When you shop for a new car, what do you do first? If you’re like most people, you start by looking for the car itself. You compare models, go on test drives, and decide exactly what model and options you want. I like to start with Edmunds.com to do as much research as possible on the cars I’m considering. Then, once you’ve found the car of your dreams, you sit down with the dealer to negotiate a loan.
Unfortunately, this is the worst possible way to shop for a car loan. Dealers are experts at wringing as much money out of you as possible. Not only do they charge higher interest rates than banks, but they also try to stretch out loans for the longest possible term, carefully disguising the total cost of the loan by focusing solely on the size of the monthly payments. They also try to bundle all kinds of extras you don’t need into the loan cost: extended warranties, floor mats, rustproofing, whatever they can sell you.
Dealers can get away with this because they typically hold all the cards in the loan negotiation. They know you can’t just walk away, because you’re already in love with the car. With that intoxicating new-car smell still lingering in your nostrils, you’ll take whatever terms they offer to be able to drive it home that day.
To avoid this situation, you need to separate loan shopping from car shopping. This allows you to look for the best deal on a car loan the same way you would for a mortgage or home equity loan: by going to multiple lenders, comparing rates, and choosing the best deal. Shopping for your car loan this way this could save you hundreds or even thousands of dollars over the life of the loan.
Keep these tips in mind to get the best deal on your next new car.
1. Look Into Financing First
Financial experts at Consumer Reports, U.S. News, and Money magazine all agree: The best time to figure out how you’ll pay for your new car is before you even start shopping for the car itself. You’ll know what you can afford, and you won’t risk falling in love with a car that will overstretch your budget.
Consider Paying Cash
The best way to fund your new car purchase, if you can afford it, is to buy the car for cash. That way, you’ll pay zero interest, potentially saving thousands of dollars.
Of course, you can only do this if you have a significant amount of savings that isn’t earmarked for retirement, your emergency fund, or some other specific need. But if you have the money, spending it on a new car is a better investment than letting it sit in the bank. The money you’ll save by not having to take out a car loan will far exceed the amount you could earn at today’s pitiful interest rates.
If you’re worried about depleting your savings this way, consider “self-financing” your loan. After paying for the car out of your savings, take the money you would have spent on a monthly car payment and pay it back into your savings account each month. By paying this money to yourself, instead of to a lender, you’ll not only avoid interest, but you also won’t have to worry about having your car repossessed if you miss a payment.
Get Pre-Approved for a Bank Loan
If paying for your new car out of pocket isn’t an option, your next best bet is to get a loan from a bank or credit union. These lenders can usually offer you a better interest rate than a dealer will, and they won’t try to pressure you into a longer-term loan. Another great option is myAutoloan.com. They match you with four different lenders online so you know you’re getting the best interest rate possible.
Experts recommend going to the bank before you start car shopping and getting pre-approved for an auto loan up to a certain amount. That way, you’ll be under no pressure to sign up for a loan from the dealer. You can still give the dealer a chance to get your business, but only if they can beat the terms offered by your bank. That puts the advantage in the negotiation on your side.
2. Check Your Credit
Before you start comparing car loans, check your free annual credit report and your credit score. There are several ways to check your credit score for free, including online through Credit Sesame. Doing this has two advantages.
First of all, knowing whether you have good credit or poor credit will give you a better idea of what interest rate you’re likely to qualify for. That way, when a bank makes you an offer, you’ll know if it’s reasonable. Sites like ValuePenguin and myAutoloan.com can show you what rates are typical for your credit score.
Second, it gives you a chance to make sure your credit report is accurate. If you find any errors that could be dragging down your score – for instance, a loan you don’t really have, or a missed payment that was actually made on time – you can correct these errors before you apply for a loan. To give yourself time to do this, you should check your credit report a few months before you need to start loan shopping.
3. Know Your Budget
Another thing to do before you start comparing loans is to figure out exactly how much you can afford to pay for your car loan. Look at your monthly household budget and see how much of your money is already set aside for other expenses, such as housing, food, insurance, and utilities. Then, figure out how much that leaves you to devote to car ownership.
If you don’t have a budget yet, now is a perfect time to set one up. You can sign up for an account with Personal Capital, and they will automatically import your account information into an easy-to-understand budget. They even calculate your net worth.
If this will be your first car, keep in mind that the cost of owning a car isn’t limited to the loan payment. You’ll also have to pay for auto insurance, gas, maintenance, and maybe extra fees such as parking or tolls. On the other hand, you’ll probably be able to drop some expenses you have right now for transportation, such as a monthly train or bus pass.
Let’s say you’re currently bringing home $2,500 per month, and you’re spending $2,100 on expenses such as rent, food, and transportation. However, $100 of that is for your bus pass, so dropping that expense brings your budget down to $2,000 a month. That leaves you $500 a month to spend on all your car-related expenses. If you estimate that you’ll need $75 a month for gas, $75 for maintenance, and $100 for insurance, that means $250 a month is the absolute limit you can afford for a car payment.
4. Shop Around
Once you know your credit score and budget, it’s time to start looking for loans. Experts recommend getting quotes from three different lenders to make sure you’re getting a good deal. According to Money magazine, there’s probably no need to go to more than three lenders, since the offers you get aren’t likely to vary too much.
Know Where to Shop
Places to look for a car loan include:
- Local Banks. It’s easy to check a bank’s loan rates on its website, and many banks let you apply online as well. However, Consumer Reports recommends going to a local branch in person if you can. You’ll be able to ask questions about the loan and avoid misunderstandings, and there’s a chance you’ll get a better offer this way. The bank where you have your checking or savings account is a particularly good place to start your loan shopping because it knows the most about you and your personal finances.
- Credit Unions. If you have a credit union in your area, this is also a good place to shop for a loan. Credit unions generally offer lower interest rates and fees than banks, along with better, more personalized service. Also, according to U.S. News, many credit unions offer special loan programs for first-time car buyers and people with poor credit. However, you’ll have to become a member of the credit union before you can take out a loan there.
- Online Banks. Like credit unions, online-only banks typically offer lower interest rates than bank branches. They’re also very convenient to use; chances are you can complete your loan paperwork without ever leaving your home. However, they usually can’t provide the personal service that a bank branch or credit union can.
Before signing on with any lender, check it out and make sure it’s trustworthy. Look at the bank’s ratings with the Better Business Bureau and consult online reviews to see what other customers have to say about it. Even the best banks are likely to get a few complaints, but seeing a lot of them is a warning sign that a lender may be hard to work with.
Make Lenders Fight for Your Business
Lenders aren’t legally required to offer you the best rate you qualify for. However, if they know you’re shopping around, they’ll have an excellent incentive to do so. Let them know you’re getting quotes from multiple banks, and there’s a good chance they’ll come up with a better offer than their initial one.
One easy way to pit lenders against each other is to use an online loan service, such as LendingTree or myAutoloan.com. With these services, you enter your information just once and get offers from several competing lenders. The downside is that you risk being bombarded with calls and emails from all the lenders for weeks to come. Also, these online services don’t usually cover local credit unions, so if you want a quote from one, you’ll have to get that separately.
Limit Loan Shopping to 2 Weeks
There’s one problem with getting quotes from several different lenders. Every time you apply for a new loan, whether you use it or not, it knocks a few points off your credit score. Thus, applying for a bunch of loans could bump your score down into a lower tier, making it harder to qualify for the best interest rates.
However, there’s a way around this problem. If you make several loan applications within a two-week period, the credit bureaus ding you for only one loan inquiry on the assumption that you’re doing exactly what you’re doing: applying to multiple lenders for just one loan. So, to avoid hurting your credit score, aim to get all your loan shopping done within two weeks.