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Kicking the Tires on an Auto Loan: Don't Kick Yourself for Paying Too Much
Buying a new vehicle is stressful enough without having to make a decision about how to pay for it. Zero-percent financing, rebate offers of thousands of dollars, small down payments, bank financing, dealer financing so many choices are enough to make your head spin even before you've taken your dream purchase out for a spin. FDIC Consumer News offers these tips to help you save time and money when it comes to shopping for an auto loan.
1. Review your credit report long before you intend to apply for a loan. A credit report is a summary of your financial reliability for the most part, your history of paying debts and other bills as compiled by a company called a credit bureau. Why should you see your credit report before applying for a car loan? To correct any error before it slows down your credit approval or prevents you from getting the best possible loan terms. "Erroneous information can cost you hundreds of dollars because you could be disqualified from the best financing terms available," says Joni Creamean, a Senior Consumer Affairs Specialist with the FDIC. "You will be considered a riskier borrower and charged higher rates or be required to provide a larger down payment." Creamean adds that it could take months to correct errors in your credit history.
It's also smart to review your credit report from each of the three major credit bureaus that operate nationwide-Equifax (www.equifax.com), Experian (www.experian.com) and TransUnion (www.transunion.com). Credit report content may vary significantly among the credit bureaus, so that's why experts suggest you request copies from all three companies. The costs of these reports can vary, too. However, beginning December 1, 2004, in western states and moving east with completion scheduled for September 1, 2005, you will be entitled to a free credit report annually under the provisions of the new Fair and Accurate Credit Transactions Act.
2. Shop for a loan before you visit a dealership or bid for a car over the Internet. Contact your bank and several other local lenders. Ask about the loans they offer the number of months for which you can borrow, the interest rates being offered, whether there are penalties if you pay the loan off early, and so on. Ask about other options for financing the car.
For example, some homeowners may want to consider a home equity loan or line of credit instead of a traditional auto loan. "A loan tied to your home may be available with very attractive terms, and with recent gains in the housing markets many folks have some built-up equity available to use for a new car," says Creamean. A home equity loan also may come with tax benefits (but consult your tax advisor). Important to remember is that if you pledge your home as collateral for a loan, and you can't repay, you could lose your home. (For more information, see the new brochure published jointly by the FDIC and nine other federal agencies entitled Putting Your Home on the Loan Line Is Risky Business, available on the FDIC's Web site at www.fdic.gov/consumers/consumer/index.html.)
Janet Kincaid, FDIC Senior Consumer Affairs Officer, points to yet another reason to shop for a loan before you shop for a car: "Knowing what your spending limit is and sticking to it permits you to focus only on the vehicles within that range," she says. "This also helps you avoid taking on more debt than you are comfortable with in the long run."
Also consider getting pre-approved for a loan, meaning a lender evaluates your creditworthiness and explains your loan options and likely costs before you buy a car. "Getting pre-approved doesn't mean you have a loan in hand but it does give you the benefit of knowing what you can afford and what it will cost you in the way of a loan," Kincaid explains. "You'll also know you won't be surprised with news that you've been denied credit or charged a higher rate due to your credit record." (Consumer advocates also suggest that you not tell the dealer if you've been pre-approved elsewhere for a loan until after you've negotiated the best price on a car. Some dealers may be less flexible on the price of the vehicle if it's clear that the dealership won't be earning money on a loan.)
After you know what's available in the marketplace, including the interest rates, consider learning what the dealers are offering by reading their advertisements, making phone calls or checking the Internet. Find out if only certain models are eligible for zero-percent financing from the dealer or if a manufacturer's rebate isn't available if you opt for zero-percent financing. Having this information helps you make a good decision about financing when you're face-to-face with a sales person or finance officer at the dealership. For example, "In some situations, it may be best to accept the dealer's rebate and pass up the zero-percent financing in favor of a loan from a bank that does charge interest," says Creamean. "You'll have to do the math and decide what is best for you."
3. Be careful figuring out how much to borrow and for how long. Of course, the dollar amount of your loan largely will be determined by the sale price of the vehicle minus your down payment, any rebates and the value of any trade-in. But there are other costs that you should consider when deciding how much of a car you can afford and how much of a loan you need. Those costs include auto insurance, sales taxes, annual property taxes on the car (if any), and options you may be inclined to buy, such as an extended warranty. Also remember that every item you add to your loan instead of paying up-front will add to the total cost of the loan because you will be paying interest on the amount financed.
After you determine how big a loan you need, try to pick a repayment period that makes sense for you. For example, a $15,000 loan at 4 percent interest for 36 months equals a monthly payment of $443. Stretch the same loan out to 48 months and the monthly payment drops to $339. While it's tempting to go with a longer loan to reduce your payment, be careful. "Don't make the common mistake of thinking only in terms of monthly payments rather than the total cost of the loan," warns Creamean. "In the end, extending a loan term will cost you more since you will be paying interest on the loan another year or more."
Creamean says to be especially cautious before taking an auto loan term of five years or more. "First," she says, "if you have little cash for a down payment and you have to take on a loan of five or seven years, you might be trying to buy more car than you can really afford. Also, in the later years of the loan, you'll still be making payments on what is an older vehicle that may have a lot of repair and maintenance costs."
Creamean also cautions that, in five or seven years, you may still owe more on the loan than the trade-in value of the car, and that puts you in a difficult financial position. "Just when you need or want a new vehicle," she says, "problems with your old car may require you to come up with extra cash to pay off the old loan or you might have to roll the old loan into a new loan, which may push up your interest rate. It can become a vicious cycle."
4. Know what you are signing and speak up if you think there's a problem. A variety of laws provide consumer protections in the context of auto loans. Among them: the federal Truth in Lending Act, which requires lenders to disclose to borrowers the terms of a loan (including the Annual Percentage Rate and the total cost of the loan), and federal and state laws that prohibit unfair or deceptive business practices. However, you have a responsibility for protecting yourself, too.
"One of the most important things a borrower can do is to carefully review the loan document before signing it, because this is a contract legally binding you to repay according to the terms of the document," says FDIC attorney Mark Mellon. While the Truth in Lending Act gives consumers the right to cancel certain mortgage contracts up to three business days after signing the contract, Mellon says, "there may or may not be a similar protection for your auto loan depending on your circumstances and state law, so it's best to be comfortable with your decision before you sign on the dotted line."
If you have a question or a concern about an auto loan and you can't resolve the matter with the lender or auto dealer directly, contact the appropriate federal regulator - one of the banking agencies listed on For More Information if the situation involves a banking institution, or the Federal Trade Commission (toll-free 877-382-4357 or www.ftc.gov) for a nonbank lender, such as an auto dealer or finance company.
And for more information about how to get a good auto loan, we recommend the FTC Web site at www.ftc.gov/bcp/conline/edcams/automobiles/index.html, including the fact sheet "Understanding Vehicle Financing."
The bottom line: By being better informed about auto loans, we believe you're more likely to drive away happy with extra savings in your bank account that can be used for other things, such as gas money... or fuzzy dice.
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