Some consumers will spend days making sure they get the lowest price on a vehicle, yet they won’t bother to shop for the best auto loan. If you don’t have financing in place when you visit the dealership to buy, you’re leaving yourself vulnerable to whatever terms the dealer offers, which may have a much higher interest rate than you could get elsewhere. And dealers often mark up the interest rate of a loan over what you actually qualify for, which can cost you hundreds of dollars extra.
Ultimately, you want to balance a loan’s total cost against a monthly payment you can afford. But if you concentrate only on the monthly payment, you’ll increase the chances that you’ll unknowingly end up with a bad deal.
Keep an eye on a loan’s total cost
When comparing loans, the figure to focus on is the annual percentage rate (APR), which varies from day to day. A lower rate can produce significant long- term savings. For example, a three-year, $15,000 loan at 5 percent APR would save you nearly $500 overall, compared with the same loan at 7 percent.
Another key consideration is the term of a loan, which can significantly affect both your monthly payment and the total cost of your financing. A shorter term means higher monthly payments but less money paid overall. Try to keep the length of the loan as short as you can afford.
A three-year loan costs far less overall than a five-year loan. For example, if you borrow $15,000 at a 6.5 percent APR for 36 months, your monthly payment will be $460, and the total interest will be $1,550. The same loan stretched out to 60 months would lower the monthly payment to $293—over $150 less—but increases the interest by $1,060 to a total of $2,610. And that doesn’t even take into account that longer loans often have higher interest rates.
Another concern with long-term loans is that they lengthen the time before your payments begin building equity in the vehicle. For example, with a 60-month loan, it might take 18 months of payments or longer before the car is worth more than you owe on it. This means that if you want to trade in or sell the car early, the price you’ll get won’t cover the amount you still owe, also called being “upside down.” The same is true if the car were stolen or destroyed. Your insurance payment won’t be high enough to pay off the rest of your loan.
You can reduce this period by taking a shorter loan. For example, with a three-year loan, you already might have built thousands of dollars of equity in the vehicle by the end of the first year.
You can avoid being upside down by making a significant down payment. When financing the purchase of a new car, we recommend having a trade-in or down payment of at least 15 percent of the total cost.
Where to shop for an auto loan
Walking into a dealership with a guaranteed auto loan in your hand gives you bargaining power and flexibility. It also helps you avoid the common sales tactic of mixing up the vehicle price with financing costs. On the other hand, going into the dealership without doing research on how you are going to finance your purchase is setting yourself up to overpay.
One place to start your search for a loan is at bankrate. The website shows you the current average loan rates nationally. And by entering your ZIP code, you can see some offers tailored specifically for your area. But the site often doesn’t include a lot of local lenders or, in some cases, national ones. So it’s worth checking with individual institutions, as well.
A dealership may be able to offer you the best financing terms. But you should still do your homework beforehand by carefully shopping for the best loan offers so you have a comparison point.
Also, taking the automaker’s low- or zero-percent financing often means having to pass on a rebate, since your choice generally is one or the other, not both. But you often can get the best of both worlds by taking the rebate from the dealer and getting financing elsewhere, even if the interest rate is higher than the promotional one from the manufacturer.
Typical Auto Loan Options
- Local banks. Banks generally have very specific, conservative loan policies and may only cater to those with better credit references. As such, banks are in a position to offer some very competitive loan rates. Since you probably have a relationship with at least one bank already, that might be a great place to start your financing search. Most banks have websites where you can check their current loan rates, but if you decide to apply for a loan, you should stop by a branch office and deal with a real person. It’s a good way to control where your personal information goes, and by avoiding mistakes or misunderstandings, you might walk out the door with a pretty good interest-rate offer.
- Local credit unions. Credit unions operate a bit like banks, but they lend money only to their members, who are also owners of the credit union itself. Because credit unions are nonprofit, their operating costs are fairly low and their lending rates can be quite competitive. Many people belong to credit unions just to take advantage of the convenient loan policies.
- Dealerships. Along with arranging loans from automakers, dealers work with banks and other independent sources. One benefit to arranging financing through a dealer is convenience. But often the rates they quote include a markup for the dealership itself, which can make these loans expensive. Armed with offers from some of the other sources we’ve mentioned, you may be able to negotiate the dealer’s initial quote down to something attractive. But you must do your homework first. Also, some dealers advertise that they will work with buyers who are credit risks, but you should count on paying a high APR.