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If
you've read How Buying a Car Works, you know the car-sales lingo
and the ins and outs of negotiating with a seasoned car
salesman. Let's say you've battled for the best deal and finally
agreed to a price you can live with -- time to breathe a sigh of
relief? Not exactly. Did you know that if you finance a new car
through the dealership, the finance person is working on
commission? That means that the financing deal you get is still
up in the air, although they'll never tell you that. Those
things that get added on in the final stages of the deal
(extended warranties, undercoating, alarm systems, etc.) are
often what the dealership makes the most money on. It's the
finance-office person's job to upsell you on those items AFTER
you've agreed to a price for the car with the salesman.
In this article, we'll cover the choices you have for financing,
what determines the interest rate you get, and how to determine
if you're really getting the best deal, as well as some scams to
watch out for. We'll even give you a cheat sheet to take with
you when car shopping to help you figure out things like whether
taking the rebate or getting the 0% interest deal is best.
Choices for Financing
If you're like most people, paying cash to buy a new car just
isn't in the realm of possibility. And even if it's in the
realm, you may not want to deplete your savings account to buy a
new vehicle. This means that you're either going to be leasing
the car, or buying the car by financing it. If you're buying,
then you're probably financing it through the dealership, a bank
or credit union, an online financial institute, or maybe even a
family member.
While leasing is good for a lot of situations, it's a whole
other animal and has its own article. In this article, we're
focusing on financing. If you know you want to finance your car
rather than pay cash, then you need to do your homework and
decide how to get the best financing deal.
Financing Sources - Pros and Cons
Dealership
Pros: Convenient, fast, sometimes competitive
Cons: High pressure, usually not competitive; be prepared for a
big sales push on add-ons; loans are often front-loaded
(payments are made up of more interest in the beginning of the
loan than toward the end -- that's bad if you think you may be
paying the loan off early.)
Bank or credit union
Pros: Competitive rates, personal service, no sales pitch for
add-ons; often can tell you if you're paying too much for a car;
often provide free life insurance or disability insurance with
loans; loans are usually simple interest loans (interest spread
evenly throughout the term of the loan)
Cons: Not as convenient as dealership financing -- can't set it
up at night or on the weekend
Online financial institution
Pros: Usually competitive rates, quick, easy
Cons: Not a personal service; dealing with an unknown; some
scams to watch out for
Home equity loan:
Pros: You can deduct some of the interest from your taxes;
competitive rates
Cons: You're tying your car to your home (may be risky)
Family member or friend
Pros: Personal service, easy, sometimes flexible; usually
competitive rates
Cons: Could jeopardize a relationship
Determining the Rate
The interest rate you get when financing a new or used car can
vary quite a bit from the advertised rates you see on TV or read
in the paper. Probably the biggest influence on your rate is
your credit rating to get the full story). Your credit history
and credit score tell lenders a lot about your money habits and
are designed to give them an idea of what their risk is if they
loan you money. They often raise the interest rate if your loan
is seen as high-risk.
Another thing that affects the rate you get is the length (term)
of the loan. Typically, the shorter the loan, the lower the
rate. Keep in mind that the shorter the term, the higher your
payments will be.
Used cars will have higher rates than new cars. The newer the
car, the lower the rate. (You may find an exception to this rule
at some credit unions. Some give the same interest rate for new
and used cars.)
Your geographic location can also be a factor in the rate you
get. Your cousin may have gotten 7% on the other side of the
country, but in your home town, 8.5% may be the lowest rate you
can find.
At the Dealership
While these are the usual things that affect the rate you get
through a bank or other financial institution, financing through
the dealership may or may not actually work this way. When you
finance through the dealership, you have to remember that the
Finance and Insurance (F&I) department is often a bigger profit
center than the sales department. The business manager (the
person you deal with in the F&I department) sends your credit
information to the lender(s) they deal with. The business
manager then takes the lowest approved interest rate and marks
it up (increases it). The marked-up amount is the dealership's
profit on the financing. There is no law saying the dealer has
to reveal that mark-up to you. This is why you have to keep your
negotiating hat on throughout the process! This financing is
really just another product the dealership sells, known as a
Retail Installment Sales Contract (RISC).
Special Incentives
You're watching your favorite late-night TV show, and between
the shampoo and fast-food commercials you see a car ad that
offers 0% interest or a $2,000 rebate on a car you've been
thinking about buying for months. Wow! What a deal! You have to
get to the dealership now! So the next day, you do just that.
Factory-to-Consumer Rebates
First, let's find out what those offers mean. With the
factory-to-consumer rebate, there really is no catch. These are
rebates the car manufacturer offers directly to you as an
incentive for you to buy a specific car. They offer them when
they see a larger number of that particular car sitting on car
lots than they would like to see. So, in order to move the cars
off the lots (i.e., get people to buy them), they offer the
rebate. The rebates are not part of the dealer's package and
shouldn't even come into play when you're negotiating the sales
price with the salesperson. Don't let them try to use the rebate
as a way of making the purchase price lower. You have the choice
of applying the rebate to your down payment (or not). As Michael
Royce says on his Web site, Beat The Car Salesman.com, "Take the
money and smile."
0% APR
Zero percent interest? Who wouldn't jump at that? And you should
jump at it if you can handle the term. Often (but not always),
in order to get 0% financing, you have to agree to a shorter
term loan, sometimes 24 or 36 months. This means your payments
are going to be quite high. Of course, it also means you'll have
the loan paid off relatively quickly (compared to the more
common 48- to 60-month term). Here are few other things that may
come between you and that 0% rate:
In addition to the usual shorter term of the loan, you have to
qualify for that rate. In most cases, if your credit score is
lower than 680, you won't be able to get the lowest rate.
You may be limited to buying from what's on the lot, rather than
being able to order a car with the exact features you want.
Know that by going for the low interest rate you usually lose
the cash rebate. It's one deal or the other -- not both.
In many cases you're better off taking the rebate and financing
elsewhere at a higher rate:
To figure out which is the better deal between taking the cash
rebate or the low APR, use this calculator at Edmunds.com. Don't
forget to try the same calculation taking the rebate and
financing with your bank or credit union. Also, read about How
10% Can Beat 0% at the Consumer Task Force for Automotive Issues
Web site.
For a list of current rebates on specific cars, check out
Intellichoice: Rebates and Incentives.
Recent Graduate Programs
Many car manufacturers offer a special "recent college graduate"
program that gives new graduates a discount on the purchase of a
new car. The savings is usually around $400. Each manufacturer
may have different rules. For instance, some have rules about
excluded models and selecting a car from dealer stock. Be sure
to ask about it if you're a recent graduate. (Recent, for most
manufacturers, means within the last two years. Double check
that when you're shopping.)
The smart thing to do is to visit the manufacturer's Web site
before you go to the dealership so you know what special deals
are being offered directly from the manufacturer.
Dealer Financing
You're in the "Finance and Insurance" office setting up your
financing with the business manager. Your guard is down now that
the deal is done, and you're really excited about driving home
that new car. Make sure you're not so euphoric you forget to use
good judgement for things like:
Interest rate, term of the loan, down payment, rebates, and
monthly payments: Remember you can negotiate that interest rate
(see the next section to arm yourself for this step). Make sure
every element is spelled out on your contract and is correct.
Don't sign until you're satisfied that all of the numbers have
been filled out correctly. Also, make sure the interest rate you
are agreeing to doesn't change during the term of the loan, and
ask about prepayment penalties. Remember that the bottom line is
how much you're paying for the car, not what your monthly
payment is. You may be getting a really low monthly payment, but
how long will you be paying it? Almost any payment level can be
reached if the loan term is long enough. Make sure there is no
"subject to financing" or "subject to approval" statement on the
contract (see Spot Delivery warning below).
Extended warranties: The business manager will always offer you
the extended warranty on your new car. Some experts are of the
opinion that the warranties that now come with new cars are
comprehensive enough that you don't really need the extended
warranty. If you feel you do need it, explore other sources for
those warranties so you can compare. You will be able to get a
better price (usually half of what the dealer charges), and
sometimes even a more comprehensive warranty, by buying one
through online sources or through some banks or credit unions.
Rust protection, undercoating, fabric protection and paint
protection: The rust protection, as well as the undercoating, is
usually already applied at the factory, so there is no need for
you to have it done again (and pay for it twice). Check the
car's factory warranty to make sure it has a Rust Perforation
Warranty.
You can easily apply the fabric protection and paint protection
yourself. The fabric protection is usually no better than you
could do with a can of fabric protector you can buy at the
store, and you can protect your paint with any polymer sealant
car wax. Even the paint protection the dealer applies has to be
reapplied every six months.
If these things are already on the car, then negotiate the price
down to something reasonable. Since there is usually a 100%
markup, start at 50% of the asking price for each item. If they
won't budge, then feel free to walk out on the deal.
Alarm systems and window etching: Sure, you want to protect your
car from car thieves, but with the amount of money most
dealerships charge for the system you could hire a guard to
watch your car. You can get an alarm system installed at most
reputable auto shops that's just as good as the one the dealer
would install. This can often save you over $500.
Window etching is when they etch the Vehicle Identification
Number (VIN) on all of the vehicle's windows to deter car
thieves and help in the recovery of a stolen car. Having the
numbers etched on the windows forces the thief to replace all of
the windows in order to disguise the vehicle's true
identification.
Many insurance companies will give you better rates if your
vehicle has VIN etching. Many police departments also recommend
it because it makes it easier to trace your car. Now, with that
said, do you need to pay the dealership hundreds of dollars to
do it? Not really. There are companies that sell the supplies to
do it yourself for about $20 or $30, and it only takes a few
minutes.
If the car is already etched, it's the same deal as with the
other add-ons. Negotiate the cost down to something reasonable.
Sure, they took the time to etch the windows and deserve payment
for that, but you know the cost of the supplies and how long it
takes to do it. Make your offer based on that information.
Insurance: You will almost always be offered life and disability
insurance while you're financing at the dealership (often at
banks and credit unions, too). Do you need this insurance?
Maybe. The idea is to protect your investment in the event that
something happens to you. The thing to remember is that there is
no requirement that you get it even if the business manager
tries to imply that there is. You should also be on the lookout
for this insurance being added without your knowledge. You can
get much better rates elsewhere for this type of insurance, and
banks and credit unions sometimes include it free of charge if
you finance your car with them.
Read on to find out about additional ways that the dealer may
try to up your total cost.
Watch Out
Here are some more things to watch out for when financing a car.
Spot delivery: Many of us have never heard of spot delivery.
What happens is that the dealer takes your down payment, tells
you the amount that your monthly payments will be, and sends you
home in the car. What hasn't happened is a final contract.
Before your permanent tags and payment book are sent out, you
may get a call saying the financing they thought you were going
to get didn't go through (as if they didn't know your credit
score when they sent in the paperwork). You'll have to either
bring the car back or sign a new contract, sometimes pay more on
your down payment, and always have a higher monthly payment. It
can be a nightmare! ALWAYS make sure you are signing a completed
contract and every detail is approved and included accurately.
Watch for the "subject to financing" statement.
Additional Dealer Markup (ADM): These charges can include many
of the items we mentioned above such as rust proofing,
undercoating, VIN etching, as well as dealer prep and other
fees. Dealer prep can be $500 or more for something that takes
the dealer two hours to do. Always negotiate these costs if
they're included in the deal. None of them are written in stone
-- even though the dealer may want you to think so by
preprinting them on the form.
Credit reports even if you're paying cash?: Don't let people run
your credit report unless you think you're going to be financing
with them. Every time your credit report is run, your credit
score can decrease. Some dealerships may say it's their policy
to always run a credit report on potential buyers -- even those
paying cash. Don't let them. They will sell you a car without
it.
How much is the total financed amount?: Make sure your down
payment, trade-in, and rebates are being applied to the sale
price of the car accurately. According to 'Lectric Law Library:
Auto Dealer "Swallowing" Of Customer Downpayments, Trade-Ins,
And Rebates, there have been many instances of these dollars
disappearing (usually into dealers pockets).
Next we'll discuss why it's important to shop for a loan before
you decide on a car.
Shop for a Loan First
To avoid having to deal with the potential scams and high costs
of financing through the dealership, you may want to explore all
of your financing options before you get to that point. By
preparing yourself with good information and knowing what your
options are, you can make a much better financial decision.
Don't let the excitement of driving off the lot in that new car
distort your perspective on things and cloud your judgment.
That's just what the salesman wants!
Before you start shopping for cars, you should shop for the
money to buy a car. Before you can shop for the money, however,
you have to figure out how much of a car payment you can afford
to pay each month. Once you know how much you can afford, use
one of the hundreds of online car payment calculators to find
out what that total car purchase price can be You'll need to
know the current average interest rates for car loans before you
can calculate that, so also visit an online banking site to see
what the best interest rates are at the time .
Here is an example of how this would work. Let's say you've
looked at your budget and know you can afford a monthly car
payment of $300. You've also looked at interest rates and see
that the average rate is around 6% right now. If you know you
are willing to pay that $300 every month for the next five
years, then, calculating backwards, you'll know to look at cars
that cost around $13,000.
By approaching the car buying monster from this angle, you can
more easily end up with a car you can afford (even if you don't
end up with the car you've been fantasizing about). Still, this
is the smart way to go about it. Don't wait until you're at the
dealership, talking with the salesperson, to figure out the
total car price you can afford. Of course, that's what they
would like you to do; and they only want you to think about that
monthly payment, because they can always stretch out the term of
the loan to get close to the payment you want to make. Plus,
remember the funny thing about perspectives. As a buyer, when
telling the salesman you want a payment around $300 and no
higher than $350, you know you're leaning toward the $300. The
salesman, on the other hand, hears only the high number.
Now that you know why it's important to get a loan first, read
on to learn how to shop for a loan.
Loan Shopping
The first place to start is with your own bank. Always check out
their rates and overall loan costs. You already have a
relationship there, and you may get the best deal as a result of
that relationship.
Credit unions are also a good place to shop for loans. Credit
unions usually have lower operating costs and can offer lower
interest rates as a result. You may have to be a member,
however.
Both banks and credit unions will be happy to go over the
details of the loan, give you an idea of the price you can
afford, as well as tell you whether or not the price you've been
quoted is a good one. Take the information they give you to the
dealerships when you're shopping so you have it to compare to
the dealership's financing offer.
Also keep in mind that, if you're a homeowner, your best bet may
be to get a home equity loan and buy your car with cash. You'll
be able to deduct some of the interest you pay and may also get
a better rate than you could on an auto loan. And no matter
what, be sure to check online banking sources. Reputable online
lenders can often save you tons of money on your overall car
purchase.
Remember, while there can be high pressure and some scams to
watch out for when you finance through the dealership, that
doesn't mean you can never get a good deal there. Sometimes you
can. You just have to be alert to what they're really telling
you (or not telling you) and make sure you're getting the deal
you think you're getting. If they can beat the best financing
deal you can get elsewhere, then go for it.
Cheat Sheet
We've put together the most important information from this
article in the form of a "cheat sheet" you can take with you
when you go car shopping. First, we'll start with the top 10
things to do both before you go to the dealership and while
you're there, and then we'll go over some terminology.
Get a copy of your credit report and correct any errors that are
lowering your credit score (errors in credit reports do happen
-- probably more often than you think).
Have a copy of your accurate credit report with you when setting
up your financing at the dealership.
Know the MAXIMUM amount you can spend on the car -- not just the
monthly payment, but the actual car price.
Visit the manufacturer's Web site to see what special
incentives, rebates, or other deals that you may be able to take
advantage of. Many of these are available whether or not you
finance at the dealership. Print them out so you're armed when
you're negotiating with the dealer.
Visit Kelly Bluebook or Edmunds to find the value of your
existing car if you plan on trading it in. (You might also visit
your mechanic to get a list of repairs the car needs and their
associated costs so that when the dealership tries to deduct
money for those repairs, you will know what a fair amount is.)
If the dealer won't give you a fair price for your car, then
don't trade it in -- sell it yourself.
If you know which car you want to get, go to the manufacturer's
Web site and print out all of the pricing information so you
know what the car should cost with the features you want. Take
that with you to the dealership.
Shop for loans from banks, credit unions, and online financial
institutions and take detailed cost and interest-rate
information with you to the dealership so you can compare things
like the APR, whether the loan is front-loaded or simple
interest, application fees, loan terms, and prepayment
penalties. Or, go ahead and get the loan and go to the
dealership as a cash buyer.
Remember that increasing your down payment with rebate money to
lower the financed amount is often a better deal than 0% APR.
Have any rebates mailed directly to you rather than letting the
dealership "apply them to your down payment." Take money from
your savings to pay the down payment and then replace it when
you get the rebate check from the manufacturer.
Finally, don't be afraid that you're taking all profit away from
the dealership. Even if they say they're selling the car to you
at their invoice cost, they're still making money due to
"holdbacks" and other dealer incentives from the manufacturer.
Read on to learn the terminology that dealers and salespeople
use when talking about cars.
Terminology
APR:
Annual Percentage Rate
Backend:
Another dealer profit center that includes financing, insurance,
warranties, VIN etching, and those other things they try to add
to the deal when you're setting up financing
Backdoor money:
Additional rebates the dealers get from manufacturers for
selling their cars
Factory invoice:
The invoice from the manufacturer to the dealer that is supposed
to be their purchase price - It's not their actual cost because
of holdbacks, advertising fees, gasoline charges, dealer
discounts, rebates, and other dealer incentives.
Front-loaded loans:
Loans that require payback of mostly interest in the beginning
so that the lender gets paid first
Holdback:
Money the dealer gets from the manufacturer if he sells a car
within a specified time (usually three months)
M.S.R.P.:
The total Manufacturer's Suggested Retail Price. This may not
include items the dealer has added such as security systems, VIN
etching, etc. The total Base M.S.R.P. is the suggested retail
price with no options. The total Base M.S.R.P. plus Options
price includes all options. Both the Base M.S.R.P. and the Base
M.S.R.P. plus Options may still not include additional items
that have been added at the dealership (as mentioned above).
Prepayment Penalty:
A fee that some loans charge if you pay off the loan before the
end of the term.
Simple Interest Loans:
Also known as "flat rate interest," simple interest is
calculated only on the initial amount of the loan by multiplying
the principal balance by the rate of interest by the term of the
loan. This number is then divided by the number of months of the
loan for the amount of interest paid each month.
Term:
The length of the loan in months
Trade-in allowance:
The amount of money taken off the purchase price of the new car
for the trade-in of your old car
Upside-down Loan:
When you owe more on your car than it is worth
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