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Car Financing and Credit Scores

If you’re not paying cash for your car, you should know your limits and research your options before obtaining a loan.

First, figure out what kind of payment you can afford.  There are many loan calculators on the web that take into account your budget and tell you the sale price you’ll be able to handle.  Try this calculator, for example: http://www.bankrate.com/calculators/auto/auto-loan-calculator.aspx

Then, see where you can get the best deal on a loan. Many experts recommend loan shopping.  Here is a brief description of some available choices.

  • Talk to the people at your bank.  Since you already have a relationship there, they may be able to give you a better interest rate than you would find elsewhere.
  • Credit unions also tend to offer good interest rates, because they have lower operating costs than banks.  You have to be a member of the credit union to get a loan.
  • If you own your home, consider taking out an equity loan and paying cash for the car.

You don’t have to rule out dealership financing.  First, arm yourself with some knowledge about how those loans work.

If you finance through a dealer, it’s not the dealer who’s lending you the money.  The dealer is just the middleman.  Your loan actually comes from a finance company with whom the dealer has a contract.  The finance company pays the dealers commission so they have incentive to sell the loans.  They can also mark up the interest rate of the loan another 2.5%.  So if the interest rate the dealer gets you from the finance company (e.g. Ford Credit) is 6%, the actual rate you pay can be as high as 8.5%.

Another factor affecting the interest rate you end up paying is your credit score.  Lately, these three little digits have been attracting a lot of attention because they have such a powerful effect on how lenders view you.  The higher your credit score, the better the interest rate you can obtain.  In other words, someone with a poor credit score will end up paying a lot more for the same-priced car than someone with a great score.  The person with bad credit has to pay more money in interest due to the higher rate.

If you do have credit problems, one thing to keep in mind is the dealer may not actually verify your credit before letting you drive the car off the lot.  Once the credit is checked – which could be in a couple of weeks – if it turns out your loan is not approved, you have to bring the car back.  That’s pretty demoralizing.

So maintain good habits that will preserve a good credit score or improve a fair one.  If you don’t have good credit, think about saving up to buy a car with cash, or at least making a large down payment to reduce the interest costs.

If you do decide to get financing, remember to determine a reasonable budget ahead of time, shop for the best loan, and keep current on your payments.  That way, everybody wins.

 

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