We’ve come to the final leg of the 4 part section on buying a car and the choice between getting a new car or a used car: the financing. This section is longer than the past ones but is filled with great information so read on.
There are all kinds of financing schemes out there. Just look back to the mid 2000’s when banks and other mortgage underwriters were issuing mortgages to people with interest-only mortgages. How crazy is that! Mortgages were issued where the bank only expected the buyer to pay interest…. That’s it! Was that a good deal for the buyer? Well, they could buy a home that was bigger and more out of their price range since they had a smaller monthly payment BUT they were going to be paying their mortgage for the rest of their life unless they chose to pay off principal on their own. Absolutely nuts! So although that’s completely off topic, it illustrates that anyone selling you something can “work the numbers” to make the monthly payment more digestible.
When you buy a car, you can buy it outright with cash or finance it. If you finance it, you’re going to be paying interest and other cost of credit which make the car more expensive over time. One of the most important metrics to financing a car is the Annual Percentage Rate (APR). That’s the interest rate you’ll pay to finance the purchase of the car. How can you get that as low as possible?
First, you can go on bankrate.com and research not only national averages on car loan rates but also you can research rates for local banks and financing companies. Just go to the website and click on the “Auto” tab at the top and you should be able to input info to find local advertised rates. In addition, you should go to the bank that you use and ask them what their rates look like and if they have any additional financing charges should you take a loan with them. This should all be done before you actually go to a car dealer. Then when you’re at the dealer, get their rates as well. They usually try to coordinate with local banks to offer lower rates but you should definitely do research beforehand. Also, keep in mind that your credit score (https://www.kaufmanfinancial.com/resource-center/money/get-the-score-on-your-credit?utm_campaign=Get+the+Score+on+Your+Credit&utm_medium=email&utm_source=contacts:all&utm_content=video+image+link&utm_term=OCT+2012&cmid=38655989-6e0d-e211-879c-cf2711bee6a2) will affect your interest rate and depending on your score, it could affect it in a big way.
Now that you have an idea of what car you want and an idea of what interest rates you could get from banks, go to the dealer and ask them about their financing deals or even call them on the phone ahead of time. Which dealers in your area have the best deals? The best way to find out is calling them direct. A really good financing deal from a certain dealer could be a game changer and could cause you to settle with one of their cars rather than another dealer’s. Be cautious when talking to the dealers about their financing offers too. They like to offer “0% financing.” The truth is that usually these dealers only offer that for people with outstanding credit scores, so really it should be “0% financing*** see fine print at bottom.” So ask them what the qualifications for the 0% financing are. Also dealers like to say 0% financing when the great interest rate is only offered in the first year or two of financing. What happens to the interest rate after that? If the rate’s fixed, what’s the rate and is it guaranteed to remain fixed? If it’s variable, what are the details on the variable rate? What “benchmark” interest rate are they tying your variable rate to? What language is referenced in the contract? There are a lot of things to think about with the interest rate. If you sign paperwork, you agree to the terms. So the wording in the contract is VERY important.
Moreover, the car dealer is required by federal law to provide each buyer of a used car a Buyer’s Guide (Federal Trade Commission). The Buyer’s Guide provides an overview of some of the important parts of the contract; however, it will not provide every detail on the contract so you still need to read the entire contract. IMPORTANT: if there is contradicting information between the contract and the Buyer’s Guide, the Buyer’s Guide is the final determinant (Federal Trade Commission). For instance, if the contact says that you will not receive a certain warranty but the Buyer’s Guide says you will, the dealer is obligated to honor the wording in the Buyer’s Guide (Federal Trade Commission). Another important, mandatory section of the Buyer’s Guide suggests that buyers take the car to a trusted mechanic to have the car inspected before they purchase it. That’s a good idea but some people may not want to go through with it and that’s ok. If that’s the case, go online and get an online inspection checklist and take it with you to personally inspect a car you’re looking at. There are a lot of them online so go on Google and type in “car inspection checklist” and you’ll find something that you can take with you.
The interest rate is VERY important when financing a car. You should try to lower your interest rate in any way possible. Find the best possible interest rate by checking multiple banks, financing companies, and car dealerships. Consider your credit score. If your credit score is bad right now, can you work to get it higher in the next year and defer a purchase of a vehicle until your repair your credit score? If not, what company will give you the best deal even though you have a poor credit score? You need to do your research ahead of time.
When you’re nearing the end of your transaction, you may talk to the dealer’s finance guy. There’s no doubt, this guy knows his stuff but make sure you check his numbers. The finance guy can, among other things, make your loan duration longer so that your monthly payments are lower. Everyone knows that trick (or at least I hope so!). If the car dealerships’ finance guy is trying to lengthen your car loan in order to lower your monthly payment, you might want to question his thinking.
Finally, when it comes to buying a new car, that car can lose anywhere from $3,000 to $5,000 the second you drive it off the lot (credit.com). So keep that in mind when you want to buy a new car. Also the longer you finance a new car purchase, the more detrimental the transaction can be to your financial well-being. One of the longest car loans you can get is for 6 years. If you buy a new car with 6-year financing, the second you drive the car off the lot, you’re loan is under water, meaning your car is worth less than what you owe. The longer the loan, the longer it takes to pay it off. Therefore, you could be under water for an extended period of time and if you later decide to sell your car, you could still owe more than you get for your car. For example, you buy a car for $20,000 and finance it for 6 years. In 3 years, you don’t want the car anymore and you decide to sell it. You try to get the best price and the best you can get is $15,000, yet the principal on your loan is $17,000. Well guess what? You’re still going to owe $2,000 after you sell that car. But wait, you don’t even own it anymore! Well that’s too bad because you still have to pay off that loan. Now imagine that you decide to buy another car for $20,000 after selling your first car for $15,000. Well now you have two loans to pay, one for $20,000 for the new car and one for $2,000 for the old car. You’ll be taking on new debt before you pay off the old debt! Now imagine that you buy the new car and finance it with another 6-year loan… you’re doing the same thing all over again!
Alright, so whether you want it or not, you’re getting the Dougpinion. If you’re going to buy a car because you need to get from point A to point B, BUY A USED CAR! If you really like to get flashy and have the income/ assets to do it, get a nice car. Impress somebody. Show it off. However, if you’re paying off other debt and questioning whether or not you can make the payments (you need to be absolutely certain that you can make the car payments for the full amount of the loan), DON’T BUY THE CAR!
Well that’s just the basics. I don’t think it’s a good idea for anyone to buy a car on a 6-year loan. I think that’s crazy. Especially if you’re buying a new car! Like I said before, if you want to be a wealthy individual in the long run, you have to make a series of wise financial decisions throughout your lifetime. If you buy a new car on a 6-year loan or longer, you’re probably not making the best choice. Do you know where you’ll be in 6 years? Will your financial situation change dramatically in that 6 year period? What if it does, are you going to sell your car before that 6 year period is up? If you do, you’ll probably end up losing money on the transaction and you could lose big time. Since there are always unknowns in our lives, don’t put yourself up against the wall where if something bad happens, you’re forced to sell assets at a loss. That is something that can be crippling for an individual or a family. Be smart. Don’t get in over your head just because you’ve always dreamed of owning a certain kind of car.
Moreover, don’t get pushed around by a car salesman. Be prepared with outside information and good questions ahead of time to ask the car dealer. Put them on the spot. The car salesman that you’re talking to has done the 1-2 punch a thousand times and they know what they’re doing. Be different than all the other people that come into their car lot. Be conscious of your budget, price range, style, kind of car, and your financing offers from banks and companies. Know your comfort level for all of those items before talking to the car salesman and you’re going to do great. Now go be an intelligent car buyer!
Financial Executive, Member FPA
Kaufman Financial Services
*I work as a financial planner, not a car salesman. Therefore, I cannot answer specific questions about certain make or models of cars. I am simply a financial advisor.
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