6 Traps to Avoid When Getting a Car Loan

6-Traps-to-Avoid-When-Getting-a-Car-LoanIn the last quarter of 2013, the average American car buyer borrowed over $27,000. The average car payment climbed to over $450.

 

These numbers aren’t surprising. From 0% interest offers, easy dealer financing and long-term loans, it’s hard to stick to your guns against a persuasive car salesman. But if you’re ready for a new (or new-to-you car), you can avoid the most common car loan traps just by knowing about them.

 

Here are six common car-buying traps you need to avoid next time you shop for a car.

 

1. Buying a car based on the monthly payment

 

We’ve conditioned ourselves to define affordability based on whether we can make the monthly payment. You might be able to afford $500 per month in car payments. But should you really pay that much for a car?

 

The key is to negotiate the price of the car, not the monthly payment. A dealership can adjust the monthly payment in several ways, including changing the term of the loan, the down payment or even talking an unsuspecting customer into an expensive lease.

 

The more you put towards your car on a monthly basis, the less you have for other priorities, such as investing. Don’t underestimate the value of reducing a $500 car payment down to $300 by buying a less expensive car. Put that extra $200 into an investment account earning 9%, and in 5 years you’ll have banked over $14,000 (according to this compound interest calculator). In retirement, say 30 years later, that same $14,000 will grow to over $185,000.

 

2. Failing to check your credit score

 

Before you shop for a car loan, take time to check your FICO® Score. If your credit is less than excellent, you’ll pay more interest on your car loan. And over the life of a 3-5 year loan, a few points in interest can really add up.

 

For example, check out myFICO’s loan savings calculator. On a 48-month, $17,000 auto loan, someone with a middle-of-the-road credit score of 660-689 could pay interest of 6.772% on an auto loan. Someone with an excellent score of 720-850 would qualify for a loan with a rate of just 3.252%.

 

The difference over the life of each loan: $1,282 in interest.

 

So if your score is less than perfect, take time to bring it up before shopping for a car loan. Doing so could literally save you hundreds or thousands of dollars.

 

3. Not shopping around for financing

 

Dealer financing is convenient. It’s so convenient, in fact, that many car buyers finance their cars through the dealership without considering other options. This can be a costly mistake

 

Sometimes dealers can offer better financing on new cars, especially if the manufacturer is offering a sweet deal for good-credit customers. But this isn’t always the case. You may be able to get a better deal by getting a loan directly from a bank or credit union. The only way to know is to shop around for a loan before you shop around for a car.

 

4. Not negotiating the interest rate

 

And while we’re talking about shopping around, don’t forget to negotiate. “Just like the price you pay for the car is negotiable, so is the interest rate,’ says ConsumerFinance.gov.

 

So don’t take those three or four loan offers you gather at face value. Take time to talk with the lender or dealer about interest rate reduction. You may find that to get a lower interest rate, you just need to ask.

 

5. Taking out a long-term loan

 

JD Power recently released a report noting that 33.1% of retail car sales are made with a long-term loan of 72 months or more. Longer-term loans seem attractive, considering they can make a more expensive car “affordable.” But long-term loans are usually a bad idea.

 

The longer the term of the loan, the more you’ll pay in interest. So if you need more than four years to pay off a vehicle, shop for something less expensive.

 

6. Not putting enough down

 

Paying cash for a car is the best option. It forces us to buy only what we really need. If an all-cash deal is out of the question, however, consider making a sizeable down payment.

 

Putting more down on your car – preferably 20% – has many advantages. A higher down payment means a smaller loan and smaller monthly payments. A bigger down payment can also get you a lower interest rate.

 

Plus, a new car will lose about 20% of its value the second you drive it off the lot. And it’ll probably depreciate 15% a year over the next couple of years. So if you put 20% down, at least you won’t owe more than the car is worth by the time you get it home.

 

Car shopping is stressful, no doubt. And most of us just want to get it over with. But that’s no reason to make dumb car loan decisions that could cost you thousands. So next time you’re shopping for a car, take care to avoid these common car loan traps.

 

Have any car-buying tips of your own? Let us know in the comments.

 

Rob Berger is an attorney and founder of the popular personal finance and investing blog, doughroller.net. He is also the editor of the Dough Roller Weekly Newsletter, a free newsletter covering all aspects of personal finance and investing.

Disclaimer: This content is not provided or commissioned by a credit card issuer. Opinions expressed here are the author's alone, not those of a credit card issuer, and have not been reviewed, approved or otherwise endorsed by a credit card issuer. This site may be compensated by credit card issuers mentioned on the site by such companies.