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Shopping for a Car Loan

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The card-buying experience can be so aggravating that when it comes time to finance the purchase, you may be tempted to go with the dealer’s loan just to get it over with.  Nearly 80% of all car buyers arrange financing through the dealer.  Jumping at the dealer’s financing isn’t wise, though.  You may be able to borrow elsewhere at far better terms.  Dealers often stack two percentage points on top of the APR (annual percentage rate) that a bank would charge.  So before you walk into the showroom, check with at least three local lenders, including the institution where you have a checking or savings account, to see what kind of deal you can swing.  Then you’ll know whether the car dealer’s loan is best for you.

Sometimes car dealers dangle enticing loans with ridiculously low interest rates.  These loans, however, often come with three strings: they are available only on certain models; you cannot qualify for any cash rebate if you accept the financing; and you can usually get the lowest rate only by signing up for a loan of no more than two years or so.  That could make your monthly payments higher than you can afford, since shortening up the term of a loan raises the size of the monthly payments.  Here are a few alternatives:

• Credit unions. Car loan rates at the nation’s 12,800 credit unions are nearly a percentage point less, on average, than rates at banks and S&Ls.  Besides cheaper rates, major credit unions also offer Car Facts, a free car-buying advisory service developed by the Credit Union National Association.  It provides car-quality ratings, rebate information, and dealer costs for various options.
• Your bank or S&L. Sometimes banks and S&Ls give their depositors a slight break on car loan rates if they agree to have their payments deducted directly from their accounts.
• Home-equity loans. More than 10% of all home-equity loans today are used to buy cars.  Surprised?  Actually, it’s quite understandable once you look at the tax side of the car-financing equation.  Interest payments on a home-equity loan are tax-deductible no matter what the money is used for; interest on a car loan is not deductible.  If the interest rate on a home-equity loan is 8.6%, say, your after-tax rate might wind up being 6.2%, far lower than the rate on a typical car loan.
• Before applying for a car loan, decide on the length of the term that you want. The shortest term is two years, but you may be able to stretch out your payments for as long as 10 years.  Stay away from auto loans with terms longer than five years, despite their low monthly payments.  By the fifth year, the amount you still owe could be more than the depreciation value of the car, putting you in what’s known as an upside-down position.  If you sell the car, you might have to come up with additional cash to pay off the loan.
• Other car-financing tips:
• Ask if there will be any penalties for paying off the loan early. If you can choose between two loans with similar rates, go with the one that most easily lets you get rid of the loan ahead of schedule.
• Mention your credit history if it’s spotless, especially if you borrow from a car dealer. According to the Consumer Bankers Association, about a third of lenders offer slightly lower rates for borrowers who never or rarely make late payments on their other loans.  Typically, they’ll knock 1% or so off their standard interest rate.
• Try to make a down payment of at least 20%. Lenders often add a quarter of a point to their rates for borrowers who put down less.
• If you’re a young, first-time car buyer, tell your car dealer. Some dealers try to help people like you by using less stringent guidelines in deciding if you qualify for a loan.  You may also be allowed to make a smaller down payment than normal.

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