Buying a car, whether new or used, is a big financial decision. For most people, paying for a vehicle will require taking out an auto loan. Getting an auto loan isn’t necessarily a complicated process, but it's possible to make some mistakes that might cost you more than necessary. Let’s learn a little more about some common mistakes when taking out an auto loan and how you might avoid them.
Mistake 1: Finding the car before finding financing
Financing is going to play a big part in determining the kind of car you can afford, so why put it off until the end? Falling in love with a car before you think about how to pay for it can lead to heartbreak if you don’t qualify for adequate financing.
By securing your financing first, you’ll have a more realistic picture of what you can afford. It also helps you be more likely to stick to your budget and avoid overspending.
Mistake 2: Focusing only on the monthly payment
Your car loan payments will be on a monthly schedule. However, focusing solely on the lowest monthly payment could work against you.
Your monthly payment is largely determined by three things: the loan amount, the interest rate, and the length (or term) of the loan. A more expensive car, for instance, is likely to require a larger loan with bigger monthly payments.
One of the quickest ways to bring down the size of a monthly payment is to extend the term of the loan. This spreads payments out over a longer period of time, increasing the total number of payments but decreasing the payment amount each month. A downside is that you’ll be paying interest on your loan for a longer period. And longer terms are often accompanied by higher interest rates. So, even though your monthly payments might be smaller, you may end up paying more in total over the life of your loan.
Mistake 3: Only speaking to one lender
There’s a misconception that car financing is a restrictive process. Some people mistakenly believe that you have to wait until you get to the dealership to secure financing. Others think they should only speak to one lender when trying to finance a car, as speaking to several may hurt your credit. But neither of these things is actually true.
Simply speaking with multiple lenders has no effect on your credit. It is the lender inquiry from the loan prequalification or preapproval process that can sometimes result in a hit to your credit score. However, this is only temporary. Lenders also know that shopping around is a natural instinct for customers, so multiple inquiries for certain loan types (such as auto loans) within a short time window tend to get lumped together as one overall inquiry.
Shopping around among multiple lenders can work in your favor by helping you compare different offers. While lenders all generally look at the same pieces of personal data when calculating your loan offer, they make those calculations in different ways. This can sometimes lead to very different offers from one lender to the next. Shopping around and comparing differences can be one way to find a loan that’s favorable to you.
Mistake 4: Not understanding the value of a down payment
A down payment is a lump sum payment you can make toward the purchase price of a vehicle. A large down payment can help lower the amount you’ll need to borrow. In turn, this could help lower your monthly payment or shorten the term of your loan.
Making a down payment can also work to your advantage by lowering your loan-to-value (LTV) ratio. This could potentially lead lenders to offer you better rates and terms.
Mistake 5: Financing too many add-ons
Some sellers may offer to bundle add-ons like heated seats, anti-theft devices, all-season floor mats and more into your loan. It may be tempting to save a few dollars on signing day, but financing all those extras means you’ll end up paying interest on those things too.
Some of these add-ons might seem like a great deal for just a few extra dollars a month on your bill, and for some drivers, it may be worth it. However, when you add up the total cost for that add-on over the life of your loan, you may find you paid more for it than you would have if you bought it separately.
Mistake 6: Adding your old loan to new one
This is really more of a “costly solution” than a “mistake.” When you owe more on your current car than it’s worth, you’re in a “negative equity” situation. If you need or want a new car right away, you may have the option to trade in your current car to your dealer and add the negative equity to the loan for your new car. This may mean you’ll pay a higher interest rate due to your low equity position, and you’ll also pay more interest due to the increased loan amount, but it’s one way of getting out of one car and into one you’d rather be driving. Keep in mind that you must have sufficient income to make the larger payment, and relatively good credit to be approved for this type of transaction.
With just a little know-how on avoiding some common auto loan mistakes, you might be able to secure a better deal. Practices like shopping around for financing and making a larger down payment can help you have a smoother experience with a more manageable loan.