Whether you’re getting a car loan or using a personal loan to pay off your car, the process of choosing the best financing can be confusing at best. If you’re not careful, you could end up spending a lot more than you should on your next car loan.
Before you take out a loan to pay for your next car, here are some common financing mistakes to avoid.
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1. Having too expensive or unnecessary collateral in your loan
If you buy a used car, chances are it is no longer under warranty. This means that if you have any issues with your car that need to be fixed, you will likely end up paying for them out of pocket. For this reason, most car dealers will try to sell you a dealer warranty or extended warranty that will cover the cost of some repairs and often routine maintenance as well.
This isn’t necessarily a bad deal, but in most cases a dealer will try to sell you a warranty that is worth hundreds, if not thousands, of dollars. They might even try to sell you a warranty that only covers a limited list of issues that you are unlikely to encounter. If you take out a loan, they will often offer to shift the cost of the collateral into your loan, which can add thousands of dollars to your overall loan.
In many cases, extended warranties on used cars are not worth it. That being said, you might like the peace of mind that if you are having serious and costly issues, they will be covered by your warranty. Do some math beforehand to determine how much you plan to spend on repairs and maintenance and compare it with the price of any dealer warranty offered to you, and make sure you know exactly what is covered by that warranty. You can usually negotiate the cost of a warranty a bit, but don’t force yourself to buy one unless you’re sure it’s what you want.
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2. Being upside down on your car loan
Being upside down on a car loan means you owe more on your loan than the value of your car. Cars lose value quickly, to the tune of hundreds of dollars every month. If you pay off all or most of the car with a loan, rather than making a down payment, you may end up owing $ 18,000 when your car is only worth $ 15,000.
This is not necessarily a problem other than that you will be paying off this loan for a while. However, if you were to have an accident and total your car, your auto insurance would only cover the current value of the car. If your car is worth $ 15,000 and you still owe $ 18,000 on your loan, you will end up paying $ 3,000 out of pocket for a car you can no longer drive.
To avoid this error, make a larger deposit. Shortening your loan term can also help – while it increases your monthly payments, it also means you pay off your loan quickly.
Be sure to check out this guide to types of auto insurance coverage to help you determine the amount of auto insurance that’s right for you.
3. Accept dealer financing without being pre-approved elsewhere
Getting the best low interest car loan can save you hundreds of dollars a year in interest. To do this, you’ll want to shop around and compare rates from a variety of lenders.
While it is convenient to take financing from the dealership, you will get a better deal by applying for pre-approval from various banks and credit unions before you start buying a car. It will also give you a better idea of how much you can borrow and what rates you qualify for, which will help you budget. In addition, these institutions could offer you a better deal than a car dealership.
4. Take the rate from your bank or credit union without asking if your broker can beat it
Once you’ve received pre-approval from a few different institutions, you can print out your pre-approval letters and take them to the dealership with you. Asking the dealer if they can beat the rates you have already been offered can also save you a lot of money.
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Some people prefer to go to their bank or credit union rather than financing from a dealership. You might think it’s easier or safer than going with what your car dealership offers. However, in most cases, it is better to go with the one who can offer you the best loan. Getting the lowest possible interest rate should be your top priority, but also make sure you can get a loan term that’s comfortable for you. And avoid loans that charge a prepayment fee if you pay off the loan early.
5. Choose the wrong loan term
Auto loans usually have loan terms ranging from 24 months to 72 months. You might be tempted to get the longest loan term because it lowers your monthly payments. However, extending your loan for a long time means paying more interest. It can also mean finding yourself upside down on your loan if you pay it back more slowly than your car’s value depreciates.
On the other hand, choosing a short-term loan means larger monthly payments. If you find them difficult to pay off, you could end up with a missing monthly payment, which can cause you to take on more debt and hurt your credit. A slightly longer loan term with lower monthly payments will give your budget a little more leeway.
You can always pay off your loan early. It’s a good idea to keep your loan term as short as possible, but you can opt for a term that leaves you with less monthly payments than you can actually afford to give you some flexibility.