Did you know that the average price of a used car is more than $13,000?
And what about new cars? They’ll cost you more than $33,000.
That makes us wonder (and probably you, too) how does anyone buy a car these days with cash? The answer to that is pretty simple: They don’t. In fact, a 2007 article from the New York Times revealed that 11.7 percent of car buyers paid cash.
In other words, unless you’re part of that 11 percent, you’re going to have to finance your car. And what does that look like today? Here are a few stats from 2015:
- The average length of a car loan is 67 months.
- The average amount financed is $27,811
- The average monthly payment is $485
Taking that trio of stats as one entity, you start to realize that an auto loan is a lot of money spread out over a long period of time.
We want you to be in the driver’s seat during your next car-buying experience, so we’ve talked with experts and done our own research to come up with six different tips for getting a car loan.
1. Focus on Interest Rates and Length of the Auto Loan
Think of your interest rate like you would your skin during a day at the beach. The goal is to avoid a painful sunburn, right?
The time you spend in the sunlight is the length of your loan. If you’re in the sun for 36 minutes, that exposed spot on your skin isn’t going to be nearly as red or painful as if you were in the sun for 72 minutes. Twice as long means twice as red.
But let’s say you miss a spot. That spot is your interest rate; anytime you take out a loan, you’re going to get a little burned because of an interest rate. The bigger the interest rate, the more of your skin that’s left unprotected and the more burned you’ll get.
Whenever you’re checking out a bank, credit union or dealership financing rates, your goal is to get burned the least amount possible. To do that you have to keep a laser-like focus on interest rates and loan lengths.
Your goal is to get the lowest interest rate over the least amount of time, just like your goal on a sunny day is to keep your skin as protected as possible and away from the sun as much as possible.
Matthew Coan, a personal finance expert from Casavvy.com, put it this way: “Whenever you are planning on financing a large purchase such as a car, the two things you should look at is the interest rate you will be paying along with the length of the loan that is offered.”
Matt also offered a great tip about the auto-financing marketplace.
“Auto financing is a very competitive market,” he said, “and they all want to compete for your business.”
But how do you know who offers the best rates? That’s what we’ll discuss in the next section.
2. Do Your Research Beforehand to Find the Best Rate
Think about your normal process for buying a car. Most likely, you check a few websites like Autotrader or Cars.com, narrow down your favorites then head to the dealership to take a test drive.
You should approach your financing the same way, Matt says.
“Before you go to the dealership, do some research and shop around for the best rate you can find,” he said.
This search can take many different forms. You can call up the banks or credit unions with whom you’re already a customer. I used this method last year when I bought a used car. I checked Bank of America, USAA and Navy Federal, all of which had slightly different rates.
David Bakke, a writer for personal-finance website Money Crashers, pointed out websites like Bankrate.com let you compare loan lengths and interest rates from several different lenders. This method of price comparison is an excellent choice if you’re not sure where to start your financing journey.
Once you find a rate and loan length you like, get pre-approved for the amount you think you’ll spend. This is something we’ve learned through our own experiences, and it’s also something that Matt from Casavvy.com mentioned. Not only does a pre-approved letter let you skip the hassle of financing at the dealership, but it also forces you to set a budget and stick with it.
With your lending secured, you can print out your pre-approval and take it with you to the dealership. But don’t let your salesperson know you’ve been pre-approved; hand it to him or her once you’ve decided on a price.
“Do not give the dealer your pre-approved letter before negotiating a price on the car,” Matt said. “This will tell them the amount you are approved for and may hurt your leverage when negotiating the price.”
3. Don’t Feel Like You Have to Finance Your Car Through the Dealership
One-stop shopping is an attractive proposition, especially when it comes to cars.
What’s more efficient than going to one dealership to test drive, buy and finance a car? The truth is, there isn’t a more efficient way to do it and that’s what dealerships will use to reel you in. However, we think it’s best for you to use a bank or credit union for your loan. The dealership is merely a middleman trying to get the most money out of you. Banks/credit unions lend directly to you, so they don’t use the gimmicks and tricks that dealerships do.
David from Money Crashers agrees.
“One thing consumers need to know about car financing is that you don’t have to get it through the dealership,” he said. “That could possibly be where you’ll pay the highest rate of interest.”
Think about it from a dealership’s perspective. You have customers who come in and want to buy a car. They haven’t been pre-approved from a bank or credit union and they want to finance through you.
You give them an attractive monthly payment amount (an issue we’ll cover next), see the smile on their face and then offer them in-house financing. At that point, the customer probably doesn’t care what the interest rate is. They just want a good monthly payment and a nice car.
It’s almost like a free pass to charge them a few more percentage points than what they could secure through their own research.
4. Never Mention Monthly Payments
This is something we mentioned in our article about tricks car dealerships use to get more money out of you. We want to review it here because it’s an important part of your car’s financing.
As we mentioned earlier, it’s important to focus on interest rates and the length of your loan. If you don’t and choose to put your attention on monthly payments, you tend to get burned. Why? Because the dealership knows if they convince you of a low monthly payment, they can lock you into a long-term loan.
The longer you have to pay back your loan, the more money that ends up in the pockets of the dealership or the bank.
Let’s say you want to buy a used car and pay $200 per month for it … you don’t care about the interest rate or the loan length. At $207 per month, you could get a $7,000 car with a loan at 36 months. You’d end up paying about $7,439 over the life of the loan, or $439 in interest.
But if you walk into a dealership and say, “I want to pay about $200 a month,” your salesperson isn’t thinking $7,000 over three years. He or she is thinking of putting you in a $13,000 car that you’ll pay back over seven years.
The monthly payment is actually less than that $7,000 car ($203), but you’ll end up paying $1,640 in interest. That’s about $1,200 more than the $7,000 car. Don’t fall into the monthly payment trap.
“Sure, you could get a rather inexpensive monthly payment,” David from Money Crashers says, “but if that is stretched out over six years or longer, you’ll be paying more in the long-run.”
5. Monitor Your Credit History in the Months Leading Up to Your Financing
Your credit scores affect many areas of your life, and the terms of your auto loan are one of them.
James Pollard, a credit expert at PersonalFinanceGenius.com, said consumers should monitor their credit history before shopping for cars.
“The basic idea when it comes to shopping for a car is to monitor your credit for months in advance,” James says. “Take all the necessary steps to improve it and safeguard it, like paying on time and keep your credit utilization ratio low.”
An excellent way to check your credit history on a regular basis is to sign up with Credit Karma, a free website where you can keep track of your TransUnion and Equifax credit scores. Their website also allows you to file disputes about late payments on your card, a process that can bump up your score quickly.
For example, I used Credit Karma to dispute some late payments on my credit history. I won the disputes and my TransUnion and Equifax scores jumped about 25 points (read this article to learn more about improving your credit scores).
Also, if you’re a disciplined consumer who happens to have a high balance on a credit card, consider opening a card with a 0% balance transfer offer. Arrange the transfer in a way that gets both cards under 30% of their limit. If you do so, you should see your credit score jump up nicely.
The reason why it jumps is that your credit scores rely heavily on utilization. If a card’s balance exceeds 30% of its credit limit, your credit score will go down; that is what’s known as high utilization.
This isn’t a tactic we suggest you use all the time, but it’s a good short-term strategy to bump up your score and get a lower interest rate.
How much of a difference does it make? If your score jumps between 10 and 20 points, it could put you into a different credit tier: from good to excellent, for example.
According to the experts at Credit.org, If you’re buying a $25,000 car with a five-year loan at the normal rates, the bump up in creditworthiness (and the resulting drop in interest rate) could save you about $1,000 in interest payments over the life of the loan.
6. Know Your Rights as a Consumer
One of the things we often forget when buying a car is our rights as consumers, which are protected by laws on the state and national level. According to the Fair Trade Commission (FTC), your lenders are required to give you all the reasonable information you’d need to understand how much your car loan will cost you.
You can head to their website to get the full rundown, but we’ll include a few tips here:
- Credit practices rule: Mandatory reporting of a co-signer’s responsibility
- Truth in Lending Act: The dealership or bank is required to give you all the details of your loan, including finance charges, monthly payment amounts and APR.
- Risk-based pricing rule: If the dealership runs your credit, they are required to give you your score and explain how that score affects your loan.
The Bottom Line on Car Financing
When it gets down to the basics of buying a car, we want two things: a reliable automobile at a good price.
Once those two factors are in place, financing is the next key. What kind of loan can you get for your car? To answer that question, you have to be diligent in your research:
- Focus on the loan’s interest rate and length.
- Use websites, credit unions and banks to compare the best rates.
- Don’t feel obligated to finance through the dealership.
- Don’t mention a monthly payment amount if you’re going to finance through the dealership.
- Monitor your credit closely, beginning a few months before you buy.
- Know your rights as a consumer.
If you follow through on each of these areas and apply some good bargaining strategies with your salesperson, you should get the car you want at the price you need.
But we know that buying a car isn’t always that easy. So, as you consider your financing options, take a moment to see the bigger picture. You need to decide if you’re going to buy new or used and you also need to know which websites will help you find that diamond in the rough.
For the new vs. used debate, check out our take on the situation. We’ll help you understand the advantages and disadvantages to each type of car, as well as give you an idea of depreciation and yearly expense.
Once you decide on a new or used car, stop by our article about six of the most popular car-buying websites. The article gives a really good picture of what each site offers and which one might be the best fit for you.