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How to get the best car loan

Shop around for a loan to save more

Last updated: February 2014

Some consumers will spend days making sure they get the lowest price on a vehicle, yet they won’t bother to shop for the best auto loan. If you don’t have financing in place when you visit the dealership to buy, you’re leaving yourself vulnerable to whatever terms the dealer offers, which may have a much higher interest rate than you could get elsewhere. And dealers often mark up the interest rate of a loan over what you actually qualify for, which can cost you hundreds of dollars extra.

Ultimately, you want to balance a loan’s total cost against a monthly payment you can afford. But if you concentrate only on the monthly payment, you’ll increase the chances that you’ll unknowingly end up with a bad deal.

Keep an eye on a loan's total cost

When comparing loans, the figure to focus on is the annual percentage rate (APR), which varies from day to day. A lower rate can produce significant long- term savings. For example, a three-year, $15,000 loan at 5 percent APR would save you nearly $500 overall, compared with the same loan at 7 percent.

Another key consideration is the term of a loan, which can significantly affect both your monthly payment and the total cost of your financing. A shorter term means higher monthly payments but less money paid overall. Try to keep the length of the loan as short as you can afford.

A three-year loan costs far less overall than a five-year loan. For example, if you borrow $15,000 at a 6.5 percent APR for 36 months, your monthly payment will be $460, and the total interest will be $1,550. The same loan stretched out to 60 months would lower the monthly payment to $293—over $150 less—but increases the interest by $1,060 to a total of $2,610. And that doesn’t even take into account that longer loans often have higher interest rates.

Another concern with long-term loans is that they lengthen the time before your payments begin building equity in the vehicle. For example, with a 60-month loan, it might take 18 months of payments or longer before the car is worth more than you owe on it. This means that if you want to trade in or sell the car early, the price you’ll get won’t cover the amount you still owe, also called being “upside down.” The same is true if the car were stolen or destroyed. Your insurance payment won’t be high enough to pay off the rest of your loan.

You can reduce this period by taking a shorter loan. For example, with a three-year loan, you already might have built thousands of dollars of equity in the vehicle by the end of the first year.

You can avoid being upside down by making a significant down payment. When financing the purchase of a new car, we recommend having a trade-in or down payment of at least 15 percent of the total cost.

Where to shop for an auto loan

Walking into a dealership with a guaranteed auto loan in your hand gives you bargaining power and flexibility. It also helps you avoid the common sales tactic of mixing up the vehicle price with financing costs. On the other hand, going into the dealership without doing research on how you are going to finance your purchase is setting yourself up to overpay.

One place to start your search for a loan is at www.bankrate.com. The website shows you the current average loan rates nationally. And by entering your ZIP code, you can see some offers tailored specifically for your area. But the site often doesn’t include a lot of local lenders or, in some cases, national ones. So it’s worth checking with individual institutions, as well.

A dealership may be able to offer you the best financing terms. But you should still do your homework beforehand by carefully shopping for the best loan offers so you have a comparison point.

Also, taking the automaker’s low- or zero-percent financing often means having to pass on a rebate, since your choice generally is one or the other, not both. But you often can get the best of both worlds by taking the rebate from the dealer and getting financing elsewhere, even if the interest rate is higher than the promotional one from the manufacturer.

To figure out which option is best in your specific case, try our free online calculator.

To use the loan-versus-rebate tool, you’ll first need to shop for the best alternative rate. Here are some places to look:

Local banks. Banks generally have very specific, conservative loan policies and may only cater to those with better credit references. As such, banks are in a position to offer some very com­petitive loan rates. Since you probably have a relationship with at least one bank already, that might be a great place to start your financing search. Most banks have websites where you can check their current loan rates, but if you decide to apply for a loan, you should stop by a branch office and deal with a real person. It’s a good way to control where your personal information goes, and by avoiding mistakes or misunderstandings, you might walk out the door with a pretty good interest-rate offer.

Local credit unions. Credit unions operate a bit like banks, but they lend money only to their members, who are also owners of the credit union itself. Because credit unions are nonprofit, their operating costs are fairly low and their lending rates can be quite competitive. Many people belong to credit unions just to take advantage of the convenient loan policies.

Online banks. Online lenders can be competitive. Instead of visiting a local office, you apply over the Internet. To find them, do a Web search for “online auto loans.” Online financing has a down­side, however. It may be difficult to control where the information you provide about yourself goes, and you may be bombarded with e-mail and phone calls from lenders you never heard of or contacted in the first place. Be sure to check each website’s privacy policy before providing personal information. As a precau­tion, if you’re not familiar with the lender, check out its site with the Better Business Bureau.

Dealerships. Along with arranging loans from automakers, dealers work with banks and other independent sources. One benefit to arranging financing through a dealer is convenience. But often the rates they quote include a markup for the dealership itself, which can make these loans expensive. Armed with offers from some of the other sources we’ve mentioned, you may be able to negotiate the dealer’s initial quote down to something attractive. But you must do your homework first. Also, some dealers advertise that they will work with buyers who are credit risks, but you should count on paying a high APR.

Understanding credit


The best rates you’ll see advertised online, in newspapers, or elsewhere often require that you have a top credit score. Your score will help determine the interest rate a lender will charge you (or whether you’ll be able to get an auto loan at all).

Your credit standing is especially important with the recent mortgage crisis and associated economic problems, which have made getting a car loan more difficult. Not only do borrowers need higher minimum credit scores, they’re increasingly being asked to produce pay stubs and documents to substantiate their income and other information they provide on a loan application.

A credit score is a three-digit number that’s used by most lenders to assess your credit-worthiness; that is, how likely you are to repay a loan and make payments on time. Although there are several scoring methods, the one most commonly used by lenders is known as a FICO score because it was invented by Fair Isaac, an independent company. FICO scores range from 300 to 850, with the higher scores indicating better credit ratings.

You can find out your credit scores by contacting the three credit reporting bureaus:

Each bureau calculates its own score and charges a separate fee.

If you’re in the market for a car now, knowing your credit score isn’t going to help, since there’s not enough time for you to take the actions necessary to improve it. On the other hand, if you’re not planning on getting a new car for a while, there may be some steps you can take to improve your loan eligibility. For tips, visit www.myfico.com and click on Education.

The three credit bureaus derive your credit score from your credit report, a detailed account of your payment history, as well as your available credit and current debt. As with your credit score, you have a different report from each of the three credit bureaus. If you’ve ever had a bank loan or credit card, information regarding your account activity will appear on your reports.

You can expect to find four categories of information in your credit reports:

Personal information. This includes your name, spouse’s name (if you are married), Social Security number, current and previous addresses, birth date, and current and previous employers. The information comes from past credit applications and depends on how accurately you filled out the forms.

Credit information. Included in this category is information about your accounts with banks, retailers, credit-card issuers, and other lenders. Credit limits as well as loan amounts and balances are detailed, along with past payment patterns.

Public information. This includes bankruptcies, tax liens, monetary judgments, and, in some states, overdue
child support.

Credit inquiries. Included here are the names of those who requested and obtained copies of your credit report.

By law, you’re entitled to one free report (which doesn’t include the credit score) from each of the three major credit bureaus every 12 months. To order your report visit www.annualcreditreport.com.

When you get your reports, scrutinize them carefully for errors, because you can challenge mistakes and ask for the credit agencies to fix them. Consumer Reports maintains a Website at www.defendyourdollars.org to help you understand your credit.

New Car Buying Guide

Learn more about choosing a car, what to do at the dealership, pricing, trading in your car, financing, closing the deal and more in our new car buying guide.




   

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