Choosing a car or truck is a big decision usually made after a lot of research. However, if you’re planning to borrow money to buy your next vehicle, and after you’ve assessed how much you should spend, you should study lenders and their terms as closely as you explore different makes and models.
Here’s what you need to know to make a well-informed choice:
Get Your Loan Preapproved
Most dealers are eager to offer you financing, but you may get a better rate—and could drive a better price on the car—if you come to the negotiating table with a loan approved in advance by the lender of your choice.
Know What You Should Spend
There can be a big difference between how much you’re approved to borrow and how much you should borrow. Determining this is as simple as knowing your financial situation and your goals—and not breaking your budget.
As you’re budgeting, consider spending no more than 15% of your take-home pay on the total cost of owning a vehicle.
Remember: A vehicle’s total cost of ownership is more than the monthly payment. It includes your insurance premium, gas, maintenance costs and, in some cases, parking. Also, factor in any anticipated changes to your income over the next few years, including bonuses and cost-of-living adjustments.
Be Careful With Long-Term Loans
One of the most important choices you’ll make is how many months you’ll take to pay back the loan. No more than a 60-month loan is recommended.
The longer the term of the loan, the lower the monthly payment. That sounds great until you realize you’ll end up paying more interest over time. With a longer term loan, you also increase the risk that at some point you’ll owe more money on the vehicle than it’s worth.
Your Credit Score Matters
As with most types of borrowing, your approval to borrow and your interest rate depend in part on your credit score and history. Keep in mind: When banks or dealers advertise low interest rates, it could be a teaser rate for which only those with the best credit scores can qualify.
Finally, weigh 0% offers with rebates and compare your options to determine the best deal. In most cases, you’ll be better off financially taking a cash rebate versus a low-rate offer.
Loan Rates Only Mean So Much
There’s more than rates to consider. Always look at the total interest expense over the life of the loan. Since your debt may span several years, you should also evaluate the lender’s reputation for providing quality service in setting up and servicing your loan.
Your Car Is Your Collateral
Car loans generally have lower rates than credit cards because they are a type of “secured loan.” That means that you pledge your vehicle as collateral: If you don’t keep up with your payments, it could be repossessed.
Be Cautious of Rolling Extra Charges Into Your Loan
Lenders may offer you the option to not just finance the car’s purchase price, but also tax, title, license and other charges. A lower out-of-pocket expense today, however, comes at the price of higher monthly payments and more money spent on interest. You should consider paying 15% to 20% as a down payment.
If you owe money on your current car, you may also be tempted to roll your old debt into your new loan. This is often the hidden maneuver behind a dealer’s offer to “pay off what you owe” on your current vehicle.
If you do this, you increase the chances of being “upside down” on your new loan—owing more than it’s worth. You also set yourself up for higher interest expenses and increase the chances you’ll fall into the same expensive cycle when it comes time to move on to your next car or truck.
Just remember: It never hurts to have some financially safe alternatives. If you don’t have to buy a car immediately, you can use the time to save a little money for a bigger down payment. Or, if you can’t wait, think about buying a less expensive car.