You’ve found the perfect car. It fits your image, your lifestyle and now it has to fit your budget. If you’re like 70 percent of Americans, you’ll have to finance the purchase.
Auto financing is a big business, generating $500 billion a year in loans. Many players are competing for a share of that business. Before you buy, find out about your financing options and ensure that you’re the one who comes out ahead.
The dealership is usually the most convenient source of financing.
But convenience comes at a high cost. The interest rate on dealer-financed loans is usually higher than on bank or credit union loans -- sometimes substantially so. Dealers set purchasers’ interest rates based on their credit rating and then tack on fees and extra percentage points. This costs car buyers up to $1 billion a year.
That’s how dealers generate revenue. Dealers also make money by selling your loan to other lenders, which pay them part or all of the markup as a commission -- creating an incentive for dealers to pile on as much interest as possible.
Studies have shown that interest rate markups can be even higher for members of visible minorities. As a result, class-action suits have been filed across the country and caps are slowly being introduced. Some states have laws that prevent interest charges over 20 percent.
Get pre-approved for a loan.
It's a good idea to get pre-approved for a car loan by a lender or lenders before going to the dealership. You can use these offers as leverage to try to reduce the dealer’s interest rate. Take the best deal you are offered.
The dealership may offer you a choice between a cash-back rebate from the manufacturer and low-rate financing -- typically a loan with zero-percent APR. Statistics from the National Automobile Dealers Association show that of the people who apply for zero-percent financing, only about one-third are approved and a mere 10 percent ink the deal. Even if you can afford the higher monthly payments that usually come with zero-percent dealer financing, it may be a better deal to take the rebate and take out a low-interest loan from the bank, if the rebate is over $1,000.
Suppose, for example, you are buying an $18,000 car and you’ve put down a 10 percent deposit. The dealer offers you zero-percent financing or a $3,000 rebate. If you take out a loan with six percent interest and apply the rebate to your down payment, you will be $1,255 better off over four years than if you had accepted the dealer’s zero-percent APR loan.
If you own a home and qualify, you can often get a lower rate by taking out a home equity loan.
With this type of loan, you borrow against the paid-up equity in your home. The interest rate is almost always lower than for other types of consumer loans because your house acts as security. You also may be able to deduct the interest from your income-tax bill. Remember to compare the home equity loan and your other options on an APR basis.
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