Shopping for a new car can be fun and exciting, but before you get to the fun part, better shop for a loan to finance your purchase. That requires almost as much homework as finding the right car.
If you walk into a dealership without a clear idea of how you plan to finance the purchase, you'll likely end up paying more for the vehicle and also paying a higher interest rate. That's because the dealer will likely offer some financing options, all of which will benefit the dealer more than you.
Avoid dealer financing
Instead of relying on dealer financing, arrange for your financing before you set foot in the showroom. That means deciding how much you can afford to spend for a car and how much you can afford to pay in the form of a monthly payment. The two things are not the same.
If you focus solely on the monthly payment, you can easily overpay for the vehicle. Extending the payments for five or six years will drop the monthly payment, making a vehicle seem more affordable than it really is.
The trouble with lengthening the payment plan is that you are paying more interest and less principal each month. As the car depreciates, as they all do, you can soon find yourself owing more for the vehicle than it's worth. Sound familiar? It should. That's been the problem with the housing market the last few years.
Loan calculator
To find out how much you can afford to pay for a vehicle, use a car loan calculator like this one at Edmunds.com. Enter the amount you feel comfortable in handling as a monthly payment for four years.
Enter your desired monthly payment, let's say $300. Next select 48 months as the term of the loan and the applicable interest rates. Current market rates on new car loans for people with excellent credit average around three percent. Enter the amount or your trade-in and/or down payment and then calculate. The calculator then gives you the price range of the vehicle you can afford. Try to stick to that range without lengthening the term of the loan
Next, you want to arrange financing before you visit your dealer. That means a visit to your bank or credit union. Banks' lending standards will be the highest so, unless you have very good credit, you might not qualify for a car loan. Your chances at a credit union will be better, and if you are not a member, it might pay you to join one before going car shopping. Navy Federal Credit Union, for example, is advertising new car loans as low as 1.79 percent.
Once you have been pre-approved, up to a certain amount, you're ready to go car shopping. When you walk into the showroom, you are a cash buyer. There is nothing to negotiate except the price of the vehicle. The sales person will either deal or they won't. But because you already have access to a certain amount of money, you have some leverage.
Subprime credit
What if you don't have good credit? You can still buy a car but it will probably cost more in the form of a higher interest rate. But again, you don't want to rely on the dealer to arrange financing for you, you want to line it up in advance.
Knowing your credit score will help you find the right loan. Generally, if your score is 670 or below, you're going to be considered subprime and you might not be able to get bank financing, although some credit unions may be lenient if you are an existing member with a good record.Â
Do an online search for "subprime auto lenders" in your state and seek bids for two or three. Again, avoid the pressure to accept a longer loan term to compensate for the higher interest rate you will pay. Instead, you'll need to recalculate the maximum purchase price you can afford.
If you find yourself in the subprime category, don't despair. An increasing number of cars are being sold to subprime buyers. Just make sure you don't overpay for the vehicle and don't overextend the term of the loan. And shopping for financing upfront gives you a little more bargaining power when it comes time to make a deal.
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