Mama Bear Blog

Guest Post: How to Fit Auto Loans Into Your Financial Health

Blog Post by Sonia Steinway - 3/27/19

Today’s special guest post on how auto loans fit into your overall financial health is brought to you by Bob Haegele, aka the Frugal Fellow.

Auto loans have been increasing in recent years. Much of that is due to an increase in the popularity of larger vehicles such as trucks and SUVs. These vehicles are larger and thus more expensive. As a result, average monthly payments are increasing. The average number of months on a loan term are on the rise, too.

I have even heard of people taking on 84-month and 96-month loans. This is bad news because that means a lot of extra money goes toward interest. Not only that, but cars are a depreciating asset. If you take out a 96-month loan (eight years, by the way), your car will likely be worth very little by the end of the loan.

As a buyer, it is important to keep this in mind because these increasingly large auto loans are a burden on your shoulders. While very few buyers can afford to avoid financing altogether, it’s a good idea to know the market. By doing so, you can protect yourself and, hopefully, avoid paying too much for a car.

The Car Buying Process

When buying a car, it is important to know that there are several different types of sellers. The biggest difference will be seen when comparing private sellers and dealerships. Each of them has their own benefits – and potential drawbacks. In this section, we will compare and contrast the two.

Private Sellers

A private seller refers to an individual who is selling their vehicle. This can happen for many reasons, but may be because the seller is upgrading to a newer vehicle or is moving to another country. Whatever the reason, these sellers could give you a great deal.

The reason for this is that private sellers, unlike dealers, are often not looking for a profit. If the seller is getting rid of a vehicle they used personally, it’s likely they are selling the vehicle for less than what they paid. As a result, they may not have a set price for the vehicle and can be more flexible when it comes to negotiation. This may not always be the case, but it’s something to keep in mind.

The buying process is also likely to be simpler with these buyers, potentially with less paperwork. The last time I purchased a vehicle from a dealer, I was there for five or six hours! You can expect less of an all-day commitment with a private seller.

Drawbacks for Private Sellers

Of course, there are things you will have to keep in mind if you do buy from a private seller. Nowadays, many dealers offer CARFAX or something similar. When buying from a private seller, you can still obtain these reports if you have the vehicle identification number (VIN) – it just may not be as convenient. Also, CARFAX reports cost money, but there are also services such as VehicleHistory.com that offer free vehicle reports.

Still, when buying a used vehicle, it is generally good practice to have the vehicle inspected by a reputable mechanic before purchasing. Even if the seller *seems* genuine, it’s better to be safe than sorry – especially when dealing with someone you don’t know very well.

Safety may also be a concern. Make sure you agree to meet the seller in a public location (like the parking lot of a local mall or Walmart). If you can, pay by check or money order rather than cash so you don’t have to carry wads of bills on you. And ask to see the seller’s title paperwork before you agree to meet up, so you know it’s a legitimate sale.

In addition, a private seller is unlikely to offer financing, so you will need to find that on your own if needed and many lenders are reluctant to provide funds for a private sale. This makes cash sales the best way to go – although that will still be out of reach for many buyers, depending on the price.

Dealerships

When we look at dealers, there are a few different types. For example, you will have your franchise dealers, like Ford, Honda, Toyota dealers, and so on. Franchise dealers can only sell the new cars from their manufacturer, but they can sell any used cars, so you might be able to find a deal that a previous buyer traded in. There are also exclusively used car dealers like CarMax, online used car dealers like Carvana, and specialty dealers that only carry exotic cars.

Most of the drawbacks to private sellers are the benefits of dealerships; the opposite is also true.

For example, dealerships will generally have a more well-documented history on used vehicles. This is one of the biggest advantages of buying from a dealer, especially if you are newer to the car-buying process. I bought my first car from a CarMax location, and they told me the car had been used as a corporate lease. I had that car for about seven years and never had any major issues. This is not to say vehicles from dealers cannot be without issues, but you generally know what you’re getting.

Dealers also typically offer financing. They are often less willing to negotiate, since they have to make a profit on each sale. However, there can be differences between negotiation on used cars and new cars, which we will cover in the next section.

Determine How Much Car You Can Afford

One thing you should ideally have in mind before you step foot in the dealer is how much car you can afford. This doesn’t necessarily have to be an exact dollar amount – even having a range in mind would be beneficial.

If you don’t know which car you may want, I recommend visiting sites such as Edmunds and Consumer Reports to get a sense of what is currently available. Doing so could give you some leverage when visiting the dealer.

If the salesperson shows you a vehicle and it is one you know nothing about, you probably will not have done any research in advance. Thus, you will probably also not know what you should be pay that particular car – putting you at a disadvantage.

Know Your Price in Advance

If you are buying used and the dealer has their inventory on its website, you can compare that price to its Kelley Blue Book (KBB) value. You can also compare it to similar listings on sites like Cars.com and CarGurus.

The price will probably be slightly above its KBB value, but it should be similar to other used cars listed online. If it’s not, there is nothing wrong with mentioning this to the seller. After all, a common negotiation tactic is to ask for a higher price than you expect in anticipation of a lower offer. But if you don’t ask, the seller is certainly not going to lower the price just to be nice.

You can do the same thing for new cars, but the KBB value does not apply to new cars since it considers mileage and condition, among other factors. For new cars, you should contact at least three dealers by phone or by email and ask for their best “out the door” price.

Of course, even if the seller’s price is perfectly in line with the market, you probably won’t be able to afford every vehicle out there. Not many people can afford a Bugatti Veyron. So, how do you determine how much car you can afford?

This is something of a personal decision, but you may remember the incredibly long loan terms I mentioned earlier. I would recommend looking at what your monthly payment will be for each loan period. Can you afford the monthly payment on a 60-month loan? If not, this vehicle may be outside of your price range. I would recommend to keeping to 60 months (or less) if possible.

Remember: generally speaking, the faster you repay the loan, the less you will pay in interest overall.

What Should My Interest Rate Be?

When financing a used car (or any purchase), interest rates can vary greatly because there are so many variables. Not every lender is going to have the same criteria for setting interest rates. Still, it would be a good idea to have some idea of what interest rates typically look like.

Bankrate has a good guide for typical interest rates. At the time of this writing, average auto loan interest rates for new cars hover around 5%. But, again, if you happen to have excellent credit, it is possible to get a much lower interest rate on a new vehicle. Interest rates for used cars tend to be higher.

If the dealer offers financing on the vehicle, you shouldn’t immediately finance through them. It’s best not to combine the purchase and financing transactions.

It’s Okay to Say No

The last thing that is important to understand about the car buying process is that it’s okay to say no. If you have taken my recommendations above but the price just doesn’t seem in line with reality, it’s perfectly okay to walk away. You can always shop around and see what other dealers/sellers are offering and what their prices are like. The internet makes it much easier to compare prices.

Maybe you don’t want to say no because you’ve already spent so much time at the dealership. But is preventing one day from going to waste worth having buyer’s remorse for years?

Don’t overpay for your vehicle. There will always be another nice car to buy.

About the author: Bob Haegele is a personal finance blogger at The Frugal Fellow. His blog primarily covers topics around personal finance with a focus on student loans, credit cards, and investing. Having moved to various parts of the US, he is a bit of a nomad. He’s working toward financial independence while blogging, writing, and traveling. A fairly new blogger, his work has already been featured on sites such as Rockstar Finance and Camp FIRE Finance.