Getting a car loan may seem easy, as long as your credit is adequate. All you have to do is find a car you like and sign on for the dealer’s financing package. That’s an easy way to get a loan, but it’s also an easy way to pay a lot more than you need to pay.
Getting the best car loan you can take a little more effort, but that effort can save you a considerable amount of money. Planning, research, and careful shopping can help you get a car and a car loan that serve your needs and aren’t an excessive financial burden.
About Car Loans
A car is the second-largest purchase most Americans will make, behind only a home. A car loan is likely to be your first major loan, other than student loans, and getting the right car loan can have a lasting impact on your credit and your financial future.
To get the best possible car loan you’ll need to make shopping for a car loan as important as shopping for a car. Setting a budget, selecting the right vehicle, knowing your credit limitations, and shopping methodically for the best financing package can help you get the best available deal at the best possible price.
Following these steps can help you get the best possible deal on your car loan.
Set a Budget
The first step in shopping for a car is knowing what you can afford. Think about what your car will cost you every month, including your monthly payment and the entire range of car-related expenses: insurance, gas, parking, and maintenance.
Review any other debt obligations you may have and calculate what your car loan will do to your debt-to-income ratio. Creditors prefer borrowers whose total monthly debt payment is no more than 40% of their monthly income, and lower is better.
Calculate the largest monthly payment that you’re absolutely sure you can afford to make. Be sure to consider your full range of expenses. Leave yourself a margin: something can always go wrong.
Check Your Credit
Your credit will have a significant impact on your loan eligibility and on the terms you are offered. Borrowers with better credit are offered much lower interest rates and better terms in general than borrowers with subprime credit. Knowing your credit status will help you anticipate the terms you’ll be offered and choose lenders and loans that are likely to approve you.
Review your credit report carefully before applying for any major loan. Look for errors that might be dragging your score down or issues that you can correct. If you have credit problems, putting some time and effort into cleaning up credit issues can get you a significantly better deal on a loan.
Decide on Your Down Payment
A down payment may seem like an obstacle to buying a car, but it can be a valuable asset. It’s worth making a down payment even if you are eligible for financing without a down payment.
Making a down payment can get you better loan terms, or get you approved for a loan even with less than ideal credit. A significant down payment can also lower your monthly payments and make your loan more affordable in the long term.
Making a down payment is particularly important on a new car. New cars depreciate fast in their first year, and without a down payment you may soon owe more than your car is worth. This can have several negative effects:
- If you sell your car you may have to add money to pay off the loan.
- You may not be able to refinance your car.
- If your car is stolen or totaled in an accident your insurance will only pay the value of the vehicle. You will still be liable for the balance of your loan.
Experts recommend a 20% down payment on a new car and a 10% down payment on a used car. If you can’t make a down payment that large you should try to make the largest down payment you can afford. If you don’t have an urgent need for a car, consider delaying your purchase while you save for a down payment.
Once you know your target monthly payment, your down payment, and your credit, you are ready to shop for financing. You’ll want to consult a range of lenders including online lenders and bricks-and-mortar businesses in your area. Don’t forget to ask your own bank or credit union for a proposal. Many financial institutions are willing to give existing customers better terms than they would give a stranger.
Keep your applications within a 2-week period. Each application will generate a hard inquiry on your credit report, and that can affect your credit. If applications for similar loans are grouped together the credit reporting companies will recognize that you are shopping for a loan and register only a single inquiry.
If you are offered loans, compare the proposals carefully. Check to be sure that the monthly payments are within your budget. Pay particular attention to these features:
- Interest rate. The interest rate or APR is the most significant cost of a loan. It’s the price you pay for the use of someone else’s money. Look for the lowest interest rate you can get.
- Additional costs. Fees and taxes can also be significant costs. Many loans come with origination fees, which cover the cost of processing the loan. There may be other fees as well. Look for loans with low fees.
- Loan term. The loan term is the time you have to pay the loan back. Longer terms give lower monthly payments, but may increase total costs, even with a relatively low interest rate, because the interest accrues over more time. Look for the shortest term that you manage without exceeding your maximum monthly payment budget.
- Down payment. You may be offered a lower down payment than you budgeted. Remember that a significant down payment can lower your monthly payments and protect you from owing more money than your car is worth. It may also qualify you for better loan terms.
Loan comparison is not always simple. You may have to compare a loan with a lower interest rate and higher fees to a loan with higher interest but lower fees. Take the time to work out what’s actually more expensive and ask for clarification of terms and procedures if you need it.
If you expect your credit to improve during the term of your loan, you should plan for the possibility of refinancing. If you think you might want to refinance eventually, check your loan proposals for prepayment penalties, which impose additional costs if you pay your loan early. A prepayment penalty can make refinancing prohibitively expensive.
Banks and credit unions will often offer a pre-approval. A pre-approval does not commit you to accept a loan and does not commit the bank to make one, but it will tell you how much the bank will be willing to lend you and what the interest rate will be. A pre-approval makes a very good basis for determining the maximum sticker price that you can consider for a car.
Shop for Cars that Fit Your Current Needs and Budget
Once you know what sticker price you can afford, consider car models that will meet your budget and your needs. Don’t be swayed by advertisements. Consider the basics: fuel economy, capacity, safety features. Know what you need, not just what you want!
If you want more car than you can afford, consider buying used. Remember that a used car will have higher maintenance costs and less warranty protection.
Make a shortlist of car models that are affordable and meet your needs. Include cars from several different manufacturers.
Now you’re finally ready to go to car dealerships. Check each of the models on your shortlist. See what appeals to you most. You will want to test drive the cars and inspect them closely. Take your time and be thorough. Some research online will give you a sense of what features matter to you and what to look for.
You have already selected appropriate vehicles, so feel free to go with a bit of sentiment at this stage. Just watch out for high-pressure sales techniques or dealers trying to divert you to more expensive models or add-ons. Pay attention to the dealer as well as the car. You want to work with someone that you’re comfortable dealing with.
Don’t Settle for the First Offer. Negotiate!
Once you’ve selected the car and dealer you prefer, you’re ready to negotiate.
Remember that car dealers often make more money on financing than they do on car sales. Your dealer will usually try to sell you a financing package as well as a car, and they may offer discounts or free add-ons for the car in order to persuade you to make a financing deal. Don’t be distracted.
Your pre-approval gives you negotiating leverage and shows the sales staff that they are dealing with an informed customer. Show the dealer your best pre-approval offer and see if they will beat it. Compare the dealer’s proposal with your pre-approval using the same criteria you used to compare your pre-approval offers.
Choose the best financing deal and sign the papers. Make sure they are complete and there are no blanks. If you are told that errors or blanks will be corrected later, respond that you’ll sign later when they are complete. There’s always some impatience and eagerness to get behind the wheel of a new car, but don’t get distracted. Unscrupulous dealers count on that excitement and will use it against you.
Watch out for “spot financing” or “yo-yo financing”. Some dealers will call you back in after a few days because there’s a financing issue that requires you to sign more papers. The new papers may offer terms that are not as good. Read the papers carefully. If there are major changes in the deal you have the right to bring the car back and start over. If the dealer sees that you’re willing to do that, they are likely to find a way to fix the problems.
What if I Have Bad Credit?
Bad credit doesn’t mean you can’t get a car loan. Car loans are secured by your vehicle, so lenders are more willing to lend to borrowers with impaired credit.
If your credit is sub-par, you are likely to pay higher interest rates and fees. Consider these options to raise your chances of getting a better deal:
- Try to build your credit first. If you don’t need a car right away, taking some time to clean up your finances and build your credit can get you a much better deal.
- Make a larger down payment. A larger down payment will show lenders that you are ready to buy and can get you approved for a loan you might not otherwise get.
- Choose a cheaper car or a used car. Many lenders are more willing to make smaller loans to individuals with flawed credit.
- Look for lenders that specialize in serving borrowers with impaired credit. Do your research and look for reputable lenders who are willing to do business with lenders who don’t have great credit.
- Consider a cosigner. Be sure that both you and your cosigner fully understand the responsibilities and obligations involved and the potential impact on the cosigner’s credit.
Some borrowers have steady employment, an adequate income, and no major black marks on their credit record, but still have poor credit because they don’t have enough information in their credit file to generate a rating. If you’re in this position, look for lenders who are willing to consider alternative data that is not listed in your credit report.
If you have credit issues you should use extra caution in comparing proposals: many predatory lenders actively seek out borrowers with weak credit. Watch out for last-minute changes of terms, confusing contracts, high-pressure sales techniques, and anything that seems too good to be true!
Important Practices for After You Get Your Loan
Ideally, you’re now the proud owner of a new car. You’re also the holder of a car loan, which may be with you for the next 5-8 years. Your management of that loan will affect your credit and your ability to get other car loans. Making payments on time will help you build good credit. Missing payments can damage your credit and even lead to repossession.
Many lenders who make car loans use a special credit score that places a higher weight on your track record with car payments. Making your payments on time will make your next car loan easier to get.
If you are ever under financial stress and you may miss a payment, contact your lender immediately. Explain the circumstances and try to negotiate a payment schedule. You may be able to keep the lender from recording a late or missed payment on your credit report.
If your credit improves, consider refinancing. Your better credit can get you a new loan at a better rate. You can pay off the old loan and replace it with the new one. Watch out for prepayment penalties and compare the numbers carefully to be sure you’re getting a better deal!
Informed Decisions Save Money
The process of shopping for a car loan may look tedious and time-consuming, and it may seem much easier to just go to a dealer, pick a car you like, and take whatever financing the dealer offers. Remember that an impulsive choice of a car or a financing package can set you up for high-interest costs, inappropriate vehicles, large monthly payments, credit damage and even repossession.
Shopping carefully and making informed, sensible decisions can save you money and protect your credit. In the long run, the gains are worth the effort.