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 a 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: 85.5 percent of new vehicles and 53.3 percent of used vehicles sold in early 2017 were purchased with loans, according to credit bureau Experian.
- Auto loans are big debt: In early 2017, the average loan for a new vehicle was $30,534, Experian says. For used vehicles, the average loan was $19,126.
- Long loan terms can mean toxic debt: The problem comes when 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 more than five years for used vehicles, Experian says. Seven- and eight-year loans aren’t unusual. Meanwhile, over that long period, the car is losing value with every mile. So buyers risk getting “upside down,” or owing more on a car than it is worth. That can easily start a vicious debt cycle.
The right way to borrow for a car is to shop for financing first and the vehicle last. This puts you in control and can save you thousands of dollars. Follow these steps:
1. Figure out what you can afford
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When considering the cost of a car, make sure you add up all expenses. These include: insurance; maintenance; delivery charges; registration fees; tax; 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. The Consumer Financial Protection Bureau explains how to budget and figure out what you can afford.
Edmunds’ affordability calculator is another way to find a target price range that works for you.
2. Shop for financing
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Before vehicle shopping, get preapproved for loans from several lenders. Include credit unions and banks in your shopping as well as auto dealers, so you can compare interest rates and fees available to you. The CFPB tells how to do it, and why:
Then, at the dealership you can focus more attention on items like your trade-in or auto choice. Because you have preapproved loan offers in your pocket, you get to choose whether to stick with one of them, or negotiate with the dealer for the best financing option.
The CFPB offers a 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.
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.
- You need emergency money but can’t sell the vehicle.
- You 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.