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When you're in the market for a car, one of the smartest moves you can make is to do the same kind of comparison shopping for financing as you would for the vehicle itself. Doing your homework to scout out the best financing deal can save you hundreds of dollars. Below, we explain the pluses and minuses of the most common options:
Getting a Loan from a Bank or Credit Union
Before setting foot in a dealer's show room, check out the average auto loan rates in your area and know which banks offer the best rates. The gap between lowest and highest auto loan rates easily can be two percentage points, so it's definitely worth shopping around. Though it may not seem like a lot, one percentage point could mean savings of a couple hundred dollars over the life of a typical auto loan.
For even lower rates, look into a credit union. They often offer interest rates up to one percentage point less than prevailing bank rates. The Credit Union National Association website can help you find out if you are eligible for credit union membership through your employer, a professional organization, your community or as relative of a military veteran.
Once you have found a lender to work with, be sure to get pre-approved for your loan before you hit the showroom. There is enough work to be done negotiating the best price for your car without having to worry about finance negotiations. Pre-approval also gives you a realistic view on how much you car you can afford before you tempt yourself with those showroom gems.
Your minimum down payment can range from zero to 25% of your vehicle's purchase price. The average term for auto loans is between four and five years, and some lenders even allow you to stretch your loan over seven years. There's no sense in having to pay for a car you no longer own, so don't get loan whose term exceeds the number of years you plan on owning the car. Also be aware that while taking a longer term loan cuts your monthly payments, it sharply increases your total interest costs.
Dealer Financing
Auto dealers usually offer their own financing arrangements, which many consumers take advantage of simply for the convenience of one-stop shopping. If you decide to take this route, don't discuss any financing arrangements until you and the dealer agree in writing upon a purchase price for your car. "If you tell a salesperson what your goal is for a monthly car payment, it's easy to get bamboozled by all of the numbers they'll throw at you and lose sight of the hard realities: how much you're paying for the car and what interest rate you're being charged," says Keith Gumbinger, vice president of HSH Associates, a financial reporting firm in Butler, N.J. Case in point: one of Gumbinger's co-workers told a car dealer she wanted to pay no more than $200 a month on her car loan, so the dealer gave her a financing package that did just that, but at an interest rate she later discovered amounted to 22% annually, versus the going rate at the time of 8.5%.
Home Equity Loan
If you are a home owner, you may be living in your best loan option. Home equity loans and lines of credit allow you to borrow against your home equity (the amount of the current value of your home minus the principal owed on your mortgage). Unlike other loans, the interest you pay on these loans is tax-deductible. Be sure to include all of the loan fees when doing your math for home equity loans and lines of credit, high fees could wipe out your tax savings. Above all, remember you are putting your house on the line with a home equity loan, missing payments could mean losing your house.
Leasing
Leasing has become an increasingly popular alternative to buying a car on credit, especially for those who prefer to drive a new vehicle every two to three years and who accept perpetual monthly car payments as an inevitable part of life. To determine whether leasing may be right for you, consider the following list of pros and cons:
PROS
- You may be able to drive your otherwise unaffordable dream car. Up front fees typically are no more than $2,000, even for luxury vehicles with sticker prices of $40,000 or more.
- Monthly payments are often lower than what you'd pay under a conventional auto loan.
- You never have to bother with selling your car or haggling with a dealer over trade-in value.
- If you use your car for business, you can reap greater tax benefits because you deduct both interest costs as well as depreciation when you lease.
CONS
- You don't own your car at the end of the lease. However, depending on what leasing terms you negotiate, you may have the option to buy the car at a pre-set price that ends up being lower than the true market value of the car when the lease ends.
- Excessive wear and tear and driving the car beyond the mileage limit (generally 15,000 miles per year) can result in additional costs when you turn in the car.
- If you move and want to end your lease early, you'll pay a penalty that could be as high as six months' worth of payments.
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