Car Loans Guide

1. How to Buy a Car (And Deal With the Dealer) When you walk into a dealership, one of the first things you'll be asked is how you intend to pay for your new car.

When the dealer starts yapping, just explain that you intend to pay in cash. Now saying you'll be paying in cash doesn't mean you're going to open up a briefcase with bricks of money inside. It just means that you're not interested in the dealer or manufacturer financing.

In some cases (if you have perfect credit, if the car is about to be replaced by a newer model) dealer-sponsored financing might be a better deal, but most of the time it's not. You can usually find better deals on car loans at credit unions and banks.

Telling the dealer that you're not interested in their financing accomplishes two things:

  • It takes away an opportunity for the dealer to pad the deal with extra profit (dealers are, as you may suspect, a wily bunch, and they have ways to slip in various fees and charges into the financing arrangement)
  • It allows you to focus on the actual and total purchase price of the car, which is far more important and useful than focusing on the monthly payment figure.

Once you get the financing talk off the table, you can get down and dirty with your dealer and negotiate the purchase price of the car. Here are a few factors to consider when thinking about auto financing:

1.) Resist the temptation to lease
Leasing is a fancy way to say "renting." When you lease a car, you have to give it back at the end of the lease, or buy it from the dealer at a predetermined price. When you take a loan out to buy a car, you pay it off and then the car is yours free and clear. The only payments you'll have to make after that are for gas, repairs and insurance.

Lots of people lease. Smart, respectable people lease. It's not a terrible thing to do, but it's not the best way to buy a car. Why? You'll always be making payments.Lease a car for three years and, when three years is up, you're looking for a new lease (or shelling out thousands-or tens of thousands-to purchase the car you've been driving). Read more about car leasing here.

2.) Consider "Factory Certified Pre-Owned" Cars
"Certified pre-owned" is French for "used." But it does come with some extra assurances about the car's condition. Going pre-owned can be a really smart move-most cars drop 18% in value in their first year.A certified pre-owned car is one that has been inspected and fixed before it goes out on the used market, and comes with a manufacturer-backed warranty, like new cars do.

2. Sizing Up Your Future Car Loan Once you decide you want a new car, the first thing you should do is figure out how much car you can afford. As we said in Section I, don't let your dealer help you with these calculations. Do them yourself before you go shopping.

1.) Figure out how big a loan you should get: A decent rule is that your monthly car payment should be no more than 20% of your disposable income. That means that after you've paid all your debts and living expenses, take one-fifth of whatever's left over and that's your maximum monthly auto expense. Keep in mind that, ideally, this number should not just cover the car payment, but also your insurance and fuel costs for the month.

2.) Decide how long you'll give yourself to pay your car loan back: A monthly payment is, essentially, the amount of your loan, plus interest, divided over the number of months you have to pay back the loan. The more months you have to pay it back, the lower the monthly payment will be. But stretching out a car loan-or any loan, for that matter-will ultimately cost you a truckload more in interest payments. Here's an example:

You get a $20,000 car loan at 5%. If you borrow the money over four years your monthly payment will be $460.59. At the end of four years, you'll have paid $2,108.12 in interest.

If you borrow the money over 10 years, your monthly payment will only be $211.12, but at the end of 10 years, you'll have paid $5,455.72 in interest.

Keep your loan term to five years or less (three would be ideal) and you should be in good shape. If the monthly payments are too much even at five years, the car you're looking to buy is probably too expensive.

3.) Consider all pools of money.
Should you sell investments to pay for the car instead of borrowing at 7%?Well, that's a tough call. For Pete's sake, do not spend any of your tax-sheltered retirement savings (IRAs, 401ks), as you'll pay through the nose in penalties and taxes. As for taxable investments, consider whether cashing out would have lousy capital-gains implications (you'll pay 15% for investments held longer than one year; investments held less than a year are taxed at your ordinary income-tax rate) or what you might need that money for in the next two to three years, if anything.

Should you take out a home equity loan since the interest of that loan is tax-deductible? Many people think home loans are the perfect way to finance a new-car purchase. Many people are wrong. The problem with home loans is the length of the term-most require payments over at least 10 years. Financing your car purchase over that amount of time is going to send your total costs through the roof, even after you've accounted for the tax deduction. Remember, borrow for no more than five years, lease (if you have to) for no more than three. If you're considering a home-equity line of credit, remember that most HELOCs have a variable rate, so it's possible that your payments will rise over time.

3. How to Get the Best Deal Ok, so you're going to show up at the dealer with your own loan, but where should that loan come from?

Start by getting a sense of the prevailing rate for a new-car loan. The number you're going to want to focus on is the APR, or annual percentage rate. With this number, you can cross-compare loans from one lender to another, so long as the durations of the loans are the same.

You'll probably get the best deal at a credit union-which is essentially a members-only, non-profit bank. Because it is a non-profit it has cheaper loans than your typical bank. But you should also check out rates at traditional banks and at online-only car lenders such as Capital One and E-Loans.

Pretty much anyone is fair game: The rate and the duration are really the only two things that matter.

Don't be distracted by dealership offering rebates or zero-percent financing. "Zero-percent financing"means you are not charged any interest on the loan. So if you were buying a car that cost $24,000 and you had a 48-month car loan, your monthly payment would be $500. A rebate is money taken off the price of the car. Rebates are also called "cash-back" deals.

Here's the thing about those offers: you're probably getting screwed one way or another. If you qualify for 0% interest (and most people don't, as it's given only to people with insanely good credit scores), your dealer won't budge on the price. If you take the rebate, you won't get a rock-bottom or 0% interest deal. If you want to run the numbers between zero-down and rebate, check out our handy calculator here.

That's why splitting up financing and purchasing is such a good idea: First, you can shop around for the best credit-union car loan (which has the added benefit of being a less shark-infested environment) and then you go to dealer and focus on negotiating the purchase price of the car. It's when these two transactions are bundled together that you get into trouble, so keep -em separated.

If you do choose to go with a dealer, be extra vigilant about what you discussed, and what you're signing-it's not uncommon for dealers to add in various fees (rustproofing, extended warranty) that are unnecessary and only there to rip you off. Question everything that wasn't covered in your negotiation, and don't be afraid to head for the door if you feel you're getting played.

There are some easy ways to catch a break with your dealer when negotiating the price of your car. Timing can be everything:
1.) Shop early in the week- Weekends are primetime for dealers, so if you show up on a Monday, they may be more motivated to cut you a deal, since business is sorta slow for the next few days.

2.) Shop at the end of the month - Car dealers get monthly bonuses if they move enough metal. If you show up on the 30th and your guy's two cars short of his bonus, he may cut you a better deal so he can make his numbers.

3.) Shop for a car that's about to be replaced/discontinued - Pretty simple logic here: Things that are about to be considered "old" go for less. If you're looking at a 2008 Honda Accord and the 2009s are about to be trucked in to the dealer, you usually can get a deal. If the 2009 model is completely new and different from the 2008, you'll save even more. (Who wants to be seen driving the old-looking model? Oh, right-smart, frugal people.) And if Honda decided the Accord wasn't selling much anymore and were killing it after '08 (fat chance)? Untold riches await you.

4. Grilling Guide: Questions to Ask When Financing a Car What is the loan's annual percentage rate (APR) and duration?
Again - the APR is your magic number. You want to go with the lowest APR for the amount of time that you want the loan to last (remember: the shorter the better.)

Can you show me any and all fees associated with this car loan and explain each and every one to me?
You may sound like a big hassle with this question, but that's exactly what you should be. Any loan process is an opportunity for the lender to throw in junk fees that have no purpose other than to make the lender richer. Go over all of them, make sure they're legit and remember-everything's negotiable, so if you see something you don't like, see if the lender will eliminate it. If not, walk.

I'm thinking about leasing. What is the annual mileage restriction on this car?
It could be 15,000 miles a year, or 25,000. Or 10,000. Whatever the number is, make sure it matches what you drive in a year (give yourself a few thousand miles of breathing room as well). If you put more miles on the car than the lease specifies, you'll pay through the nose when you turn the car in.

Does this lease have a down payment?
Don't pay it if it does. Have your dealer roll the down payment into the monthly payments-don't cough up a lot of money at the outset.

You say this car is certified. Is that certification issued by the manufacturer? What is the warranty on this vehicle?
Just make sure your car is "Factory Certified Pre-Owned." That is, by the manufacturer of the car, not the dealer or some other third party. The car should have undergone a full inspection and should come with a multiyear/mileage warranty. There are a lot of cars out there that are "certified" by nothing more than a repair shop-meaning you can't be sure of the quality and, should something go wrong (and something always goes wrong), you could be stuck with a hefty tab.

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