Get Up to Speed on Auto Financing

Monday, February 15 at 09:05 AM
Category: Personal Finance
Lenders consider a number of factors to determine whether you qualify for financing and how large a loan you can reasonably repay. These factors include your credit score, debt and income level and collateral value.

The credit score will tell them your credit worthiness or how well you have paid debt in the past. Income and debt load will help the bank to determine your ability to repay. A higher collateral value relative to the loan size will be viewed positively by the bank.
Pre-Approved Financing 
Many lenders will pre-qualify you for a certain loan amount based on your income and credit history. You'll know approximately how much car you can afford and be able to compare your financing deal with financing options offered by the dealership. The ability to compare rates could lead to a lower interest rate and ultimately a lower cost to you.

Financing Options
  • Dealer Financing. The big advantage of dealer financing is convenience. You buy and finance the car at the point of sale. The dealer acts as a middle man between you and the financing source, but remember the dealer expects to be compensated for this service so the final rate you pay may not be the best available. Be sure to always compare your pre-qualified rate to the rate the dealer is offering. Dealers may also offer special rates or a discounted price (incentive) from the auto manufacturer to reduce inventory. You will want to compare the lowered rate with the incentive to determine which is a better deal for you. You may save money by taking the incentive and negotiating your own loan rate.
  • Banks. You may get a lower interest rate at a bank than a dealership, especially if you are an existing bank customer. They may require a 10-20 percent down payment to cover the depreciation of the car in case you default on your loan. Smaller banks offer personal relationships, which are important, but may not be able to compete with rates of bigger banks. 
  • Home Equity Loans. You can use your home as collateral for the loan which can be a little bit scary. If you can't pay the loan, the bank can take your house. But, if you're sure you can afford it, a home equity loan is a great way to go because you may get a lower interest rate and your interest may be tax deductible. 
  • The Internet. As with everything else these days, you can shop for car loans on the internet. You miss out on any kind of personal relationship, but you can get quick approval and competitive pricing.
  • Trade-in. Your old vehicle may have value that can be used to reduce the amount you finance on your new auto purchase. The dealer will determine a value for your vehicle and you can apply that amount to the new transaction less any loan balance on the trade-in. You may also consider selling your current auto yourself. Trading to the dealer is more convenient, but you will probably get more money for your auto if you sell it privately.
Negative Equity
The value of a new car drops dramatically as soon as you drive it off the lot. That's because it becomes a used car. It doesn't matter you only used it for five minutes; it's still used and is worth much less because of that fact.

This depreciation is an important concept to understand when dealing with financing because while the value of your car drops immediately, your loan principal drops more gradually. So if you try to sell the car too soon, you may end up owing more on it than you can sell it for. That's called negative equity.
You can avoid getting into negative equity situations by following these simple rules:
  1. Keep your car until it is paid off completely. Obviously, no matter how much your car depreciates, you won't have negative equity if you don't owe anything.
  2. Don't buy a car that is too expensive. If you struggle too much to make the payments, you may decide to sell the car earlier than is financially prudent.
  3. Don't drag out your payments. You might get a slightly better interest rate and your monthly payment will be smaller. But, it will staple you to that car for the financing term. Five years later you'll still be paying for a car that may no longer fit your needs.
  4. Make the biggest down payment you can. This will help offset the impact of depreciation and start giving you some positive equity.
As you become informed about different sources of auto financing, you place yourself in a better position to make the best possible decision for your situation.  

Blog edited by Blog Admin on 3/14/16.

Tags: Financial Education, Lending and Financing
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