How to Finance a Car the Smart Way
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How to finance a car the smart way (what NOT to do)!
Three years ago I bought a car. After taking it for a spin and deciding it was the one, the salesperson immediately asked, “How much can you pay each month?”
At first glance, this might seem like a fair question, as most people have a rough monthly budget in mind before car shopping. However, it’s actually a trick question, and I’ll explain why.
For many people, a car is their first big purchase, and their second-largest one after a house. Surprisingly, though, some people really don’t know the best way to finance one, and this often leads to costly mistakes.
So, whether you’re thinking about getting a new or used car, here are a few tips that are guaranteed to save you money.
Don’t negotiate based on the monthly payment
When you step into a dealership, one of the first questions they may ask is, “How much do you want to pay per month?”
But while this may seem like a reasonable question, it’s actually a clever tactic used by dealerships to increase their profit. The truth is, negotiating the monthly payment can divert your attention from the bigger picture, which is the total cost of the car.
When you’re only focused on the monthly payment, the dealership will often do whatever it takes to achieve your ideal payment. This might include increasing the purchase price, lowballing your trade-in, or extending the loan term. So instead of financing the car over five years, you’re now financing it over six or seven years.
Therefore, never negotiate based on the monthly payment. Instead, focus on negotiating the out-the-door price, which includes all taxes and fees, and then discuss a monthly payment based on that figure.
Beware of 0% financing
Zero percent financing can be an enticing offer, but it’s crucial to run the numbers before jumping on this deal.
What’s interesting about 0% financing is that you often lose the ability to negotiate the car’s price, leaving you stuck with the sticker price. However, if you decline 0% financing and opt for a loan with interest, this can open the door to price negotiations – potentially saving you money in the long run.
For example, if the price tag is $27,000 at 0% interest over a 60-month period, your monthly payment comes to $450, and you’ll spend a total of $27,000 for the car.
However, if you decline this offer and opt for a financing option with interest, you might be able to haggle the price down to $24,000. In this scenario, your monthly payment would be approximately $440, and your overall cost would be roughly $26,500.
To be clear, I’m NOT saying that you should never accept these financing offers.
If you do, though, first calculate the total cost of both scenarios to determine which option is truly the better deal.
Avoid spot delivery
Spot delivery is when you take a car home before the bank finalizes financing. This is a common practice and it’s also convenient, but it can lead to complications.
If you get financing through a dealership, their finance department might review and approve your loan application on their end. However, it’s ultimately the bank (their lending partner) that approves the loan, and it can take up to a week to get a final approval from them.
And unfortunately, the bank might later decide not to approve the loan, in which case you’ll have to bring the car back to the dealership or agree to a higher interest rate.
Now, this isn’t likely to happen if you have good credit. But if you have shaky credit, my recommendation is to wait until “after” you receive final approval from the bank before taking the vehicle home to prevent potential embarrassment.
Don’t roll an existing car loan into a new one
Rolling an existing car loan into a new one is a costly mistake that many people make.
If you trade in a car with an outstanding loan balance, the amount the dealership offers might not be enough to pay off your existing loan. Therefore, they’ll add the remaining loan balance to your new car loan, creating negative equity.
For example, if you’re buying a car for $27,000, and the remaining balance from your trade-in is $5,000, you now have an auto loan for $32,000.
It’s almost always better to pay off your existing loan first, either by finishing the loan term or selling the car privately before committing to a new car loan. This way, you can avoid accumulating more debt than your new car is worth.
Keep your cash plans to yourself
Car dealerships make money not only from selling cars, but also from financing deals. So when their finance partners provide an interest rate, some dealerships will mark up this rate and profit the difference to make extra money.
This is need-to-know information if you’re planning to buy a car with cash.
Many dealerships don’t gain much from cash buyers. Therefore, if you reveal that you’re a cash buyer too soon in the process, you’ll likely lose some of your bargaining power. In other words, they’re less likely to budge on the sales price.
Keep in mind, too, that it’s not uncommon for salespeople to push “financing discussions” early to gauge your intentions. If this happens, don’t fall for it and stay focused on negotiating the price.
Once you’ve agreed to a sales price, then let them know you’re paying in cash.
Get pre-approved and compare rates
One of the most crucial steps in the car buying process is getting pre-approved for financing before setting foot in a dealership.
While some dealerships offer competitive interest rates, others don’t. With that being said, always get multiple quotes from other lenders (such as your local bank or credit union), and then compare their rates with the dealership’s offer.
Pre-approvals not only help determine affordability, they also turn you into a cash buyer. Just remember not to disclose your pre-approval too early in the process to maintain your negotiating power.
Buying a car is a big financial decision, and avoiding these common mistakes can save you money and stress. With this knowledge, you can navigate the car buying process with confidence.