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Auto Loans

Find out how an auto loan can help you purchase a vehicle.

Many people will need an auto loan to purchase a new vehicle. [©Shutterstock, 2010]
©Shutterstock, 2010
Many people will need an auto loan to purchase a new vehicle.

Auto loans allow consumers to purchase vehicles on credit, thus extending their buying power. The Federal Trade Commission indicates that the average price of a new car is more than $28,000, and a used car averages more than $15,000. Because this high cost may be prohibitive, buyers agree to pay for the car over time with interest. Traditionally the buyer trades in an older vehicle to reduce the purchase price or makes a cash down payment and finances the balance of the purchase price.

Most financial institutions, such as banks and credit unions, will approve auto loans before the car is even selected, and often with the best interest rates. Some consumers purchase cars with home equity loans since the interest may be tax deductable. Finally, dealers themselves typically offer financing. Occasionally, dealer financing may provide the best terms, but often the terms and interest rates cannot compete with those of other lenders. Potential buyers may do well to compare their financing options as carefully as they compare cars.

Auto Loan Options

Buyers should consider not just how much they want to pay for a car, but the financing terms they are willing to consider. Available interest rates are only one consideration. Potential buyers should consider the monthly payment and the length of the loan as well. Shorter loans may carry financial incentives, but make the monthly payment difficult to afford. Extending a loan by one or two years could bring the monthly payment down but increase the total cost of purchase. Even more important, buyers need to be aware that depreciation will lower the value of the car over time. As a result, they should try to avoid financing that will leave them owing more than the car is worth if they have to sell it before the loan term is up.

Buyers should also consider the amount of the down payment. Higher down payments can increase the owner's potential equity and reduce the payments or length of the loan. In addition, some manufacturers offer rebates with financing but the rebates often carry a higher interest rate on the loan. Whether or not the purchaser should take the rebate or finance with a lower interest rate depends on the amount of the rebate and the potential savings gained by financing at a lower rate over the life of the loan.

Loan Shopping

Potential buyers do not have to wait to find the car they want before securing financing. They can compare financing prices and incentives from a number of local and national lenders by checking the lenders' Web sites. Several sites, such as Bankrate.com, offer daily or weekly updates for auto loan interest rates. Buyers can compare the industry averages to the Annual Percentage Rates on their loan offers to determine if the rates are competitive. Three different loan quotes should provide a good starting point, but the buyer should make sure any offer is final and not subject to additional fees, especially if the terms seem low. Having loan quotes available should help buyers negotiate with the dealer both on the car price and possibly for better terms with dealer financing. Buyers should always be aware that the first offer need not be final and they have the right to negotiate better terms.

Evaluating a Loan Contract

The value of a loan can depend on more than the size of the down payment or the monthly payment. Bankrate.com lists a number of questions buyers should answer before agreeing to a loan's terms. Perhaps most important is to determine the loan's Annual Percentage Rate (APR), which is the real interest on the loan's unpaid balance, and possible penalties. Penalties can include potential charges the buyer might accrue, hidden charges or penalties for paying the loan off early. Finally, buyers should make sure they know who is financing the loan and that the terms are finalized before they take possession of the car.

Other important considerations include:

  • The total vehicle cost with finance
  • The total finance charges
  • The total amount being financed by the loan
  • The exact payment amount and exact number of payments

Almost all loans are negotiable and the terms can be affected by the credit rating of the buyer, the value of the trade-in, the amount of the down payment and the length of the loan.

Leasing as an Alternative to Financing

Potential buyers may discover that leasing is a better option than purchasing a car with financing, although leasing is not universally recommended. LeaseGuide.com estimates that 20 to 25 percent of new cars and 75 percent of luxury cars are currently acquired through leasing and offers a number of guidelines to consider for finding good terms for a lease. Under the terms of most leases, car payments are made for a period of two to four years. During the lease term, the car cannot be sold or traded and cannot be subject to more than normal road wear without penalties. At the end of the lease period, the car can either be returned, traded, or purchased for a predetermined price.

Potential benefits of leasing include lower monthly payments, the ability to upgrade the vehicle at the end of the lease term, smaller or no down payments, and reduced tax liability in some states. Potential buyers should avoid leasing if they tend to drive in excess of 15,000 miles each year, intend to paint or customize their vehicle, or tend to subject their cars to more than normal wear and tear.

As of late 2008, some car manufacturers were scaling back their lease programs. In addition, some leasing companies were requiring a larger "capital cost reduction" (essentially a down payment). This makes a lease less attractive. The money put into a leased vehicle up front is money the consumer will never get back. By contrast, a down payment on a purchased vehicle represents equity in the vehicle.

Zero Percent Financing

Dealers sometimes offer zero percent financing as a purchasing incentive. While an interest-free loan may seem to work in the buyer's interest, some financial experts warn that buyers should exercise caution before buying. Interest-free loans may require a higher purchase price or include hidden penalties and charges. Others may require shorter loan periods forcing the buyer into a higher monthly payment than they can otherwise afford. Consumers with less than perfect credit may discover they do not qualify for the interest-free loans and end up signing loans with higher interest rates than they might find elsewhere.

The Federal Trade Commission recommends asking several questions about special financing deals, including:

  • Would the price of the car be lower if purchased with cash?
  • Does the special financing require a large (20 or 25 percent) down payment?
  • Does the financing apply to only specific models?
  • Is the loan limited to 24 to 36 months?

Asking these questions up front can help consumers compare financing options and find the best deal on an auto loan.

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