2015 was a record-setting year for auto sales in the United States. Automakers sold 17.5 million vehicles, according to the Wall Street Journal. That’s a year-over-year sales increase of 5.7% compared to 2014. With the industry so hot now and for the foreseeable future, it’s a great time to examine the dos and don’ts of auto loan financing.
Experian Automotive reports the most common length of an auto loan is now 6 years (72 months). Approximately 43.5% of buyers take out this long of a term. Meanwhile, some 25% of people stretch their monthly obligation even longer to seven years!
Clark has long advised that you should never take longer than 42 months when financing a car. Why does he advocate such a short term? Because of depreciation.
The reality is that the minute you drive off a dealer lot, your new car’s value plummets. So if your loan is 72 months long, you’re upside down in the car (owning more than it is worth) for a long time. What happens if you total the car in an accident or it gets stolen before you get out from under that upside-down vehicle?
It’s very difficult to close the gap between your rapidly depreciating car and the amount of the loan you’ve taken out. So the industry will tell you gap insurance is the solution. But this is a solution to a problem you shouldn’t have in the first place!
Keep these tips in mind when financing a car…
Pre-arrange your auto loan financing
You may have spent hours researching a potential car purchase thoroughly, but did you do the same when it came to getting your loan? One of the biggest mistakes people make when buying a car is to not arrange financing before they walk into a car dealership.
Dealers are entitled to make money on a loan if you don’t do your homework and get pre-qualified elsewhere. When you do a credit application at a dealership, the dealer goes out to wholesale the money for you. They might get money at 4%, but they could write the loan at up to 7% or even higher — especially if they con you into thinking you have bad credit. The younger you are, the likelier it is that you’ll be conned into thinking you weren’t good for the money and they were heroes to get a loan for you!
So what should you do as an alternative? Credit unions offer interest rates on car loans that can be 1% to 3% points lower than other lenders. You may also want to check online lenders. Even your auto insurer may be able to give you a competitive interest rate.
By prequalifying elsewhere, it will change the whole equation at the dealership. You can then go in and tell them the interest rate you’ve prequalified for. If the finance department can beat the deal you have, that’s great. By all means, you should give them a chance to make some money when they originate the loan. But don’t let them make money by gouging you on the markup of a loan.
Avoid ‘the grind’ at car dealerships
One thing you should never do when buying a car, new or used, is go to the dealership and negotiate the purchase of your car then and there. Doing so means you risk facing ‘the grind.’
The grind happens after you’ve test-driven the vehicle and kicked the wheels on the lot. When you’re ready to talk financing, the nice salesperson says he or she will go talk to their manager about getting you the best deal on your intended vehicle.
Instead they go watch TV for five minutes and eat a sandwich. Then they come back looking defeated while telling you that they really went to bat for you, but the manager couldn’t help out with a better price despite their best efforts on your behalf. This is total baloney.
They hope you’ll agree to a higher price they want you to pay. When it comes to price, you’ve got to understand that they have home field advantage because they sell cars every single day. You, on the other hand, may only buy a handful of vehicles over the years.
That’s why it’s so important to get a direct, no-hassle price online at websites such as CarsDirect.com, TrueCar.com, Overstock.com and USAA are great for this purpose. Costco has a car-buying program that moved 400,000 vehicles last year alone!
If you have that price quote in hand, you’re not going to agree to pay a higher price at a dealership. If the dealer wants your business, they’ll have to offer a competitive price. You want to play in your ballpark, not theirs.
Never finance for longer than 42 months
The longest auto loan you should ever take out is 42 months. If you can’t afford the payment on a 42-month loan, then you should buy a cheaper car!
The right way to buy a car is to save money first. Of course, it’s probably unrealistic to think that you can pay for a new car entirely in cash; estimates suggest only 1% of Americans are able to do so. But by saving a down-payment of 20%, for example, you can have a shorter loan and pay less interest.
Never trade in a car you still owe money on
Picture this scenario: You have a car and you’re still paying off the loan. But uou decide to trade it in and get a newer vehicle, taking out a new loan in the process.
Several months later, you are contacted by the lender on your last car about missed payments. What happened? It’s possible that the dealership never paid off your loan when you traded your car in…and you don’t have the vehicle anymore.
Unfortunately, you are still responsible for payments on the car that you no longer own. Your credit is dinged because of the missed payments and your new car may be repossessed if you can’t meet both loans!
This was happening all over America during the Great Recession. The car dealerships that took trade-ins and did this were not intentionally trying to cheat customers. But when they hit hard times and went insolvent, they weren’t worrying about paying off your note. The car industry is going today, but you can never be too careful!
Besides, there’s actually a real double whammy here. If someone had the misfortune of buying the car you traded in, that person could have it repossessed from them because your original loan is outstanding. And they would still have the obligation on the loan they took out! Talk about a train wreck.
Be sure you’re not buying a used car with an outstanding note on it by doing a free title search at CarFax.com or checking with your local Department of Motor Vehicles. Until state legislatures pass bonding laws to protect consumers, we’ll continue having this problem.
Read more: Why you should never ‘top off’ your gas tank
For more money-saving advice, see our Cars section.