How to Get Financing Before Buying a Car

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Jan Stromme/The Image Bank/Getty Images Plus

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New cars these days have better safety features and more tech gizmos than models from a decade ago. And let's face it, trading in a beat-up clunker with grimy seats is an enticing idea.

But many Americans make big mistakes buying cars. Take new car purchases with a trade-in. A third of buyers roll over an average of $5,000 in debt from their last car into their new loan. They're paying for a car they don't drive anymore. Ouch! That is not a winning personal finance strategy.

But don't worry — NPR's Life Kit is here to help. Here's how to buy a car without getting over your head in debt or paying more than you have to.

1. Get preapproved for a loan before you set foot in a dealer's lot.

"The single best advice I can give to people is to get preapproved for a car loan from your bank, a credit union or an online lender," says Philip Reed. He's an automotive expert who writes a column for the personal finance site NerdWallet. He also worked undercover at an auto dealership to learn the secrets of the business when he worked for the car-buying site Edmunds.com. So Reed is going to pull back the curtain on the car-buying game.

For one thing, he says, getting a loan from a lender outside the car dealership prompts buyers to think about a crucial question: "How much car can I afford? You want to do that before a salesperson has you falling in love with the limited model with the sunroof and leather seats."

Reed says getting preapproved also reveals any problems with your credit. So before you start car shopping, you might want to build up your credit score or get erroneous information off your credit report.

And shop around for the best interest rate. "People are being charged more for interest rates than they should be based upon their creditworthiness," says John Van Alst, a lawyer with the National Consumer Law Center.

Van Alst says many people don't realize it, but the dealership is allowed to jack up the rate it offers you above what you actually qualify for. With your credit score "you might qualify for an interest rate of 6%," says Van Alst, but the dealership might not tell you that and offer you a 9% rate.

If you take that bad deal, you could pay thousands of dollars more in interest. Van Alst says the dealership and its finance company, "they'll split that extra money."

Reed says having that preapproval can be a valuable card to have in your hand to help you negotiate a better rate.

"The preapproval will act as a bargaining chip," he says. "If you're preapproved at 4.5%, the dealer says, 'Hey, you know, I can get you 3.5. Would you be interested?' And it's a good idea to take it, but make sure all of the terms and conditions, meaning the down payment and the length of the loan, remain the same."

2. Test drive, test drive, test drive.

These days many of us like to research things we buy online. And that's good. But you also need to get your hands off the laptop or smartphone and onto some steering wheels or you'll waste a lot of time researching vehicles that you won't like in the end.

Dianne Whitmire sells cars at a Toyota dealership near Los Angeles. She says she constantly sees people who spend hours and hours online researching a car, finding the best price, all the other information. They call her 10 times. But when they finally show up to drive the car, they say, "I didn't realize this seat was this way. This is not the model I want."

Whitmire says you need to be a bit more old school about things and actually drive a bunch of cars. "I've been doing this for 40 years," she says. "It used to be that people would go to a dealership and drive around and figure out what car they actually wanted, what their choices were."

She suggests driving cars that are within your budget so you aren't seduced by what you can't afford. This means you want to find salespeople who are OK showing you a bunch of cars and not being too pushy or trying to upsell you into a pricier model.

"That person who says, 'What about right now, that car right out there right now? What would it take?'" — repeatedly trying to sell you a car that very day — she says that's probably a sign you've got the wrong salesperson.

One thing you can do in that situation is just tell the salesperson, "Look, I'm not ready to buy a car today. I'm test-driving a few cars, I'm narrowing it down. If you're not comfortable with that maybe there's another salesperson here who can show me a car."

3. Start with the price of the car.

If you're buying a car at a dealership, focus on one thing at a time. And don't tell the salespeople too much. Remember, this is a kind of game. If you're playing cards, you don't hold them up and say, "Hey, everybody, look — I have a pair of queens," right?

So at the dealership, Reed and Van Alst both say, the first step is to start with the price of the vehicle you are buying.

The salesperson at the dealership will often want to know if you're planning to trade in another car and whether you're also looking to get a loan through the dealership. Reed says don't answer those questions! That makes the game too complicated, and you're playing against pros.

If you negotiate a really good purchase price on the car, they might jack up the interest rate to make extra money or lowball you on your trade-in. They can juggle all those factors in their head at once. You don't want to. Keep it simple. One thing at a time.

Once you settle on a price, then you can talk about a trade-in if you have one. But Reed and Van Alst say to do your homework there, too. A little research online can tell you what your trade is worth in ballpark terms.

Reed suggests looking at the free pricing guides at Edmunds.com, Kelley Blue Book and NADA. On Autotrader, you can also see what people in your area are asking for your car model. And, he says, "You can get an actual offer from Carvana.com and also by taking the car to a CarMax, where they will write you a check on the spot."

He and Van Alst say don't be afraid to walk away or buy the car at a good price without the trade-in if you feel the dealership is lowballing you on your old car. You have plenty of other good options these days.

Will Sanders/Stone/Getty Images Plus

Will Sanders/Stone/Getty Images Plus

4. Beware of seven-year car loans.

A third of new car loans are now longer than six years. And that's "a really dangerous trend," says Reed. We have a whole story about why that's the case. In short, a seven-year loan will mean lower monthly payments than a five-year loan. But it will also mean paying a lot more money in interest.

As with other types of loans, you pay a lot more interest than principal in the early years, so you're paying off what you actually owe much more slowly in a seven-year loan. "There's so much interest front-loaded in that," says Whitmire.

Seven-year car loans are financially dangerous because cars depreciate in value the moment you drive off the lot. "You're waging this battle against depreciation because basically you're paying off a loan while the car drops in value," says Reed.

One big risk is that you might need to sell the car well before seven years. You might lose your job, or you have a kid, or a third kid and need a minivan. When you go to sell that car on a seven-year loan, you're likely going to find out that you owe thousands of dollars more than the car is actually worth.

NPR talked to one car buyer who rolled over $17,000 into his next car because he was so upside down on the vehicle — in other words, he owed that much more on the loan than the car was actually worth. So a seven-year car loan: bad idea.

"If a friend asked me," says Whitmire, "I'd say I wouldn't do it."

A lot of people could apparently use this advice. According to industry data, 32% of new car buyers with a trade-in are rolling over about $5,000 in negative equity into their next loan when they buy a new car.

A better way to go, Reed says, is a five-year loan for a new car, and "with a used car you should really finance it for only three years, which is 36 months." One reason that makes sense, he says, is that if your used car breaks down and isn't worth fixing — say the transmission totally goes — you're more likely to have paid off the loan by that time.

Reed says a five-year loan makes sense for new cars because "that's been the traditional way — it's kind of a sweet spot. The payments aren't too high. You know the car will still be in good condition. There will still be value in the car at the end of the five years."

5. Don't buy any add-ons at the dealership.

If you've bought a car, you know how this works. You've been at the dealership for hours, you're tired, you've settled on a price, you've haggled over the trade-in — then you get handed off to the finance manager.

"You're led to this back office. They'll often refer to it as the box," says Van Alst. This is where the dealership will try to sell you extended warranties, tire protection plans, paint protection plans, something called gap insurance. Dealerships make a lot of money on this stuff. And Van Alst says it's often very overpriced and most people have no idea how to figure out a fair price.

"Is this add-on, you know, being marked up 300%? You don't really know any of that," Van Alst says. He and Reed say a good strategy, especially with a new car, is to just say no — to everything. He says especially with longer-term loans, there's more wiggle room for dealers to try to sell you the extras. The finance person might try to tell you, "It's only a little more money per month." But that money adds up.

"Concerning the extended factory warranty, you can always buy it later," says Reed. "So if you're buying a new car, you can buy it in three years from now, just before it goes out of warranty." At that point, if you want the extended warranty, he says, you should call several dealerships and ask for the best price each can offer.

That way, he says, you're not rolling the cost into your car loan and paying interest on a service you wouldn't even use for three years because you're still covered by the new car's warranty.

Gap insurance promises to cover any gap between the purchase price of replacing your almost-new car with a brand-new car if your regular insurance doesn't pay for full replacement if your car gets totaled. Van Alst says gap insurance is often overpriced and is fundamentally problematic. If you still want the product, it's best to obtain it through your regular insurance company, not the dealer.

6. Don't buy too much car. And consider a used car to save a lot of money.

"The golden rule is that all of your car expenses should really be no more than 20% of your take-home pay," says Reed. And he says that that's total car expenses, including insurance, gas and repairs. "So the car payment itself should be between 10 and 15%."

And if a new car with a five-year loan doesn't fit into your budget, you might decide you don't really need a brand-new car.

"We're actually living in a golden age of used cars," says Reed. "I mean, the reliability of used cars is remarkable these days." He says there is an endless river of cars coming off three-year leases that are in very good shape. And even cars that are older than that are definitely worth considering.

"You know, people are buying good used cars at a hundred-thousand miles and driving them for another hundred-thousand miles," says Reed. "So I'm a big fan of buying a used car as a way to save money."

He acknowledges that which car you buy matters. It's a good idea to read reviews and ratings about which brands and models are more or less likely to run into costly repair problems down the road. He says some European cars are famously expensive to maintain.

NPR has a personal finance Facebook group called Your Money and Your Life. And we asked group members about car buying. Many said they were shocked by how much money some other people in the group said they were spending on cars.

Patricia and Dean Raeker from Minneapolis wrote, "40 years of owning vehicles and our total transportation purchases don't even add up to the cost of one of the financed ones these folks are talking about."

Dean is a freelance AV technician, and Patricia is a flight attendant. They say, "our nicest, newest purchase was a 2004 Honda Accord for $2,400, bought last year, that with regular maintenance could likely last another 100,000+ miles." And they say they "can't understand those who insist on driving their retirement funds away."

Even if you buy a slightly newer used car than the Raekers', the couple raises a great point. What else could you be spending that car payment money on? And if you can cut in half what you might otherwise spend, that's a lot of extra money for your retirement account, your kids' college fund or whatever else you'd rather be doing with that money.

We'd love to hear from you — if you've got a good life hack, leave us a voicemail at 202-216-9823 or email us at LifeKit@npr.org . Your tip could appear in an upcoming episode.

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The audio portion of this story was produced by Sylvie Douglis.

How to Get Financing Before Buying a Car

Source: https://www.npr.org/2020/02/14/806073375/how-to-buy-a-car-without-being-taken-for-a-ride#:~:text=Get%20preapproved%20for%20a%20loan,the%20personal%20finance%20site%20NerdWallet.

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