The wrong choice could cost you thousands.
Whether you get a car loan or use a personal loan to pay for your car, the process of choosing the best financing can be confusing at best. If you’re not careful, you could end up spending way more than you should on your next car loan.
Before you take out a loan to pay for your next car, here are some common financing mistakes to avoid.
1. Having overpriced or unnecessary collateral built into your loan
If you’re buying a used car, chances are it’s out of warranty. This means that if you have any issues with your car that need fixing, you’ll likely end up paying for them out of pocket. For this reason, most car dealerships will try to sell you a dealer warranty or extended warranty that will cover the cost of certain repairs and often routine maintenance.
It’s not necessarily a bad deal, but in most cases a dealer will try to sell you a warranty that costs hundreds or even thousands of dollars. They might even try to sell you a warranty that only covers a limited list of issues that you’re unlikely to encounter. If you take out a loan, they will often offer to build the cost of collateral into your loan, which can add thousands of dollars to your overall loan.
In many cases, extended warranties on used cars aren’t worth it. That being said, you might like the peace of mind that comes with knowing that if you have any serious and costly issues, they will be covered under your warranty. Do some math ahead of time to figure out how much you plan to spend on repairs and maintenance and compare that with the price of any dealer warranty you are offered, and make sure you know exactly what that warranty covers. . You can usually negotiate the cost of a warranty a bit, but don’t force yourself to buy one unless you’re sure it’s what you want.
2. Being upside down on your car loan
Being upside down on a car loan means you owe more on your loan than your car is worth. Cars lose value rapidly, by hundreds of dollars each month. If you pay off all or most of the car with a loan, rather than making a down payment, you may end up owing $18,000 when your car is only worth $15,000.
This is not necessarily a problem, other than the fact that you will be paying off this loan over a period of time. However, if you were to have an accident and total your car, your auto insurance would only cover the current value of the car. If your car is worth $15,000 and you still owe $18,000 on your loan, you’ll end up paying $3,000 out of pocket for a car you can no longer drive.
To avoid this mistake, make a larger down payment. Shortening the term of your loan can also help – although this increases your monthly payment, it also means that you pay off your loan quickly.
Be sure to check out this guide to types of car insurance coverage to help you determine the amount of car insurance that’s right for you.
3. Accept dealer financing without being pre-approved elsewhere
Getting the best low interest loan for your car can save you hundreds of dollars a year on interest. To do this, you’ll want to shop around and compare rates from various lenders.
While dealer financing is convenient, you’ll get a better deal by getting pre-approved from various banks and credit unions before you start shopping for your car. It will also give you a better idea of how much you can borrow and the rates you qualify for, which will help you budget. Also, these institutions might give you a better deal than a car dealership.
4. Take your bank or credit union’s rate without asking if your dealer can beat it
Once you have received pre-approval from a few different institutions, you can print out your pre-approval letters and take them to the dealership with you. Asking the dealer if they can beat the rates you’ve already been offered can also result in big savings.
Some people prefer to go to their bank or credit union rather than financing from a dealership. You may think it’s easier or safer than going with what your car dealer offers. However, in most cases it is best to go with the one who can offer you the best loan. Getting the lowest interest rate possible should be your main priority, but also make sure you get a loan term that’s right for you. And avoid loans that charge prepayment charges if you pay off the loan early.
5. Choosing the wrong loan term
Auto loans typically come with loan terms ranging from 24 months to 72 months. You might be tempted to get the longer loan term because it lowers your monthly payment. However, extending your loan over a longer period means paying more interest. It can also mean that you end up upside down on your loan if you pay it off slower than the value of your car depreciates.
On the other hand, selecting a short-term loan means larger monthly payments. If you find them hard to pay, you could miss a monthly payment, which can put you further into debt and hurt your credit. A slightly longer loan term with smaller monthly payments will give your budget a little more wiggle room.
You can always repay your loan early. It’s a good idea to keep your loan term as short as possible, but you can opt for a term that leaves you with lower monthly payments than you can actually afford to give yourself some flexibility.
The Ascent’s Best Personal Loans for 2022
The Ascent team has scoured the market to bring you a shortlist of the best personal loan providers. Whether you’re looking to pay off debt faster by lowering your interest rate or need extra money to make a big purchase, these top picks can help you reach your financial goals. Click here for the full rundown of The Ascent’s top picks.