There’s more to buying a car than simply picking up the one you want and driving it home. You also need to figure out a way to pay for it. For most car buyers that means borrowing money from a bank or other financial institution. According to the credit reporting bureau Experian, 85 percent of new car buyers and 53 percent of used car buyers took out car loans to pay for their vehicle purchases in the third quarter of 2018.
The easiest way to get an auto loan is to let the dealership's financing office take care of everything for you – and the majority of car buyers do just that. Unfortunately, taking the easy route can cost you thousands of dollars in extra interest payments, force you to pay for unnecessary extras, and have you making car payments for years longer than you should.
Doing a little bit of homework before you head for the dealer can save you money each month with lower payments, and over the life of the loan with less total interest paid. Read on to learn about the most common car loan mistakes and how you can avoid making them.
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Common Mistakes We Will Cover in This Guide:
- Thinking About Financing Last
- Shopping Without Preapproved Financing
- Focusing on the Monthly Payment
- Taking Out a Loan That Is Too Long
- Not Shopping Multiple Lenders
- Not Considering an Online Lender
- Not Considering a Credit Union
- Not Making a Down Payment
- Rolling Your Existing Loan Into the New One
- Not Knowing Your Credit Score
- Financing Add-Ons
- Choosing the Wrong Deal
- Not Considering Your Entire Monthly Budget
- Not Reading the Fine Print
- Taking Out a Loan When You Didn’t Have To
- Not Walking Away From a Bad Deal
- Not Refinancing a Bad Loan
Most of us think about the car we want first, then how to pay for it once we’ve fallen in love with our dream car. If you want to save money, however, you should reverse the process. It’s better to think about your financial situation, budget, credit score, and financing options before you start visiting car dealerships. The only way to be assured that a car fits into your budget is to have a good idea of your finances before your shopping begins.
You wouldn't go to a five-star restaurant without knowing if you could afford it, and your car-buying strategy should follow the same rule.
By considering your financing first, you can prioritize checking your credit score, shopping for a great financing deal, and having a preapproved financing offer in place before you start looking at car models. The idea of putting your financing first applies whether you’re shopping at new car dealerships, used car dealers, or private-party sellers.
If you take one thing away from this article, let it be this: Having a preapproved offer in your pocket before your car shopping begins is critical to avoiding a plethora of auto loan mistakes.
When you have a preapproved auto loan in hand before you step foot in a dealer, you immediately have an advantage in negotiating financing terms. You can’t be pressured into accepting their first offer, plus you’ll have a benchmark that they have to beat if they want to earn your financing business.
Unbundle the Deal
At some dealerships, salespeople try to bundle all of the components of car-buying into a single package. They'll want to mix the cost of the vehicle, the financing, and the value of your trade-in when they come up with a monthly payment. While that makes it simple, it's a horrible way to buy a car. Combining all of the components allows the salesperson to shift the numbers around to make it look like you're getting a good deal on one piece of the puzzle while giving you a lousy deal on the others. It also can lead to confusion, which is advantageous to the dealer.
When you bring your own financing deal to the table, you’re much better equipped to unbundle that component from the deal. That makes it less confusing and takes away one of the variables in the shell game that car buying can be at some dealerships. It’s good to remember that a car dealer is trying to sell you a vehicle, while a financial institution is focused on getting you into a financing deal that they feel you will be able to repay. When it comes to your financial future, the latter goal is more important.
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It is essential that your monthly payment fits into your budget. However, concentrating solely on the monthly payment is one of the biggest mistakes you can make when you get a car loan. Not only can you get roped into an auto loan that's years longer than you should accept, but an unscrupulous car dealer can pack costly extras into the financing package.
A talented salesperson can manipulate the numbers to get the payment as low as they think you need it to be. Often, they’ll extend the car loan to ridiculous lengths to do so. Stretching out an auto loan to six years or more is a way to get people to buy more expensive vehicles than they can realistically afford.
Instead, your focus should be on the price of the car and the total cost of financing over the life of the loan. Smart buyers insist on knowing the price of the car before they start discussing financing.
Avoid Telling a Salesperson Your Monthly Budget
The last thing you want to do is tell the dealer how much you can afford each month. They'll just start with that number – or more – and pack the highest car price, financing cost, and expensive add-ons into that monthly payment as they can by stretching the loan out as long as it takes to hit your payment number.
You should know how much you can afford each month, but it’s a good idea to keep it to yourself.
When you focus on the monthly payment instead of the car price, you’ll often end up with an auto loan that is extra-long. Lenders are increasingly making loans that are seven to eight years or longer. A 72- or 84-month car loan can be both expensive and financially risky.
The extra expense stems from the interest payments you’ll be making each month. Because a longer loan comes with additional risk to the lender, they’ll charge higher interest rates for a longer loan. In other words, you’ll be paying more interest for a longer time. Those extra payments can quickly add up to thousands of dollars in unnecessary interest charges.
Most new cars depreciate quickly during their first few years on the road. Because of that, you could end up in a position where you owe more on the vehicle than it is worth. It's called having negative equity, being upside-down on the loan, or being underwater.
Being underwater on your car loan becomes a problem when your vehicle is stolen or involved in an accident severe enough that your insurance company declares it a total loss. If you are underwater, you still have to pay your lender the entire loan balance, and the check you get from your insurance company won’t cover the whole amount. The difference between what the insurance company gives you and the amount you owe will have to come out of your pocket. The longer the loan you have, the bigger that amount will likely be.
Determining Total Cost
To determine the total cost of a loan offer, multiply the monthly payment by the number of months in the loan term, then add your down payment. If, for example, you have to pay $300 per month for 60 months and put $5,000 down, you multiply $300 times 60, then add $5,000. In this case, the total cost of the car would be $23,000. You can use the total cost number to compare different loan offers.
You shouldn't just visit one car dealer when you're buying a car, and you shouldn't visit only one lender when it comes to financing your vehicle.
Fortunately, shopping at multiple lenders is easier than shopping at numerous car dealerships. You can visit the websites of local banks, large national banks, online banks, finance companies, the financing arms of automakers, and credit unions from the comfort of your home. U.S. News & World Report partner myAutoloan.com can get you up to four offers with just one online application.
Getting a great loan deal is like getting a discount on the total price of the car. Different lenders will offer different interest rates and loan lengths. Every lender is likely to have different standards concerning down payments, loan-to-value ratios (how much of a car they will finance), income limits, and credit score requirements. Auto loan interest can change daily, based on demand and promotions. You can find the best financing offers directly from automakers on our new car deals and used car deals pages.
APR Range: 1.99% - 27%
Loan Term: 24 - 84 months
Loan Range: $8,000 - $100,000
At least 18 years old, resident of the U.S. (except Alaska and Hawaii), with min. income of $1,800/month and min. credit score of 500
Max mileage of 125,000 miles, 10 years old or newer
myAutoloan presents up to four offers from a variety of participating lenders based on your specific loan requirements, offering a wide variety of choice and selections.
APR Range: 3.34% - 17.49% (AutoPay Discount of 0.50% also included)
Loan Term: 24 - 144 months
Loan Range: $5,000 - $100,000
Must have good to excellent credit*
LightStream caters heavily to applicants with very strong credit scores, offering a streamlined application process and a Rate Beat program that guarantees they'll beat any other qualifying offers an applicant receives.
APR Range: 3.99% - 10.08%
Loan Term: 36 - 72 months
Loan Range: $4,000+
$1,800/month minimum income requirements, resident of the U.S. (except Alaska or Hawaii)
Limited to vehicles available through the Capital One network of dealers
Capital One offers a pre-qualification, which allows you to take your offer to any participating dealer within 30 days.
APR Range: 4.29% - 24.99%
Loan Term: 48 - 72 months
Loan Range: $4,000+
At least 18 years old
Limited to vehicles available through the Chase network of dealers, no older than 2008
After your application is approved, Chase will send the information to the dealer you choose. The offer is good for 30 days.
|Bank of America|
APR Range: 3.49+%
Loan Term: 12 - 75 months
Loan Range: $7,500 - $100,000
At least 18 years old (19 in Alabama or Nebraska) U.S. resident
Max mileage of 125,000 miles, 10 years old or newer, valued at $6,000+, plus additional restrictions
Bank of America Preferred Rewards clients can receive an interest rate discount of 0.25-0.50% depending on their tier at the time of applying for an auto loan.
Disclaimer: All information provided here is based on Annual Percentage Rate estimates from the websites of the individual lenders on 12/18/2018. It is not a binding or guaranteed loan offer. Individual auto loan rates will vary.
Notes: In compiling this data, we used new-car purchase rates for Virginia.
*To meet LightStream's standard for good credit, you must have several years of credit history with a variety of account types, including credit cards, installment debt (vehicle loans), and mortgages. LightStream also prefers to see few, if any, delinquencies and a history of savings, evidenced by things like deposit accounts and manageable revolving credit card debt. You'll also want to provide proof of stable and sufficient income to repay current debt obligations as well as any new loan with LightStream.
Reduce the Impact on Your Credit Score
There is one way shopping at multiple lenders can hurt you. Each time your credit report is viewed by a lender, a few points are knocked off your score. If your shopping is spread out over several weeks or months, the credit reporting bureaus could think that multiple credit report requests from lenders are for different purchases, which could knock your credit scores down a few points each time. Keep all of your loan shopping to a couple of weeks, and they'll see it as only one event.
Even if you have a great relationship with a local financial institution, you should consider getting your car loan from an online lender. With electronic signing, there’s no reason you should have to leave your house to complete the paperwork for a loan.
Online lenders don’t have expensive brick-and-mortar locations to support, and their economies of scale and streamlined loan processes make it easy for them to offer good deals on car loans. Many traditional lenders offer as-good or better deals when you apply for your financing through their website, rather than visiting a branch.
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Credit Unions are oft-misunderstood members of the financial world. They are member-owned cooperatives that frequently offer better auto loan rates than you’ll find at banks and other lenders. They can do this because they have no shareholders and return their profits to members through lower loan rates, low fees, and higher savings rates.
Not everyone can join every credit union, as some are tied to specific industries, communities, or companies. The country’s credit union regulator, the National Credit Union Administration, has a tool at MyCreditUnion.gov that can help you find one you are eligible to join. You’ll typically have to put a few bucks in a savings account to become a member before you can take out a car loan.
Many credit unions and some community banks offer special programs to first-time car buyers and consumers with bad credit, so you may be able to get a loan even if your credit score is low or you don't have a long credit history. While some credit unions rival national banks in size, many are smaller institutions. You may be able to make a personal connection and have an opportunity to explain your financial situation.
When you are able to make a substantial down payment on a new or used vehicle, you will likely also be able to get a good financing deal. One of the factors lenders consider is the loan-to-value (LTV) ratio, which is a comparison of the balance of the loan to the resale value of the car. The lower the LTV, the less risky the loan is to lenders. The lower risk leads to better loan rates and terms.
Making a large down payment also allows you to get a shorter loan term, which typically comes with a lower interest rate and lower monthly payments. There’s less chance you’ll go underwater on the loan, as the value of the car has a better chance of staying above the amount you owe.
The dealership ads go like this: "We'll finance anyone, even if you still owe money on your current loan." They promise to pay off your current financing while getting you a new loan for a car. In reality, rolling the balance of your existing loan into a new car loan is one of the most reckless and costly financial mistakes you can make.
Here’s the sad truth: Your first loan doesn’t really go away. Any balance in excess of the existing car’s value is added to the loan on your new vehicle. Your loan-to-value ratio will be higher than 100 percent, meaning you probably won't get a good interest rate, and you'll be in deep trouble if something happens to your car and you have to pay off the loan. Because of the large balance, the lender will likely extend the loan out to a longer term to get affordable monthly payments.
Essentially, you’ll be paying for two cars while you only have one to drive.
Why It’s a Bad Idea
Here’s an example: You have a $10,000 loan balance on a sedan that is only worth $6,000 because you took out a loan that’s too long and you’re still underwater. The dealership offers to take that $4,000 difference and add it to the loan on the $30,000 SUV you’re dreaming of. Before you even leave the dealership, you’ll owe $34,000 on an SUV that is only worth $30,000.
After a year of driving the SUV, it will probably only be worth about $22,000, due to the rapid depreciation that occurs in the early years of ownership. Unfortunately, your loan will likely still have a balance of $30,000 or so, because loan balances decline slowly during the first few years of their terms. Instead of your financial position improving as you make your payments, you will have gone from being $4,000 underwater to being $8,000 upside-down. If something happens to your SUV, the bank can demand immediate payment of the $8,000 negative equity.
Trying to get a car loan without knowing your credit score is like playing baseball blindfolded. While you may get lucky and hit a home run, it’s much more likely you won’t have any idea which pitches are good and which are bad. Knowing your credit score gives you the power of knowing what interest rate you qualify for and should demand in any financing deal.
Your credit score is a number between 300 and 850 that is created by the credit reporting companies (Equifax, Experian, and TransUnion) based on the information in your credit report. It represents your history of paying your bills on time, the amount of credit you have available, the amount of credit you are using, and the age of the credit you have. Lower scores tell lenders there is more risk in lending money to you, while higher scores can have financial institutions beating down your door to give you cash.
Though often called the FICO score, the FICO scoring model is just one of several used to determine scores, so don’t be surprised if you see slightly different scores from different sources.
Give Yourself Time to Fix Your Credit Score, If You Need To
Knowing your credit score and exploring the credit reports they are drawn on well before you start your car-buying odyssey give you time to identify and work to correct any errors that are potentially bringing your score down. It can also provide you with time to make some on-time payments to bring your score up a few points.
You can take a deeper dive into credit scores and how they affect car loans in our article What Is a Good Credit Score to Buy a Car?
The only thing you want to finance with a car loan is the cost of the car. You don’t want to finance fees, costly add-ons, or taxes. All of those extras raise your loan-to-value ratio and potentially raise the interest rate you’ll have to pay. Plus, you don’t want to pay interest on all of the extras.
Many salespeople and finance officers are skilled at selling extras, such as fabric protector and extended warranties, by explaining they will only add a few dollars to each month’s payment. When you do the math, though, you’ll realize what a lousy deal many of the add-ons are.
Take a fabric protectant package that costs just $6 per month. Over a six-year loan, you’ll pay $432 for the service, plus interest. Think of what else you could use that $432 for.
Resist the Pressure to Buy Add-Ons Now
Often, you'll be told you must buy the products on the day you purchase the car to get the deal. That's usually because they don't want you to go to other sources for the products and make price comparisons. Many of the products you'll be offered at the dealership are available from aftermarket companies, lenders, or your car insurance company.
It is critical you look at consumer reviews of the products and the companies behind them before you decide to buy. If you do decide to buy from the dealership, rest assured, they’ll sell them to you days, weeks, or months later.
Before you buy any costly add-on equipment or services, take a look at our list of 11 Things Never to Buy at a Car Dealership.
To increase the sales pace of slow-selling models and those nearing replacement, automakers frequently offer special incentives. Sometimes, you'll have a choice of getting a cash rebate or a low-interest car loan. Making the wrong decision can cost you money.
It takes a little math to determine which car deal is better, but the homework can pay off. If you are able to get a zero-percent financing deal, the total vehicle cost is whatever price you are able to negotiate for the car. Any down payment or trade-in will reduce the amount you need to finance.
Calculating Which Deal Is Best
With low-rate financing deals and cash back offers, you’ll need to use a car loan calculator to determine your monthly payment. You enter the amount you are financing, the interest rate, and the length of the loan. Then multiply that payment by the number of months in the loan term and add the value of your trade-in and any down payment you are making to determine the total vehicle cost.
Here’s an example: We’ll say that your monthly payment is $300 per month for five years, you’re trading in a car that's worth $5,000, and you're paying $4,000 down. Multiply $300 by 60, then add $5,000 and $4,000. The total cost of the car, in this case, is $27,000.
Every car-buying situation is different, so you won’t know which option is the best deal until you run the numbers for each deal. To see the best deals available, check out our new car deals and used car deals pages.
Your monthly car payment is probably not the only thing you need to pay for each month. You have utilities, food, insurance, and more, plus rent or a mortgage. As you plan your car-buying budget, you have to consider all of your current expenses, plus the additional costs of car ownership. With a car, you have to pay for fuel, insurance, and maintenance. If you’re a renter, you may also have to pay for a parking space at your apartment complex. Used car buyers should budget for unexpected repairs that are not covered by a warranty.
Negotiating a car loan without a firm grasp of your other monthly expenses is a great way to accidentally get a financing deal that is way more than you can afford. Remember, a car loan is a legally binding contract. Once you sign it, you're obligated to pay it back. Failing to do so risks the car being repossessed and damage to your credit score that can make it challenging to get another car. If you get into a car loan you can’t afford, your best solution is often to sell the car, pay off the loan, and find a less expensive car. In some cases you can refinance your first loan at a less expensive lender to lower your monthly payment.
Buying a new or used car can wear you down. By the time you’re ready to sign the purchase and loan documents, you probably just want to get on the road. Unfortunately, rushing through the paperwork and missing details can cost you in the long run.
The first thing you want to do is check that the numbers on the paperwork match the deal you agreed to. Pay particular attention to the price of the car, the interest rate, and the length of the loan. If there are blank spaces or errors on the documents, insist they are completed or corrected before you sign. It's difficult to argue about mistakes when you've already signed the papers.
Never leave a dealership until you are confident that the financing deal has been approved by the lender. Failing to do so opens you up to spot financing issues (sometimes called the Yo-Yo Financing Scam), where you're called back to the dealership days or weeks later to sign new paperwork because the deal you initially agreed to was not approved by the lender. Typically, the new deal you're offered comes with a higher price, a higher interest rate, or a much longer term. If you fall victim to this trick, your best solution is to seek financing from another lender before you return to the dealership.
It sounds like a silly question, but do you really need to take out a loan to buy your next car? If you have ample savings that aren’t devoted to your retirement, your family’s emergency fund, or otherwise committed, you might want to consider paying cash for your next car. Paying cash can save you money if your current return on your savings is significantly lower than the interest rate you can get on a car loan.
Some buyers swear by the idea of “self-financing” car purchases. Instead of borrowing from a bank, you pay cash for the vehicle out of your savings, then pay yourself back by making monthly payments into your own savings account. In addition to the thousands of dollars in interest you can save, a significant benefit of this approach is that you can miss a monthly payment and not worry about someone coming to repossess your car.
While paying cash is a great way to buy a car, you want to be smart about how you go about it. Our guide to paying cash for a vehicle can help you determine if paying cash is the right decision.
The most powerful tool that a car buyer has is their ability to walk away from a bad deal. Unfortunately, many consumers are afraid to get up from the table and leave, fearing embarrassment or being unwilling to throw away the time they have already invested in the process.
Failing to walk away from a bad deal is a mistake that can cost you for the entire term of the loan – or even longer, if you get so buried in a financing deal that it damages your credit.
You don't have to give a reason for walking away. Sometimes you'll know for sure that you're about to get a bad deal, while other times you'll just have a sense of intuition that you're not being dealt with fairly. It's then that you have to follow that gut feeling and demand a better deal or walk away. Don't be surprised if the salesperson follows you into the parking lot or calls you later with a better offer.
If you do make some car loan mistakes and fall into the trap of a bad auto loan, the best thing you can do to get out of it is to refinance the loan. With some loans, you can do it the very next day, while with others you'll need to wait a few months to a year. Many credit unions and banks have special programs for buyers seeking to refinance their auto loans. Our guide to refinancing your car loan is an excellent place to start if you're thinking about refinancing.
Check your paperwork to see if there are any prepayment penalties. They’re common if you received a cash back deal that required you work with one of an automakers’ finance companies. It’s important to wait until the prepayment penalty time period ends before you attempt to refinance.
Another reason to wait until you refinance is if you have borderline poor credit. A year of making monthly car payments on time should improve your credit score at least a few points and qualify you for a better financing deal.
More Shopping Tools From U.S. News & World Report
No matter where you are in your car-buying process, the experts at U.S. News & World Report can help you find the right car at the right price. One of our guiding principles is that you’re not getting a great deal unless you’re getting a great car.
Our new car rankings and reviews are based on the consensus opinion of the country’s top automotive reviewers, blended with quantifiable data about safety and predicted reliability. Our used car rankings and reviews add cost of ownership to the research to help you find a vehicle that’s going to be affordable for the long-haul.
We’ll show you how to get a car loan and help you find a great financing deal with our article on how to finance a car. Our partner myAutoloan.com will get you as many as four financing offers with just one simple online application.
You can find the best incentives available from automakers by visiting our new car deals and used car deals pages. Buyers can save even more by using the U.S. News Best Price Program. By connecting consumers with local dealers offering guaranteed savings, the program saves buyers an average of more than $3,000 off MSRP.