Most automotive consumers don't have readily available cash for car
purchases. They need to finance. However, auto financing is not a
subject most people learn in school and many go into it blind when they
make their first car purchase or lease.
Car loans can come from a variety of sources: the buyer's
family or friends, a local bank or credit union, a national bank, an
online loan company or broker, or through a dealer. Car dealers
typically do not finance their own loans. They arrange financing on
behalf of their customers through a car manufacturer's finance company
(GMAC, Ford Motor Credit Corp, etc.) or a large national bank. Some
low-end used-car dealers, such as buy-here-pay-here dealers, source
their own loans. It's important for first-time car buyers to understand
that it is not necessary, and often not wise, to get dealer-arranged
financing.
First time car buyers may have difficulty getting a loan if
they do not have an established credit history, have little or no job
history, have limited income, or have excessive debt. The solution for
most people in this situation is to get a family member to co-sign a
loan with them. A co-signer is not a co-buyer, but simply a responsible
party to which the loan company can come if the original borrower fails
to make payments. Having a co-signer is a good solution because it not
only gets the loan, but it allows the borrower to build a good credit
history so that a co-signer will not be necessary the next time he
needs a loan.
Car loans have four important components:
- loan amount
- interest rate
- term (months)
- monthly payment
Loan amount - Loan companies and banks determine how
much money they are willing to advance to a borrower, based on the
value of the car being purchased and the ability of the borrower to
repay the loan - based on income and debt. It is possible that the
approved loan amount may not be sufficient to pay the entire cost of
the car. In this case the buyer will have to have cash to make up the
difference as a down payment.
Interest rate - Finance companies make money by
charging interest on loans. Interest rates can vary based on the credit
score of the borrower, the finance company's policies and rate
structure, whether the loan is for a new or used vehicle, and the term
(months) of the loan. Individuals with lower credit scores pay a higher
interest rate. Some banks and finance companies charge higher or lower
rates than others. New-car rates are generally lower than used-car
rates. Longer loans typically have higher rates than shorter loans.
Dealers' finance companies do not necessarily have higher interest
rates than banks or credit unions. In fact, it is common for dealers to
offer limited-time 0% or low-interest promotional rates that can't be
matched by local banks or credit unions.
Term - First-time car buyers often opt for very long
loan terms, up to 84 months (7 years), to get the lowest possible
monthly payment. This is generally not a good idea for the following
reasons. Loan terms of 60 months or more usually have higher interest
rates, compounding the total finance charges paid during the loan. This
also contributes to the loan being "upside down" during almost the
entire term, which complicates matters in the future when the buyer
wants to sell or trade before the loan is paid off. It also makes for a
large financial risk if the vehicle is destroyed in an accident, or
stolen, because insurance only pays the vehicle's market value, not the
remaining loan amount.
Monthly payment - Car loan payments are calculated
using a complex financial formula not easily done by hand. Use a
business calculator or online loan calculator. First-time car buyers
often underestimate payment amount due to a lack of understanding of
the calculation. First-timers should avoid "payment buying" -
negotiating monthly payment with dealers - without also understanding
the loan amount and interest rate that the payment is based on.
