If you’re like most people, paying cash to buy a new car just isn’t in the realm of possibility. And even if it’s in the realm, you may not want to deplete your savings account to buy a new vehicle. This means that you’re either going to be leasing the car, or buying the car by financing it. If you’re buying, then you’re probably financing it through the dealership, a bank or credit union, an online financial institute, or maybe even a family member.
While leasing is good for a lot of situations, it’s a whole other animal, so in this article, we’re focusing on financing. If you know you want to finance your car rather than pay cash, then you need to do your homework and decide how to get the best financing deal.
If you do have the money to pay cash for your car and are considering doing it, how do you know if it’s really the right thing to do? Here are some instances when paying cash really is in your best interest.
- If you could pay more interest by financing that amount of money than you could earn if you invested it or kept it in a savings account of some sort
- If you don’t have a very good credit rating and would have to pay a high interest rate to finance (more on this later)
- If you have a lot of debt already but enough cash on hand, and don’t want to further damage your credit rating
But if you’re like many people, you probably need to finance your car. So in the next section, we’ll look at the pros and cons of financing resources and find out how to determine the best rate.
Sources of Financing
There are several different ways that you can finance your car, and there are pros and cons about each of them.
Pros: Convenient, fast, sometimes competitive
Cons: High pressure, usually not competitive; be prepared for a big sales push on add-ons; loans are often front-loaded (payments are made up of more interest in the beginning of the loan than toward the end — that’s bad if you think you may be paying the loan off early.)
Bank or credit union
Pros: Competitive rates, personal service, no sales pitch for add-ons; often can tell you if you’re paying too much for a car; often provide free life insurance or disability insurance with loans; loans are usually simple interest loans (interest spread evenly throughout the term of the loan)
Cons: Not as convenient as dealership financing — can’t set it up at night or on the weekend
Online financial institution
Pros: Usually competitive rates, quick, easy
Cons: Not a personal service; dealing with an unknown; some scams to watch out for
Home equity loan:
Pros: You can deduct some of the interest from your taxes; competitive rates
Cons: You’re tying your car to your home (may be risky)
Family member or friend
Pros: Personal service, easy, sometimes flexible; usually competitive rates
Cons: Could jeopardize a relationship
Determining the Rate
The interest rate you get when financing a new or used car can vary quite a bit from the advertised rates you see on TV or read in the paper. Probably the biggest influence on your rate is your credit rating (see How Credit Scores Work to get the full story). Your credit history and credit score tell lenders a lot about your money habits and are designed to give them an idea of what their risk is if they loan you money. They often raise the interest rate if your loan is seen as high-risk.
Another thing that affects the rate you get is the length (term) of the loan. Typically, the shorter the loan, the lower the rate. Keep in mind that the shorter the term, the higher your payments will be.
Used cars will have higher rates than new cars. The newer the car, the lower the rate. (You may find an exception to this rule at some credit unions. Some give the same interest rate for new and used cars.)
Your geographic location can also be a factor in the rate you get. Your cousin may have gotten 7 percent on the other side of the country, but in your home town, 8.5 percent may be the lowest rate you can find.
While these are the usual things that affect the rate you get through a bank or other financial institution, financing through the dealership may or may not actually work this way. Find out why in the next section.