April 2005
Autos financing alternatives
There are several ways to arrange credit for a vehicle. Some are better than others
Financing your vehicle is the second largest expense next to the vehicle itself. It's important to shop carefully for the lowest interest rate, just as you would compare cars. Considering your financing before you start vehicle shopping can also make negotiations easier.
You have several options to consider when selecting a loan for your used vehicle. Not only can you get a traditional auto loan from a bank or finance through the dealership, but you can also use alternatives such as home equity loans, home equity lines of credit, or even a credit-card advance.
You should always know your credit score before shopping for any loan. Having a sterling credit score can get you a better interest rate than having a poor score. The cheapest rates are typically only available to buyers with good credit scores. You can check your credit record online at Trans Union (www.transunion.com), Equifax (equifax.com), Experian (www.experian.com), or My Credit (www.mycreditfile.com). If you live in Colorado, Georgia, Maine, Maryland, Massachusetts, or New Jersey, you can request a free credit report annually via these credit bureaus. If there are errors in your records that hurt your credit score, try to fix them before applying for a loan. Many lenders and dealers will work with buyers considered credit risks, but such loans have a much higher interest rate.
It's important to keep an eye on the total cost of the loan. The term or duration of a loan determines your monthly payment and the total purchase price of the vehicle. 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 you far less overall than a four- or five-year loan at the same interest rate. For instance, if you borrow $15,000 at 7.5 percent Annual Percentage Rate (APR) for 36 months, your monthly payment would be $467 and the total interest you would pay is $1,797. If you finance the same amount at the same rate over 48 months, your payment would be only $363, but you'd end up paying a total of $2,409 in interest.
The bank loan
Auto loans are relatively easy to get. Lending institutions have some assurance they'll get their money back because the loan is backed by the collateral of the vehicle. If you don't make the payments, the lender can repossess the vehicle.
Before you step into an auto dealership, compare interest rates at various financial institutions with those offered by dealers. It's an advantage to be pre-approved for a loan so that you can leave financial arrangements out of the vehicle-price negotiations at the dealership.
Dealer loans
In the past few years, most automakers have provided zero percent and other very low rates on new cars, which has prompted very low rates on used cars as well. Approach them with some skepticism: attractive deals are most often found on the least desirable models. Low interest rates are no bargain if they persuade you to buy a vehicle that you will not be happy with.
If you finance your car through a dealership, make sure you nail down the price of the vehicle first, before discussing the loan. Many salespeople like to mix the vehicle price and loan together as one negotiation, often by focusing on the monthly payment figure. If you let the two negotiations get intermingled, it's a recipe for confusion. Salespeople can exploit that confusion by giving you a favorable figure in one area while inflating a figure in another.
Home-equity loan
Like an auto loan, a home-equity loan is most often a fixed-rate loan over a fixed term. Interest rates are comparable and sometimes favorable to auto loans, and all the interest on the loan is tax deductible.
However, if you have problems making payments, a lien can be put on your home. That can be a lot more precarious than risking the repossession of a vehicle.
Another big risk is going "upside-down" on the loan (owing more than the vehicle is worth) and not being able to sell the car for the balance left on the loan.
"A big downside to using this loan is that you've now tied up your home equity to this asset that is very likely to depreciate faster than the loan balance in the initial years," says Greg McBride, senior financial analyst at Bankrate.com.
Home-equity line of credit (HELOC)
A home-equity line of credit is an open-ended revolving line of credit, which is based on the equity of your home. To purchase a vehicle using a HELOC, you write a check drafted from this line of credit. Advantages of HELOCs are tax-deductible interest, flexibility in payment, and the comparatively low initial interest rate.
"But the rates are variable and in a rising-rate environment, that can be a liability," says McBride. "However, there is certainly some appeal for a purchase that you expect to pay off in the next three years."
Like a home-equity loan, this line of credit is tied to the equity in your home. As a result, people who purchase a car with a HELOC risk a lien on their home if payments are not met.
Credit card
You can also purchase a used car with a credit card using a credit-card draft, which is a cash advance that works like a personal check. You may have received a draft in the mail from your credit-card company with a letter encouraging you to pay off other credit balances or make large purchases with them. With low introductory rates, cash-advance fee waivers, and high credit limits (sometimes reaching way past $20,000) it may be tempting to use one to purchase an automobile. However, using your credit card to finance a car purchase is not advisable.
Like a HELOC, this is a revolving line of credit and you have flexibility in how much you pay every month. However, since your credit-card debt is neither secured by your vehicle nor your home equity, interest rates climb promptly once the attractive introductory rate has expired.
"The cons outweigh the pros with this, just from the interest-rate standpoint. The rates on credit cards, particularly in a rising-rate environment, will move higher," says McBride. "If you have a promotional rate that guarantees a low fixed rate for a specified period, you must also keep in mind maintaining that reduced rate is predicated on not triggering any of the penalties, such as making a late payment or exceeding your credit limit. And with grace periods getting shorter, it's a lot easier to get tripped up than it used to be. So what initially seems to be an advantage can quickly change to a severe disadvantage if you go from 3.9 percent to 13.9 percent at the drop of a hat."
Find out how much you should pay for that used car. Access our new site--the Used Car Buying Kit.
There are several ways to arrange credit for a vehicle. Some are better than others
Financing your vehicle is the second largest expense next to the vehicle itself. It's important to shop carefully for the lowest interest rate, just as you would compare cars. Considering your financing before you start vehicle shopping can also make negotiations easier.
You have several options to consider when selecting a loan for your used vehicle. Not only can you get a traditional auto loan from a bank or finance through the dealership, but you can also use alternatives such as home equity loans, home equity lines of credit, or even a credit-card advance.
You should always know your credit score before shopping for any loan. Having a sterling credit score can get you a better interest rate than having a poor score. The cheapest rates are typically only available to buyers with good credit scores. You can check your credit record online at Trans Union (www.transunion.com), Equifax (equifax.com), Experian (www.experian.com), or My Credit (www.mycreditfile.com). If you live in Colorado, Georgia, Maine, Maryland, Massachusetts, or New Jersey, you can request a free credit report annually via these credit bureaus. If there are errors in your records that hurt your credit score, try to fix them before applying for a loan. Many lenders and dealers will work with buyers considered credit risks, but such loans have a much higher interest rate.
It's important to keep an eye on the total cost of the loan. The term or duration of a loan determines your monthly payment and the total purchase price of the vehicle. 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 you far less overall than a four- or five-year loan at the same interest rate. For instance, if you borrow $15,000 at 7.5 percent Annual Percentage Rate (APR) for 36 months, your monthly payment would be $467 and the total interest you would pay is $1,797. If you finance the same amount at the same rate over 48 months, your payment would be only $363, but you'd end up paying a total of $2,409 in interest.
The bank loan
Auto loans are relatively easy to get. Lending institutions have some assurance they'll get their money back because the loan is backed by the collateral of the vehicle. If you don't make the payments, the lender can repossess the vehicle.
Before you step into an auto dealership, compare interest rates at various financial institutions with those offered by dealers. It's an advantage to be pre-approved for a loan so that you can leave financial arrangements out of the vehicle-price negotiations at the dealership.
Dealer loans
In the past few years, most automakers have provided zero percent and other very low rates on new cars, which has prompted very low rates on used cars as well. Approach them with some skepticism: attractive deals are most often found on the least desirable models. Low interest rates are no bargain if they persuade you to buy a vehicle that you will not be happy with.
If you finance your car through a dealership, make sure you nail down the price of the vehicle first, before discussing the loan. Many salespeople like to mix the vehicle price and loan together as one negotiation, often by focusing on the monthly payment figure. If you let the two negotiations get intermingled, it's a recipe for confusion. Salespeople can exploit that confusion by giving you a favorable figure in one area while inflating a figure in another.
Home-equity loan
Like an auto loan, a home-equity loan is most often a fixed-rate loan over a fixed term. Interest rates are comparable and sometimes favorable to auto loans, and all the interest on the loan is tax deductible.
However, if you have problems making payments, a lien can be put on your home. That can be a lot more precarious than risking the repossession of a vehicle.
Another big risk is going "upside-down" on the loan (owing more than the vehicle is worth) and not being able to sell the car for the balance left on the loan.
"A big downside to using this loan is that you've now tied up your home equity to this asset that is very likely to depreciate faster than the loan balance in the initial years," says Greg McBride, senior financial analyst at Bankrate.com.
Home-equity line of credit (HELOC)
A home-equity line of credit is an open-ended revolving line of credit, which is based on the equity of your home. To purchase a vehicle using a HELOC, you write a check drafted from this line of credit. Advantages of HELOCs are tax-deductible interest, flexibility in payment, and the comparatively low initial interest rate.
"But the rates are variable and in a rising-rate environment, that can be a liability," says McBride. "However, there is certainly some appeal for a purchase that you expect to pay off in the next three years."
Like a home-equity loan, this line of credit is tied to the equity in your home. As a result, people who purchase a car with a HELOC risk a lien on their home if payments are not met.
Credit card
You can also purchase a used car with a credit card using a credit-card draft, which is a cash advance that works like a personal check. You may have received a draft in the mail from your credit-card company with a letter encouraging you to pay off other credit balances or make large purchases with them. With low introductory rates, cash-advance fee waivers, and high credit limits (sometimes reaching way past $20,000) it may be tempting to use one to purchase an automobile. However, using your credit card to finance a car purchase is not advisable.
Like a HELOC, this is a revolving line of credit and you have flexibility in how much you pay every month. However, since your credit-card debt is neither secured by your vehicle nor your home equity, interest rates climb promptly once the attractive introductory rate has expired.
"The cons outweigh the pros with this, just from the interest-rate standpoint. The rates on credit cards, particularly in a rising-rate environment, will move higher," says McBride. "If you have a promotional rate that guarantees a low fixed rate for a specified period, you must also keep in mind maintaining that reduced rate is predicated on not triggering any of the penalties, such as making a late payment or exceeding your credit limit. And with grace periods getting shorter, it's a lot easier to get tripped up than it used to be. So what initially seems to be an advantage can quickly change to a severe disadvantage if you go from 3.9 percent to 13.9 percent at the drop of a hat."
Find out how much you should pay for that used car. Access our new site--the Used Car Buying Kit.
