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Financing A Car: Understanding Your Options

financing a car

You’ve found the perfect car. It fits your image, your lifestyle, your personality — now you’ve got to make it fit your budget. If you’re like most Americans, you’ll have to finance the purchase. Auto financing is a big business with many players competing for a share of the revenue, so it pays to shop around. Before you buy, read up on our auto finance tips to ensure that you’re the one who comes out ahead.

Financing a Car with the Dealership Can Cost You

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. Often, dealers will determine your interest rate based on your credit rating and then tack on fees and extra percentage points. Dealers can also make money by selling your loan to other lenders, which then pay them part or all of the markup as commission. This process creates an incentive for dealers to pile on as much interest as possible.

Here’s another caution to consider before signing on the dotted line: Studies have shown that interest rate markups can be even higher for members of visible minorities. Many states have introduced interest rate caps for auto and other consumer loans to protect buyers from unreasonably high rates. Additionally, the Servicemembers Civil Relief Act (SCRA) has implemented a six percent cap on interest rates for entering, active and deployed military service members. Before heading to the dealership, find the average current interest rates for loans in your area. This will give you a point of reference for realistic rates and the confidence to challenge an unfair deal.

Also be sure to calculate an estimate of your auto loan to make sure the dealers are not tacking on hidden costs.

Get Car Loan Preapproval Before Going to the Dealership

It’s always best to be prepared when you step through the dealership doors, and you can get pre-approved for a car loan before you even leave your couch. You can use your personalized offers as leverage to try to reduce the dealer’s interest rate. From there, choose the best deal you are offered — whether it’s from your lender or the dealership. Isn’t it nice to have options? If you can’t get pre-approved, you’ll want to consider some auto loan options for people with bad credit.

The great debate: rebates vs. low rates

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 a very small percentage of the people who apply for zero-percent financing are actually approved. Even if you can afford the higher monthly payments that usually comes 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 — especially if the rebate is over $1,000. Here’s what we mean:

Let’s say 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 (from the local bank or credit union) 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. In a situation like this, don’t hesitate to grab a calculator and crunch the numbers yourself.

Consider using a home equity loan for your car financing

If you own a home and qualify, you may want to consider a home equity loan. With this type of loan, you borrow against the paid-up equity in your home. In some cases, the interest rate may be lower than for other types of consumer loans, and you may be able to deduct the interest from your income-tax bill. Keep in mind you are using your home, not your car, as collateral for the loan. Be sure to compare the home equity loan and your other options on an APR basis.

Knowledge is Key

We know purchasing a vehicle can be tricky, but taking the time to educate yourself about auto financing is the best way to make a smart buying decision — and you’re already one step closer. If you’re ready to shop for cars online, LendingTree Autos offers new and used vehicles for sale. Start your car buying experience by browsing our online inventory of cars.

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