Buying a new (or new-to-you) car can be an overwhelming process. First, you need to research all your options to find your dream car. You’ll consider how you’d like to purchase it (from a dealership or privately), how to determine a fair price, and of course how you’ll pay for it.
Unfortunately, by the time many of us finish picking out our car, negotiating the price, and deciding on trim packages, we’re ready to just finalize the purchase and get out of the dealership. And perhaps we don’t look as closely as we should at the financing details. Don’t be that person.
A lil warning:
It’s now easier than ever to get yourself into an untenable vehicle financing situation. Deep subprime auto loans – even riskier than subprime auto loans – are becoming increasingly common, leading to more and more borrowers defaulting, which not only has personal repercussions (like ruined credit and lost property), but it drags down the market as a whole, reports Automotive News.
To avoid signing for a loan you cannot afford, you must enter the car-buying process empowered with financing knowledge. That’s where we come in. Before you finance your next car, arm yourself with our dos and don’ts.
What You Need to Know About Financing Your Car
1. Consider ALL costs associated with buying a car
Before you set foot in the car dealership, you should know exactly how you’ll finance your new purchase as well as what kind of financing rate you can expect based on your credit score and earnings. You’ll also need to factor various car-related expenses besides into your budget.
Check our comprehensive list of everything you need to consider when buying a car – complete with timeline.
The main expenses to consider when buying a car are:
- The vehicle itself: Yeah, you knew that one. But consider the MSRP, taxes, and any add-ons or other fees.
- Insurance: Likely the biggest car-related expense after financing the vehicle itself, insurance takes into account your car’s make/model and age.
- Gas: Unless you go electric, you’ll need to consider gas expenses, which can fluctuate quite a bit depending on markets and on where you live
- Maintenance: American or foreign? Old or new? Automatic or manual? Dealers can charge a pretty penny for basic maintenance, and some mechanics charge more for specialized repairs – make sure you have a maintenance plan for your vehicle type.
2. Know what you can afford for a down payment and monthly bill
Everyone’s financial circumstances are different, of course, so you’ll need to consider your own personal situation, but there are a few general guidelines most of us should follow:
- Your car payment shouldn’t be more than 20% of your take-home pay (this is your pay after taxes)
- Putting 20% down on a new car and 10% down on a used car is best financially
- Don’t finance a new car for more than 5 years or a used car for more than 3 years
“Smart financing loans typically are the subsidized rates from either the manufacturers or their credit affiliates,” Matt DeLorenzo, managing editor at Kelley Blue Book told us. “And most large lenders and credit unions offer fair rates. However, if you have substandard credit, that is where you are likely to find much higher rates and you might end up paying rates that some would call ‘predatory.’”
3. Consider financing your car with your bank instead of the dealership
Know that you’re not limited to financing your vehicle through the dealership just because they’re selling you the car and handling the initial transaction; you have options.
About 90% of people who purchase new (or used) vehicles finance them through the dealership. The remaining 10% use a personal bank or credit union or they pay in full with cash. Perhaps dealers do give that 90% a better deal, or perhaps folks just don’t know to ask. It’s a big chunk of change – so ask!
We suggest visiting your personal bank or credit union and seeing what financing rate they can offer you before you even go to the dealership. That way, at the dealership, you both know what kind of rate you can expect (based on your credit score) and you can use your private financing offer as a bargaining chip to see if the dealership can beat it.
Also, while you’re at your bank or credit union, ask what they’d charge you for a warranty policy – you might find a better deal than you’d get with the dealership who often charge between three and five times more.
4. Set up insurance ahead of time
Be prepared with your insurance details before you start the process of buying your car. Some key things to know before you go:
- Most dealerships will require you to set up the insurance policy for your new vehicle before you can take your car home.
- You’ll need to include your lender (the bank or credit union issuing your loan, or the dealership if you’re financing through them) on all of your insurance paperwork.
- You’ll probably need extra insurance coverage beyond your state’s minimum. When you’re financing your vehicle purchase, you’ll have to follow the insurance requirements set by your lender, which almost always call for more coverage than your state’s minimum requirements. Usually your lender will require you carry comprehensive and collision coverage (often called “full coverage”) in addition to liability.
- Consider GAP insurance, too. Guaranteed Auto Protection (GAP) insurance covers you in the event that your vehicle is totaled or stolen while you still owe more on it than it’s worth (which is often the case in the first few years of financing a new car, particularly if you don’t put down a large down payment). GAP insurance usually costs between 5 and 6 percent of the average insurance policy’s comprehensive and collision coverage, which works out to about $20 to $30 extra per year, on average.
- Setting up an insurance policy can take some time, particularly on the weekends, so we recommend planning ahead.
And of course, compare car insurance rates for your new ride to find the best insurance company, coverage, and price for your needs.
5. Prioritize your monthly car payment
If you don’t keep up with your monthly payments, you risk losing your car and – potentially even more damaging long term – ruining your credit. If you can’t make your payments, refinance (with a reputable lender) or sell immediately to avoid even worse debt.
And in general, remember, if a deal sounds too good to be true, it probably is.
“Predatory programs take advantage of consumers by putting them into vehicles that they traditionally would not be able to afford,” Michael Harley, Chief Analyst of AutoWeb told us. “These often ask for little or zero drive-off [payment] and extend payments upwards of 84 months — to a point where the consumer is ‘upside down’ on their vehicle, meaning they owe more than it is worth, out of warranty. They simply don’t make financial sense.”
Arm yourself with financing knowledge before you begin shopping, understand your own credit and your own budget, and buy with confidence!