The Ins and Outs of Vehicle Financing

For most Americans, the purchase of a new car is the second-largest expenditure they will make in their lives after their homes. With such an important purchase, it's especially crucial that the route you take will be affordable and well-suited to your needs. In what follows, we've provided concise summaries of the topics that most often mystify potential car buyers. From bad credit loans to refinancing strategies to leasing options, all the information you will need is here.

Preparation Checklist

Before you begin looking for a desirable lending option, you should complete the following checklist:

  • Request your credit report. The better your credit score, the more affordable your vehicle financing rate will be in most cases. About 60-90 days before you plan to purchase a car, you should request your report and score. Look over your report to identify any mistakes that you can correct to raise your score. A difference of even a few points could impact the offers you receive.
  • Determine your budget and stick to it. Ideally, your monthly car payment should not exceed 15-20 percent of your gross income. Use this as a guideline to figure out how much car you can afford. Don't forget to factor in ownership costs, such as car insurance premiums, gas, registration, and maintenance.
  • Research All Options. Don't ever walk into a dealership unarmed with statistics about the rates you should expect. Look up what the national prime interest rate is as well as the average interest rates in your area. Also make sure you're well aware about the sales and incentives available at the dealership you're visiting as well as those of competing sellers.

Car Leases vs. Car Loans

Although auto leases aren't right for everyone, they're worth at least considering in weighing your options. With a vehicle loan, you make monthly payments for a certain number of months, usually 36-60 months, and at the end of that period, you own the car outright. By contrast, when you lease an automobile, you are essentially paying every month for the right to use the vehicle. Leases usually run for 24, 36, or 48 months. Leases tend to have lower monthly payments than other lending options, but they also have the drawbacks of mileage restrictions and the absence of an opportunity to build equity in the automobile. You should consider a lease if you do not intend to drive a car for very long, would like lower monthly payments, and don't mind the mileage restrictions attached to auto leases.

Bad Credit Auto Financing

Certain financial challenges don't necessarily have to preclude you from finding a reasonable plan with which to purchase a new vehicle, but they will present certain obstacles. For one, you will have to resign yourself to the fact that you will pay higher interest rates than with the alternative. Second, you must be willing to use independent sources rather than the dealership, as independent lenders can offer better rates and less stringent qualification criteria. Finally, you have to stay vigilant about the possibility of bad credit option scams—disreputable lenders often dupe vulnerable buyers into agreements with unconscionable terms and conditions.

If you have poor credit but want to buy a new car, first think about how urgent your need for another vehicle is. If you can wait, taking a few months to improve your situation could radically lower the interest rates you pay. A few months of paying down your outstanding balances and paying on time consistently might be all you need to qualify for more affordable payments. However, if you can't wait, start comparison shopping with independent lenders online. The dealership is highly unlikely to offer the most competitive rate, so get quotes from online lending companies to see more affordable payments. Before you agree to the first option, though, make sure there is no penalty for paying the balance off early. If your score improves down the road, you might be able to refinance with no early-payment penalty to save money.

Refinancing Strategies

If interest percentages have dropped or your credit rating has improved since you took out your existing car loan, you might benefit from refinancing. Using a site like this one, you can request offers to see how much your payment would drop on average. Once you have an average interest rate to work with, you can figure out how much you would save per month and multiply that by the number of months you would have left in your term. Some buyers choose to extend or abbreviate their terms when refinancing, so make sure you have the correct number. If the total savings exceed the cost of refinancing (origination fees, early repayment fees, etc.), you should proceed with the process.

Online vs. Dealership Financing

Every car buyer dreads haggling with the salesperson at the car lot, and the haggling is now far more involved because you typically must negotiate both vehicle price and financing. Thankfully, that is not the only way to finance a car. The alternative is online vehicle loans offered by independent lenders, such as those who participate on our site. To help you decide which option is best for you—dealership or online auto lending—we've listed the pros and cons of each below. The pros and cons of the dealership route include:

  • Convenience. You can buy and finance your car all in one stop.
  • Room for negotiation. Dealers will typically negotiate with you on the interest rate and/or terms they can offer to help you fit your monthly payment into your budget.
  • Elevated rates. Dealer lending rates are almost always higher than those you would receive from an independent online lender. Salespeople routinely try to make up for the money they may have lost in lowering the car's sticker price by quoting you an artificially inflated interest rate.
  • Limited selection. Obviously, when you finance through the dealership, you only receive one quote, so the salesperson essentially has no competition to worry about. This can be especially limiting for buyers with less-than-perfect credit.

By comparison, here are the pros and cons of online car financing:

  • Multiple quotes. On this site, you submit one request and receive up to five no-cost quotes from independent providers. This takes only a few minutes, and no haggling is required.
  • Lower rates. The online auto lending market is fiercely competitive, and that means lower average interest rates for you as a borrower.
  • Negotiation power. When you walk into a dealership with a pre-approved independent offer, the dealer must either compete with the offer directly by offering a better interest rate. If he cannot do so, then you will have the upper hand in pricing negotiations, which will likely enable you to talk him down on the price of the vehicle.

Upside-Down Situations and Defaults

Not all auto lending situations are ideal, and sometimes problems arise as a result. You may have heard of a buyer being "upside down" in a car loan, otherwise known as negative equity. Being upside down in your vehicle simply means that you owe more money on it than it is worth. For example, if you bought a $14,000 car a few years ago and now owe $11,000, but the car's value has depreciated to, say, $8,000, then you are $3,000 upside down. Negative equity in an automobile creates a precarious financial situation, particularly when you try to use that vehicle as a trade-in. Although being upside down makes it much more difficult to buy a new car, it's not impossible.

Your first option is to finance the negative equity. In other words, you would ask your lender to issue a loan that covers both the price of your new car and the negative equity of your trade-in. This option is also known as rolling one auto loan into another. Because interest rates as exorbitantly high on roll-over financing, this is probably the most costly and least advisable option. Alternatively, you might instead take advantage of cash incentives. For instance, if you are $2,000 upside down in your current vehicle and wanted to trade it in for a car with a $3,000 rebate, you can erase your negative equity and still make a down payment of $1,000 on your new car. If you decide to take this route, make sure you research the vehicles that offer the largest incentives before you begin car shopping. Lastly, you might simply trade your vehicle in for a new but cheaper model, thereby erasing your negative equity with the price difference.

Defaulting is Almost Never a Good Option

If you default on your lending agreement, you will face different consequences depending on how behind you are. A summary of the ramifications of a default is provided for each stage below.

  • Short term: Late fee. If you miss a payment, your lender will likely assess a late fee. If you make the payment and pay the fine, you will likely not face any further consequences. However, if you establish a track record of not making payments on time, the consequences will become more severe.
  • Medium term: Credit bureau report and issues with lender. Most providers will notify the credit bureaus on the 90th day of default. A black mark on your report might immediately affect your interest rates and ability to secure credit in the future, so try to avoid this if at all possible. Try talking to your lender to work out a plan, refinancing, or consider purchasing a cheaper car.
  • Long term: Damage to your rating and repossession. If you fail to get caught up in several months, your lender might get a judgment against you to garnish your wages or repossess the vehicle. If either of these things happens, you can be sure that your score will plummet as a result. A defaulted car loan on your report will likely make it almost impossible to secure reasonable financing, for vehicles or any other purpose, in the near future.

How MSRP Is Calculated

Manufacturer's Suggested Retail Price is a price set by the maker of a vehicle that is a suggestion of how much the car should cost based on the following factors:

  • Invoice: The base price of the car from the manufacturer to the dealer. It includes the cost of all of the parts of the base model (the seats, the steering wheel, the paint, the lug nuts, etc...), the labor and taxes paid by the car maker in order to assemble the vehicle at its most basic, functioning level, exclusive of any additional options.
  • Factory options: The add-ons to the base model that this particular car has, such as an upgraded stereo system, iPod jack, chrome rims, upgraded paint job, leather interior, spoiler, alarm system, side airbags, etc. If you are buying a new vehicle, you have the option to customize this part of the MSRP by having the vehicle sent to the lot with exactly what you request.
  • Destination charge: The cost of shipping the vehicle from the manufacturer to the dealership.
  • Dealer prep: The amount that it will cost a dealership to get a car ready to sell once it has arrived, including washing it, filling the tank with gas, adding logo stickers to the windows, and adding floormats.
  • Holdback: The amount that the dealer paid to the manufacturer for the car and the ability to sell it. This amount as a profit declines the longer a car remains on the lot (because in part, the car has to be maintained while on the lot, which costs the dealer money). After 90 days, the holdback represents $0 profit to the dealership, so it is in the dealer's best interest to move a car quickly after it arrives on the lot.

A Word on Auto Fire Sales: Finding the Best Deal Available

A "fire sale" usually occurs when dealerships slash prices in an attempt to move their inventory. During these special promotions, buyers can find exceptional deals on brand-new cars. The most common types of fire sales are year-end fire sales and bankruptcy fire sales. With year-end fire sales, because auto manufacturers release the models for the following year anywhere from late spring to early fall, dealerships must unload their current inventories of the previous models as quickly as possible. To do so, they typically heap their own incentives onto those already offered by the manufacturer. With bankruptcy fire sales, an auto manufacturer has filed for bankruptcy and will be closing dealerships, resulting in an even greater need to unload inventory ASAP. Because of the exigency of such a situation, dealers might even sell vehicles at a loss in a bankruptcy fire sale.

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