In an ideal world we all want to be debt-free; and borrowing money is something that we all should approach with caution. However, when it comes to living a real life, very few of us will be able to escape borrowing money to finance a larger purchase. A car can be one of those big purchases and, unless you’re happy to ride a bicycle or save up money in your sock, you may need to find an alternative way to finance it.
Getting a car loan can seem a straightforward process but there are a few things you should consider. It’s very easy to fall in a trap and take a larger commitment than you can actually afford.
The majority of car loan calculators found on the web are very optimistic. They will ask you to enter your monthly or yearly income to estimate how much you can afford to borrow.
It all seems cut and dried, but there is a catch. For example, let’s assume your yearly income is $40,000 and your spouse’s is $25,000. Depending on the website you use, certain calculators will estimate that you can afford a monthly repayment of $830 (which comes to approximately $10,000 per year). However, many experts recommend that you keep your auto loan spending under 10% of your household income. So, if your total household income is $65,000 per year, it is more sensible to spend less than $6,500 on finance; that’s $540 in monthly repayments.
By staying under that 10% threshold, you’ll find living more comfortable and less stressful. Once armed with this simple information, you can then proceed with looking for a deal that offers you the best APR and repayment rates.
There are a number of different sources that you can look to in order to finance a car; each have their pros and cons. Here is a brief summary of the four most common car loan alternatives:
Bank Loans
Getting a car loan from your bank is probably one of the most common ways to finance a car. Banks traditionally offer personal loans so that cars can be purchased, and these have a fairly reasonable APR. The procedure isn’t very complicated. Bank loans are usually secured, which means you’ll have to use your home or the car as a security. You also typically need to have a very good credit rating.
Car Dealership Loans
Dealers are often associated with a particular loan company, and they can help to negotiate a better rate — although that’s not guaranteed as some dealers are quite greedy. As such, these types of car loans often have a very high annual percentage rate (APR).
Brokers
You don’t actually get financing from a broker; instead the broker compares offers from different lenders and then he presents you with a contract. Using a middleman may sound intimidating. However, in many cases this option can be rewarding, as brokers can sometimes help you to get a better deal on your car loan than either banks or dealerships. On the downside, you’ll have to pay the broker a fee in order to find you a loan, and this can be costly.
Online Loans
Online lenders can supply you with a low-cost car loan, which you can then use to purchase the car and obtain the necessary insurance. There are so many of these companies operating through the Internet that it’s likely you’ll find some company to take you on — no matter how bad your credit, or how much you need. On the downside, some online lenders aren’t legal, and they may be trying to con you. There is also a greater risk of these companies going bust, and then your debt will be sold to collectors. To avoid scams, it is essential that you research the company’s background, check online reviews, and make sure the online lender is registered with a relevant registry that governs lending companies.
When you do finally commit to a car loan, be prepared to make regular repayments for three to five years. This is not something you’ll want to do on a whim. After all, proper planning and budgeting is always the first step when planning to buy a new car.
Photo Credit: jonrawlinson
The last time I financed a car, I got the loan from the dealer to take advantage of the cash back ($1,500 or something like that.) After a few months, I took out a home equity loan and paid off the dealer so I could deduct the interest. If you do this, make sure the loan isn’t going to charge an early pay off fee.
For years, credit unions have hosted special financing days at dealerships. Members get an invitation to prequalify at the dealership. The credit union promises not to reveal how much of a loan they’re able to give you so you can still negotiate the best price.
Credit unions often have great rates compared to the banks.
That said, I’ve only ever financed one car in my life (through my credit union). I can’t see the point of buying a new car when used cars last for years. Now I just save my money and buy a good used car with cash.
I’m with you, Pamela. My next car will be a used car that is only one or two years old. I intend to let the original owner eat the majority of the depreciation all new cars suffer from in their early years. 🙂
You forgot Credit Unions. Many credit unions have money to lend and are willing to work with folks even those with less than stellar credit.
Also, while they do the paperwork, dealerships are not making the loans themselves. They work with area banks and credit unions and sometimes get paid a percentage of the loan rate for their work. ie, if your loan rate is 7%, 1% of the money you repay the loan with maybe going back to the dealer. It depends on the arrangement the dealship has made with the lenders.
Even on used cars many dealers are offering great rates (like 0.9% or 1.9%). This is usually better than what you can get anywhere else!
I buy a few years used car and pay for it in cash.
Vehicle manufacturers have an awful glut in inventory right now and are offering desperation level incentives not seen since the crash of 2007.
As usual, those who are prepared can take advantage of the contemporary financial situation.
So, when our beloved 1999 GMC Suburban died, we bought a new vehicle financed at zero interest for 4 years. Everything was included – even the titling and licensing fees.
We will make the payments from savings (we could have paid cash) but this way we have spent the savings at today’s value while preserving discretionary income (the usual source of loan repayment, as treated in this article).
The benefit of this strategy would be clearer, I think, if the words “spent the savings” were replaced by “committed to spend in the future”.
The idea is to lock in the present value of savings, while its value if left in a savings account would deflate over time.
What about leasing? Any advantages?
If one preferred to buy the use of a vehicle with future payments from savings, the strategy would work just as well, insofar as assigning the depreciation in savings to future expenditures goes.
It doesn’t help, one way or the other, with the decision whether to buy or lease in the first place, though.
Leasing usually makes sense if you own your own business for the tax write-off, otherwise, once the contract period is over, you have nothing to show for all the money you paid during the lease period.