4) Understand Car Loans
You’re already ahead of the game, and here’s why: most people do not even know you CAN bring a car loan from “outside” the dealership. Most assume you just “sign the paperwork” in the financing office after negotiating their car price with the car salesman.
You may remember from step 2 that you shouldn’t enter into a discussion of financing with a car dealer when asking for price quotes. Simply tell the dealer you do not want to discuss financing until you have found the best price. Again, to get the best deal on your car and your car loan, you need to shop for and negotiate each separately.
If you can only take away one thing from this article, it’s bring your loan from “outside” the dealership. If you don’t, you leave yourself vulnerable. Bringing your loan from “outside” means you understood your loan options, on your own time, at your pace, in your place. This is the key to making a great auto loan decision and saving $1,000 you didn’t know you were going to lose when getting your auto loan on someone else’s terms.
Why you don’t want to borrow at the dealership
This bears repeating. Hidden loan fees and markups at the dealership average over $1,800, which makes us want to roar. You could do a lot better by arranging your loan before you go to the dealership to buy your car, save time, and sidestep the dealer’s high-pressure sales tactics.
Compare offers from different lenders
All banks and all car loans are NOT the same. Lenders specialize in different loan types and interest rate offers can vary a great deal for the exact same loan. Check around with different banks, credit unions, and finance companies to get the best deal.
What you should know about interest rate
Bottom line: A higher interest rate means your loan is more expensive.
Higher credit scores, lower loan amounts, bigger down payments, and shorter terms tend to carry lower interest rates. If you qualify with a given lender, you are likely to be offered a few options for different loan terms that carry different interest rates. It always makes sense to find the loan with the lowest interest rate, whose monthly payment you can afford.
For context, the average interest rate in the US is about 6% for new car loans and 10% for used car loans according to Experian. The ranges are 4% - 15% for new cars and 5% to 20% for new cars, depending on your credit score among other things.
A shorter loan term is always better
“Loan Term” is the number of months over which you’ll repay your loan. Though longer terms can lower your monthly payment, they tend to carry higher interest rates, costing you more over the life of your loan. We advise you to go shorter, and try not to borrow for more than 60 months, with 72 months being the maximum. Average car loan terms nationwide are about 69 months for new cars, and 65 months for used cars.
Down payments: 20% as a goal
Lenders like to see that you have some skin in the game or an added commitment to repaying the money you’ve borrowed to buy your car. This is why a down payment is important. In the event that you can’t repay your loan, lenders will keep your down payment to recover some of the losses they will incur. A down payment of 20% is a good goal and will help to ensure you get the best interest rate on your loan.
Your credit score matters
When extending credit, lenders try to understand how likely a borrower is to repay. They boil many elements of your financial capacity into one number: your credit score. These elements might include whether you’ve been late on past loan payments, your annual income, how long you’ve had a job, how much debt you have outstanding, and so on. Credit scores range from 300-850, or deep subprime to super prime. The higher your credit score, the lower the interest rate you’ll be charged on a loan, all other things being equal.
Calculating monthly payment
This is what it all boils down to: How much can you afford to fit into your monthly budget? For car loans, monthly payment is a function of how much you are borrowing, the length of your loan, and the interest rate you are being charged. Find a monthly payment you can afford on a loan with the lowest interest rate and a term of less than 72 months. Average monthly car payments are about $550 for new cars, and $390 for used cars.
Most auto loans now include products that protect your vehicle and your credit in the event of unhappy surprises. These can be valuable if you purchase the right products at a fair price. (We’ll help you understand whether these are right for you Step 5.)