5 mistakes that can lead to a bad car loan

0

AIf we need more bad news about buying a car, a Consumer Reports analysis shows that many Americans are grossly overpaying on their auto loans. And we can’t blame it all on the pandemic or the supply chain issues.

In one case, Consumer Reports found that a Maryland resident with “sterling credit” who bought a new 2018 Toyota Camry two years ago will end up paying $59,000 by the end of the loan. The reason: Their interest rate was raised to 19% when they actually qualified for 4.5%.

The Consumer Reports study, which looked at 858,000 auto loans, found that bad auto loans, rising car costs and other factors pushed the average monthly car payment to about $600, a increase of nearly 25% over the past 10 years.

With a little education and free online tools, like a car payment calculator, you can set up a loan that fits your budget and avoid some common car loan pitfalls.

1. Extend the term of the loan

The term is the number of months it takes to repay the loan. The longer the term, the lower the monthly payments. However, the longer you take to repay a loan, the more interest you will pay.

For example, if someone with a credit score of around 600 buys a car for $30,000 and finances it for 60 months at 6.61%, they will pay $5,311 in interest. But if that loan is extended to 80 months, they will pay $7,175 in interest. That’s $1,864 more up in smoke.

And here’s another reason not to extend the loan: 80 months is almost seven years, and a seven-year-old car will likely need more repairs and maintenance. You will need to cover these expenses in addition to your car payments.

2. Don’t shop around for your loan

Before shopping for a car, you really should shop for a loan. I know it doesn’t sound like fun, but it saves you money and might even prevent your car from being repossessed.

Start by checking your credit and fixing any problems you discover. Then apply for a pre-approved auto loan from a credit union or online lender. By doing this in advance, you can choose the down payment and loan term to suit your budget.

Obtaining pre-approval also simplifies the negotiation process, as it allows you to focus on the initial price. You can always take dealer financing if the interest rate is lower. But your pre-approved loan will be used as a bargaining chip to get its best rate.

3. Being “upside down” on a car loan

You are upside down on a car loan when you owe more than the value of the car. Why is it a problem? Well, if you experience an unexpected life change – a divorce, death, or illness in the family – and you have to sell the car, you’ll have to repay the loan, plus the negative equity.

On the other hand, if you have equity in your car, you can use it as a down payment on your next car. Or just sell it, pay off the loan and pocket the difference.

4. Incorporate negative equity into the new loan

If someone is upside down on a car loan, but just has to buy that new car, the dealership will happily roll over the negative equity onto the next loan. This way, someone who has $10,000 upside down on a car loan can buy a $30,000 car and end up with a $40,000 loan.

There is no good reason to build negative equity into a new loan. This can lead to spiraling debt as you try to keep up with payments. Instead, keep driving your current car and try to make additional payments until you get to the spot.

5. Buy extras

Sometimes that car you agreed to buy has dealer-installed options that aren’t on the sticker. These can be mud flaps, running boards, fancy wheels, door guards or anti-theft devices. If that’s not enough, the CFO can offer you an extended warranty, wheel and tire warranty, or prepaid maintenance plan.

All of these extras go into your balance on the sales contract and result in a much larger loan to repay. The best strategy is to eliminate these extras early in the negotiation process. I like to ask for a price at the door with a breakdown of all costs and fees.

Best practices in auto credit

Here are several ways to keep control of your auto credit:

  • Use an auto loan payment calculator to estimate your monthly payment. Try using different terms and down payment amounts to see what works best for your budget.
  • Be realistic about the monthly payment you can afford and look for a loan that meets these criteria.
  • Getting pre-approved for a car loan is perhaps the best way to stay in control of your car buying transaction.
  • Get as little out of debt as possible by saving for a down payment of at least 20% of the purchase price. This will save you from being upside down.
  • If you can’t afford the new car you want, consider buying a used car or consider leasing a car.

More from NerdWallet

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Share.

About Author

Comments are closed.