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Auto Loans: Shopping around for your best option

Shopping for a car? Chances are, you're doing your homework: You probably will visit several dealerships, test drive a few different models, ask your network of friends and family for advice, and search the web for some ratings, right?

Well, surprisingly, many people spend a great deal of time comparison shopping for the perfect car for their needs, but they fail to do the same thing when it comes to comparison shopping for financing. A car is a significant purchase, and it really can pay - saving you hundreds of dollars - to do a little legwork when it comes to financing that purchase.

Financing Options

Options abound when it comes to financing a car. Here is a list, along with some pros and cons of the various options:

Bank or Credit Union Loan

As difficult as this may be (hey, you want to get out for a test drive!), a very critical step must be taken first: Before you even start to look at actual cars, check out the average auto loan rates in your area and know which banks offer the best rates. The gap between the lowest and highest auto loan rates can easily be two percentage points, so it's definitely worth shopping around. Although a percentage point may not seem like a lot, consider this: it could mean a savings of a few hundred dollars over the life of a typical auto loan.

Once you have identified a lender to work with, be sure to get pre-approved for your loan before you hit the showroom. After all, there is enough work to be done negotiating the best price for your car without having to worry about finance negotiations. Pre-approval will also give you a realistic range of how much car you really can afford before you get tempted by an enthusiastic salesman tempting you with a flashy car beyond your means.

Your minimum down payment will range from 0-25% of your vehicle's purchase price. The average term for auto loans is 4-5 years. Some lenders will even allow you to stretch your loan to up to seven years. Keep in mind the length of time you plan on owning the car, since you definitely don't want to have to keep paying for a car you no longer own – make sure the term of the loan is shorter!

Remember, too, that even though a longer term will drop your monthly payments, it will also increase your total interest costs significantly.

Dealer Financing

Auto dealerships usually offer their own financing arrangements, which many consumers take advantage of simply because it provides the convenience of one-stop shopping.

However, if you choose this option, make sure that you hold off on discussing any financing arrangements until you and the dealer have agreed (in writing) upon a purchase price for the car. For example, if you tell the salesperson what you would like to spend on a monthly car payment, it is easy to get confused by all of the numbers they will throw out at you – something that they do to make you lose sight of the really important figures: how much you're paying for the car and what interest rate you're being charged.

Imagine telling a car dealer that you wanted to pay no more than $200 per month on a car loan, only to later find out that the financing package met that requirement but included a 22% interest rate, versus the going rate at the time of 8.5%!

Home Equity Loan

If you own your own home, consider it as a loan option. Home equity loans and lines of credit allow you to borrow against your home equity, which is the amount of the current value of your home minus the principal owed on your mortgage. Remember, though, that you are putting your house on the line with a home equity loan, which means that missed payments could lead to losing your house.

Leasing

For those who prefer to get a new vehicle every two or three years and who can accept monthly car payments on an ongoing basis, leasing has become an increasingly popular alternative to buying a car on credit. To determine whether leasing may be right for you, consider the following:

The Case FOR Leasing:

  • You just may be able to drive that otherwise-unaffordable dream car, since up front fees are generally no more than $2,000, even for luxury vehicles with sticker prices of $40,000 or more.
  • Monthly payments are often lower than what you would pay under a conventional auto loan.
  • The hassles of selling your car or haggling with a dealer over trade-in value are eliminated.
  • If you use your car for business, you can reap greater tax benefits.

The Case AGAINST Leasing:

  • You don't actually own your car at the end of the lease period. However, depending on the leasing terms you negotiate, you may have the option to buy the car at a pre-set price that ends up being lower than the true market value of the car when the lease ends.
  • Excessive wear and tear and driving the car beyond the mileage limit (generally 20-25,000 km per year) can result in additional costs when you turn in the car at the end of the lease period.
  • If circumstances change and for whatever reason you want to end your lease early, you will be faced with a penalty that could be as high as six months' worth of payments.