So you need a car. And you’re thinking of applying for a loan. You’re not the only one. 85% of new car buyers and 53% of used car buyers took a car loan in the third quarter of 2018 alone. A large number of them, it’s safe to assume, made some critical mistakes that were easily avoidable. Here’s how you can make sure the same thing doesn’t happen to you.
1. Applying for a loan without checking your credit score
Your credit score is a three digit number that reflects your credit history. It basically acts as your financial resume and the better your score, the easier it is to get a loan. Make sure you know your credit score before applying for a loan because if it’s low, there are steps you can take to improve it – making you eligible for a loan with more favourable terms and conditions. Most people don’t know what their credit score is and there are some dealers that try to take advantage of this. They lie about the person’s credit score and set them up with a high interest rate loan. Knowing what your credit score is, will help protect you from this scam.
2. Not fixing your budget in advance
Many people tend to look at the cars they want, do a rough calculation on whether they can afford them and then finalize the deal. Don’t do that because dealers and loan-providers often make payment options seem more favourable than they really are. In the long run, that often leads to missed payments, car repossession and the death of credit scores. Instead, figure out your financing options in advance (we’ll talk about it a little more below) and stick to a strict budget that takes into account both short-term and long-term financial considerations.
3. Not exploring different financing options
Shopping around ahead of time is the best thing you can do. First of all, it will help you discover the loan amount you’re eligible for and what your payments will be. Knowing this will help you with fixing your budget. It will also help you figure out what interest rate you should be paying. Secondly, it will help set you up to save even more. Dealers tend to offer a better rate than the one you show them to win you over. But if the loan-term they offer is longer, it will increase your total payments. Another thing to keep in mind is even a small increase in interest rate will lead to a large increase in your total payments.
4. Not paying attention to the term of the loan
The term of the loan (also called the length of the loan) is a very important aspect of car financing and also, one of the most overlooked ones. There is one rule you must always remember. The longer the term, the more total interest you’ll pay. Dealers often extend the length of the loan to give their customers lower monthly payment options. But if you choose this option, you will definitely end up paying more over time.
5. Focusing on monthly payments
Another common and dangerous mistake. Don’t make it the primary consideration when you’re choosing an offer. The dealers you meet will probably want you to because it helps them sneak in higher interest rates and added costs while keeping your monthly payments deceptively low. Instead, negotiate for the price of the car and the interest rate on the loan separately. Second, make sure your loan term is as short as possible – ideally, it should be 36 months but never longer than 60 months.
6. Ignoring early payoff penalties
You’d think a lender would be happy to get their money back sooner than expected, wouldn’t you? But it means they get less money in the long run which is why many of them have penalties for early payoffs in place. There are two scenarios you need to watch out for. Let’s say you have enough money saved up to buy your car in cash but you apply for a loan in order to get a promotional rebate. Your plan is presumably to pay off the loan immediately but what might end up happening is your rebate will be offset by the early payoff penalty. And if the penalty is more than the rebate, you’ll end up losing money. The second scenario to watch out for is one where you find yourself deciding to sell your car before the loan term ends. You might have to pay a penalty for this. Unfortunately, people usually don’t realize these disadvantages when making their decision or financial plan. So research, research, research. All the advertising in the world cannot fool someone who’s truly educated.