6 common car loan mistakes that cost you money
If you want to save money on your next car purchase, you’ll need to do more than negotiate a good deal with the salesperson on the sticker price. A mistake when taking out a car loan can cost you money and wipe out negotiated savings on the purchase price. Avoid these car loan mistakes if you want to walk away with the best deal possible.
1. Negotiating monthly payments instead of the purchase price
Although the monthly cost of your car is important — and you should know in advance how much you can afford each month — don’t show the salesperson your entire hand. If you do, you give up your ability to negotiate a lower purchase price.
Once agreed upon, the monthly car loan amount tells the dealer how much you are willing to spend. A salesperson may also try to hide other costs, such as higher interest rates and add-ons. They may also pitch you on a longer payment timeline, which will keep that monthly payment within your budget but cost you more overall.
2. Let the dealer define your creditworthiness
Your creditworthiness determines your interest rate, and a borrower with a high credit score will qualify for a better car loan rate than one with a low score. Shaving just one percentage point of interest off a $15,000 car loan over 60 months can save hundreds of dollars in interest paid over the life of the car loan.
Knowing your credit score ahead of time will put you in the driver’s seat in terms of negotiations. With that, you’ll know what rates you can expect — and if the merchant is trying to overcharge you or lie about what you qualify for.
What is a bad APR for a car loan?
According to data from Experian, the average rate for new auto loans in the second quarter of 2022 was 7.23 percent. Those with excellent credit qualified for a rate of about 2.96 percent, while those with bad credit had an average new car rate of 12.84 percent.
Rates for used cars are higher – 11.35 percent of credit scores. And the bad credit average was much higher, at 20.43 percent.
Therefore, a “bad” annual percentage rate for a car would be at the upper end of these numbers. Legally, the APR on the car loan cannot exceed 36 percent. A bad APR will be subjective based on your credit score, but in general, you should look for a lender that offers you an average rate or better.
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3. Not choosing the right word length
Car loan terms range from 24 to 84 months. It’s easy to get attracted to the long term because, generally, the monthly payment is low. But the longer you spend paying off your car loan, the more interest you’ll pay.
To decide which option is best for you, consider your priorities. For example, if you’re the type of driver who’s interested in getting behind the wheel of a new vehicle every few months, being stuck with a long-term loan might not be right for you.
On the other hand, if you have a limited budget, a long term may be the only way you can afford your car. Use a car finance calculator to figure out what your monthly payment will be to decide which option is best for you.
4. Financing the cost of add-ons
Dealership profits are largely influenced by add-on sales – particularly aftermarket products sold through finance and insurance offices. If you want an extended warranty or credit life insurance, these items are available at a lower cost from sources outside the dealership.
Wrapping these add-ons into your financing will cost you more in the long run, as you’ll be charged interest on them. Question every fee you don’t understand to avoid unnecessary increases in your purchase price.
If there’s an add-on you really want, pay for it out of pocket. Better yet, check to see if it’s available outside the dealership for less. For aftermarket products, extended warranties and gap insurance, it is often cheaper to go to a third party.
5. Rolling forward negative equity
Being “upside down” on a car loan is when you owe more on your car than it’s worth. A lender may allow you to roll over that negative equity into a new loan, but that’s not a smart financial move. If you do, you’ll pay interest on both your current car and your previous car. And if you were upside down on your last trade-in, chances are you’ll be upside down again.
Instead of rolling your negative equity into your new loan, try waiting to pay off your old loan before taking out a new loan. You can also choose to pay your negative equity upfront to the dealer to avoid paying extra interest.
6. Don’t shop around
Dealership financing is easy and convenient. But that makes it more expensive. Dealers know they can mark up their rates by a few percentage points.
Shop around and get a few quotes from banks or credit unions before visiting the dealership. Doing so will give you an idea of the interest rates available for your credit score and ensure you’re getting the best deal.
Once you are pre-approved for a loan, you can negotiate more effectively with the dealership. After all, if they aren’t willing to beat the rate you already have, you don’t need to rely on their financing to get the car you want.
Borrowing more than you can afford
It’s exciting to finally be able to own a new car, and it’s natural to want to buy the best car for your needs. However, it is important that you don’t get carried away and borrow more than you can comfortably repay. “Too large a loan can mean financial stress and a high probability of default. First calculate the amount you can afford to pay each month and base your loan amount on that. Then choose a car that fits that budget range instead of going the other way,” says Adhil Shetty, CEO, BankBazaar.com.
Choosing the wrong loan tenure
Remember to use your EMI calculator to choose your loan tenure. Generally, the term of a car loan is between 1 to 7 years, depending on the loan you opt for. A shorter loan tenure will mean higher EMIs, but you will repay the debt in less time. Longer loan tenure means smaller EMI payments, with higher interest payments.
Not factoring into your credit score
Car loan interest rates are directly related to your credit score, and if your credit score is below the mark, you may be charged significantly higher interest rates. Additionally, it can also limit your choices of lenders and offers. So, keep an eye on your credit score and make sure your record is clean.
Not comparing different lenders
It is very important to compare the terms and conditions, interest rate, tenure, speed of approvals, service and other factors before making a decision. “Factors like hidden costs and charges, pre-payment penalty, penalty on pre-closure of loan etc. can make a big difference in your loan cost,” says Shetty.
Not reading the fine print
A clear understanding of loan terms and conditions is essential if you want to avoid nasty surprises. So, make sure you read the contract in detail and understand the clauses before signing anything. If in doubt, please clarify it with your lender.
When you opt for a car loan, you don’t need to dip into your long-term savings like fixed deposits as banks offer attractive loans. So, it makes sense to check all the pros and cons and then decide on your loan to buy your favorite car
The key to success when it comes to getting a car loan is preparation. This means negotiating monthly payments, knowing your credit score, choosing the right term length, being aware of add-on costs and avoiding rolling over negative equity.
By working with a potential lender to keep these mistakes in mind, you’ll walk away with saved money and time.