According to statistics released by the Federal Reserve, the average car loan is nearly $28,000. Buying a car involves a considerable amount of money, and is oftentimes the second largest purchase decision made by households. The ability to understand and analyze the available financing options is critically important.
In this article, we're going to discuss the basics of car financing; which will include comparison shopping, how to buy a car on credit, financing terminology, as well as questions to ask lenders before making a decision. Finally, we're going to finish with several examples, demonstrating how to analyze the cost of a new car loan. We'll also provide links to online tools, which can be used to perform this comparison.
With slumping sales of new cars, automobile manufacturers continue to invent new ways to lure potential customers to their showroom floors. While low monthly payments, no money down bargains, and zero percent financing all sound like great deals, consumers should be able to make fair comparisons.
Before running out to buy a car, there are three very important factors an informed consumer should know:
A new car loan will only add to the financial burden of households that aren't saving a lot of money each month. Before buying a car, it's worth the effort to create a household budget. Going through this process allows buyers to gain a better understanding of what "affordable" really means. A good rule of thumb is a car payment should be no more than 20% of a household's disposable income. That's the money left over after paying for living expenses, a mortgage, monthly utility bills, and credit card payments.
Prices of new cars can be found on websites such as CarsDirect.com, Edmunds.com or Kelley Blue Book. These websites will not only allow users to research prices, but also figure out how much their existing car is worth if it's going to be traded in as part of the purchase arrangement.
When it comes to car loans, it often pays to shop around. Typical choices include credit unions, local banks, and automobile dealerships. Finding a lender that provides a pre-qualification or pre-approval process allows the consumer to negotiate from a stronger position with car dealerships.
When comparison shopping for a loan, make sure there is a clear understanding of the assumptions used by the lender. Down payments, interest rates, term or length of the loan, are all important factors to consider when comparing offers. Don't be intimidated or afraid to ask a lender for information that's vital to understanding the terms and conditions of the loan.
There are several important terms to understand before buying a car and arranging for its financing. The following language will typically appear either as terms and conditions on a loan, or will be part of the loan origination process.
By discussing the above information with a lender, and asking questions about each factor, a consumer can be assured of getting the best possible deal.
Earlier we promised to demonstrate how an educated consumer can make a good choice when buying a car. We're going to do that by using some of the online car loan calculators we've made available on this website.
At one time, Ford offered the following two deals on their Ford F150 truck line. Consumers had the choice of zero percent financing for up to 60 months, or a cash rebate of $3,545. So what is the best deal? We're going to use our simple auto loan calculator to help answer this question.
Statistically, the typical new car loan is for around 90% of the purchase price of the vehicle. Let's assume this consumer is buying a mid-range truck selling for $24,000, which means they're financing around $22,000.
Amount Financed: $22,000
Monthly Payments: $366.67
Interest Paid (0%): $0
Total Payments: $22,000
Amount Financed: $22,000 - $3,545 = $18,455
Monthly Payments: $356.79
Interest Paid (6.0%): $2,952.21
Total Payments: $21,407.21
This example demonstrates why it's so important to understand financing basics when buying a car. Even though zero percent financing sounds attractive, the cash rebate offers more savings in the long run. In this example, the buyer would save nearly $600 by taking the cash rebate offer.
In this next example, Cadillac is running a similar deal on their STS model line. But this time the deal was a bit more complex, offering the consumer a choice of $1,550 in cash rebates with a 0% APR, 60 month loan or $2,450 in cash back with a 5.9% APR loan. The STS Sedan cost, at that time, was around $55,000. Once again, we're going to assume 90% financing, which works out to just about $50,000.
Amount Financed: $50,000 - $1,550 = $48,450
Monthly Payments: $807.50
Interest Paid: $0
Total Payments: $48,450
Amount Financed: $50,000 - $2,450 = $47,550
Monthly Payments: $917.07
Interest Paid: $7,473.92
Total Payments: $55,023.92
In this second example, the importance of understanding the concepts behind car loans and how to make intelligent choices is clear. The difference between these offers is over $6,570 during the five year life of the loan.
Understanding the calculations behind these two examples, along with the online tools offered, will help consumers to make a more informed decision. It's obviously possible to save thousands of dollars by making an informed choice when buying and financing a new car.
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