Auto loans are like the modern automobile, a complicated machine with lots of moving parts and hidden components. However, it’s likely there are more people who understand the basics of car maintenance than auto finance.
Another thing cars and car loans have in common: Many people view them as indispensable to their lifestyle. According to the Consumer Finance Protection Bureau, nearly 90 percent of Americans commute to work in cars. In addition, Federal Reserve figures show that in 2015, the total amount of auto loan debt in the U.S. crossed the $1 trillion mark for the first time.
In other words, people are highly dependent on cars and car loans, and that type of dependency can lead to consumers being taken advantage of if they are not well informed. Just as there are some fundamental pointers you should know about shopping for a car, there are some basic issues it is important to understand when financing that vehicle.
Getting a car loan? 8 factors to consider
Here are some of the issues you have to consider when choosing a car loan:
1. How much to put down
“No money down” is a popular car dealer come-on, but is it in your best interest? Building a savings account and making a significant down payment will save you in the long run because you will be paying interest on a smaller loan. Also, since new cars depreciate rapidly as soon as you drive them off the lot, if you make no down payment you will probably owe more than the car is worth for a while. That means if your car is totaled in an accident or stolen, the insurance payment you get might not be enough to pay off the entire loan balance.
2. Length of term
Auto loan terms have been getting longer and longer. This means lower monthly payments, but also more interest expense. In particular, beware of long loans for used cars, which are likely to have a shorter useful life. You don’t want the loan to outlive the car.
3. Interest rates
Car loan interest rates vary, so be sure to compare lenders before settling on a loan offer. Also, loan rates are typically higher on longer loans, so this is another argument for choosing a shorter one.
4. The cost of deferred payments
“No payments for six months!” You’ve probably heard that pitch before, but if you think that means you effectively have free use of your new car for six months, guess again. Chances are the loan terms are such that you will be accruing interest all the while. Since you won’t be paying down principal at first, that means an extra six months of interest payments on the full loan balance in the long run.
5. Direct vs. indirect lenders
You can get your loan directly from a financial institution, or indirectly through the car dealer. As convenient as it may be to have the dealer arrange financing, be aware that sometimes they receive mark-ups on the interest rate or other financial incentives that can increase the cost of the loan. Don’t settle for dealer financing terms unless you have independent loan offers to compare them with.
6. Price vs. loan terms
Using dealer-arranged financing may also affect the price of the car or what rebates apply. When negotiating on price, tell the dealer you have not decided yet on financing. You want the price quoted with and without financing. This will help you identify the true cost of financing through the dealer.
7. Captive vs. independent lenders
Captive lenders are financing companies owned by a dealer, while independent ones are outside companies the dealer may work through to arrange financing for you. Know the dealer’s relationship with the lender because this will tell you whether the dealer can objectively try to find you the best deal, or is funneling business to an affiliate. However, even independent lenders may have a financial arrangement with dealers who steer them business.
8. Early payment fees
Before you sign up, pay attention to any fees that would apply if the loan is repaid early. This could affect you in a number of ways. For example, if you wanted to trade in the car for a newer or different model, you’d have to pay off the existing loan early. That would add to the cost of the trade-in.
To be sure, shopping for a car is more exciting than shopping for a loan. Even so, they are both decisions you may have to live with for years, so put some time and research into choosing your car loan the way you would into choosing a car.