe selling your old vehicle for more money.
If this approach sounds familiar, don’t feel bad. You’re in good company. But now that you know the downside, wouldn’t you rather have that money in your pocket instead of the dealer’s?
How things go wrong
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- Americans love auto loans: 85.9 percent of new vehicles and 54.7 percent of used vehicles sold in late 2015 were purchased with loans, according to credit bureau Experian.
- Auto loans are big debt: In late 2015, the average vehicle loan was $29,551 (average monthly payment: $493; average interest rate: 4.63 percent), Experian says. For used vehicles, the average loan was $18,850 (average payment: $359, average interest rate: 8.78 percent).
- Long loan terms can mean toxic debt: More than half of the 38,500 complaints received by the Consumer Financial Protection Bureau since mid-2011 were about vehicle loans. It’s not hard to see why. Buyers sign up for loans that stretch over many years to get affordable payments on expensive cars. Today, the average vehicle loan term is nearly six years for new vehicles and over five years for used vehicles, Experian says. Seven- and eight-year loans aren’t unusual, meaning that buyers pay more in fees and interest and take much longer to grow an ownership stake in the vehicle. Longer loans are risky if you get “upside down,” meaning that you’ve borrowed so much that when you trade in the vehicle you still owe more than it’s worth. That can easily start a vicious debt cycle.
Get in the driver’s seat
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The right way to shop flips the process around. Shop for financing first and the vehicle last. This puts you in control and can save you thousands of dollars, as you’ll see below.
The Consumer Financial Protection Bureau recently made comparison shopping for auto loans easier with a new set of tools called “Take control of your auto loan” that helps you see the total cost of your purchase and lets you compare several loan offers.
Next time you buy a vehicle, follow these steps to a more affordable auto loan:
1. Figure out what you can afford
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The CFPB explains how to budget and figure out what you can afford. When adding up your costs, include the cost of insurance, maintenance, delivery charges, registration fees, tax and lender charges like the origination fee, document fee, loan preparation fee and any add-ons you buy from the dealer such as an extended warranty, stolen vehicle recovery insurance, or fabric and paint protection.
Edmunds’ affordability calculator is another way to see what you can afford to pay for the vehicle. This Edmunds article about sales contracts tells what to expect from a contract and how to cut a good deal.
2. Shop for financing
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Before vehicle shopping, get preapproved for loans from several lenders (the CFPB tells how to do it). Include credit unions and banks in your shopping as well as auto dealers, so you can compare interest rates and fees available to you. (Make all of your applications within 14 days to ensure that your credit score won’t suffer from multiple credit inquiries.)
You can shop for loans online, including right here in our Solutions Center.
Print this worksheet from the CFPB to use in comparing your offers. Preapproval gives you negotiating power with a dealer and the time you need to find the best deal.
3. Focus on total cost
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Getting fixated on monthly payments can blind you to the actual cost of your loan and how long it’ll take you to pay it off. Shorter loans are cheaper, even though the payments probably will be higher, because you’ll pay fewer fees and less interest. Longer loans often carry a higher interest rate.
Getting into a long loan in which you owe more than the vehicle is worth puts you in a jam if you:
- total the car in a wreck. Insurance covers only the vehicle’s market value, leaving you to come up with the cash to cover the remainder of the loan.
- need emergency money but can’t sell the vehicle.
- become bored and want a new car or truck.
4. Learn the value of your old vehicle
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Don’t depend on a dealer to tell you what your trade-in is worth. Instead, use Kelley Blue Book to find the potential value. Also read want ads, dealers’ used-car ads and Craigslist to learn what people are paying for similar vehicles in your area. This way you’ll know if you’d come out ahead by selling your old vehicle yourself and applying the money to the purchase.
Here’s the bottom line: If you find yourself stretching too hard to buy a vehicle you can’t really afford, pull back and be more realistic. Buying within your means — especially on large purchases like this one — will help you live a less stressful life.
What lessons have you learned buying cars and getting car loans? Share with us in comments below or on our Facebook page.