Just because you've figured out what you can afford, it doesn't mean lenders will agree. That's where your credit report comes in. Lenders decide how much you can borrow by looking at your credit report. It's nothing personal. They don't care what you look like or what you think about the status of your personal finances. They only care about the numbers that appear on your credit report.
The credit report will tell them your credit worthiness (how well have you paid past debts?), financial means (do you have sufficient income to repay a loan?) and debt load (do you have too much debt to be able to take on more?).
Many lenders will pre-approve a certain loan amount based on your income and credit history. You'll know exactly how much you can borrow for a car and be able to use your pre-approval amount as a bargaining chip with car dealerships.
- Dealer Finance The big advantage of dealer financing is convenience. You buy and finance the car at the same time. But if the dealer is just reselling a bank loan to make a profit, the rates won't be the best. Occasionally dealers offer special rates to get rid of overstock, especially at the end of a model year. So make sure you ask them about financing and compare their offer to your prearranged financing.
- Banks You can usually get a lower interest rate at a bank than a dealership, especially if you are an existing bank customer. They'll probably require a 10% to 20% deposit to cover the depreciation of the car in case you default on your loan and they need to repossess it.
- Credit Unions Credit unions have lower overhead costs than banks, which can allow them to offer less expensive financing.
- The Internet As with everything else these days, you can shop for car loans on the Internet. You miss out on any kind of personal relationship, but you can get quick approval and very competitive pricing.
- Trade-In You can trade in your old car for a discount when you buy a new vehicle. If it's worth enough, you may be able to use it as a deposit. Trade-ins are a convenient way to use the car you already own to help purchase a new one.
The value of a new car drops dramatically as soon as you drive it out of the dealership. That's because it then becomes a used car. It doesn't matter that you only used it for five minutes - it's still used and is worth much less because of that.
This depreciation is an important concept to understand when dealing with financing because while the value of your car drops immediately, your loan principal drops more gradually. So if you try to sell the car too soon, you may end up owing more on it than you can sell it for. That's called negative equity.
You can avoid getting into negative equity situations by following these simple rules:
- Keep your car until it is paid off completely. Obviously, no matter how much your car depreciates, you won't have negative equity if you don't owe anything.
- Don't buy a car that is too expensive. If you struggle too much to make the loan repayments, you may decide to sell the car earlier than is financially prudent.
- Don't drag out your payments. You might get a slightly better interest rate and your monthly payment will be smaller. But it will staple you to that car for the financing term. Five years later you'll still be paying for a car that may no longer fit your needs.
- Make the biggest down payment you can. This will help offset the effect of depreciation and start giving you some positive equity.