Saving on Auto Finance Costs

dad with car keys and son
May 2019

With most car purchases, the biggest contributor to the total cost of ownership is the financing, especially if you consider the fact that a car is a depreciating asset and has a finite useful life. So, if you want to keep your total cost of ownership to a minimum, you need to find the least expensive way to pay for your car. Cash would be best, of course, but if you have to finance - and most people do - it's important to thoroughly understand the ins-and-outs of auto financing, what to look for, and what to avoid.

Go Big on Your Down Payment

The biggest mistake people make when buying a car is to try to finance it with as small of a down payment as possible. First, if you don't have the money for a sizable down payment, then you're probably not financially prepared to buy a car. Second, with a minimal down payment and the speed at which new cars depreciate, you are very likely to be upside down in your car the minute you drive it off the lot. It's far less expensive to save for a few extra months to accumulate a bigger down payment than it is to finance the difference over the period of five years. What's a sizable down payment? As big as you can possibly muster; but, it should be no less than 20 percent.

Avoid Auto Dealer Financing

If there was just one key piece of advice car buyers need to heed it would be don't succumb to dealer financing. Car dealers have crunched the numbers in such a way that, whether you are offered zero percent financing, or a cash rebate, they will always come out way ahead. Nothing puts you into a better bargaining position than cash. Before walking onto the car lot, be sure to have your cash already lined up.

Go to the bank

Banks are still the best source of auto financing, offering competitive loan rates and terms. As with any type of financing, the better your credit standing is, then the better your terms will be. In many cases, you can secure an auto loan the same day you apply.

Tap your equity

Some financial planners will question the wisdom of borrowing from your home's equity for purchasing a depreciating asset such as a car. But if you simply consider the dollars and cents, a home equity line of credit will usually provide much cheaper access to money for a car purchase. Presently, HELOC rates are generally lower than auto financing rates. Plus, the interest expense of a HELOC may be tax deductible (always seek the guidance of a tax professional on such issues). The downside of a HELOC is that it's a variable rate and the possibility exists that it could increase.

Additionally, because HELOCs usually only require interest payments, there is the temptation to simply pay the minimum interest instead of paying down the portion of debt attributable to the car. A HELOC really only makes sense if you have the discipline to pay down the auto debt within a three-year period. Otherwise it could end up costing you as much or more than any other financing method.

Never Charge Your Down Payment to Your Credit Card

Unless you absolutely, positively plan on paying it off immediately, putting a car down payment or even a mortgage down payment on a credit card completely goes against the purpose of the down payment, which is to increase the equity of your asset. With a car, it's a depreciating asset, so you are likely to be upside-down in your equity the minute you drive off the lot. And, if you don't have the down payment available in cash, it's just foolish to charge it. The car will wind up costing you much more than you anticipated which could put you in a deep hole for a long-time to come.

Watch Out for Car Financing Scams

If you are unable to qualify for an auto loan through regular channels, you definitely should avoid any type of financing schemes that smells like the following:
  • Loan/Lease Payoff Offer: This is a very common offer made by dealers of all types. They will pay off your loan or lease "no matter how much you owe." At first blush it seems like a very generous offer; however, it is nothing more than a manipulation of the numbers that makes it appear that your current loan disappears. In reality they have simply rolled your loan balance into a new loan. Because the new loan is amortized over five or six years, it's hard to notice; however, in most cases, buyers drive off the lot already upside down in their new car loan.
  • Yo-Yo Loans: You can be victimized by this scam even with a "legitimate" car dealer. It generally targets people with poor to fair credit who are most likely to accept whatever terms a dealer is willing to give them. When a deal has been made on a car purchase, the finance person sees that your credit is questionable; yet, you are still allowed to drive off the lot with the car. Why? Because he knows that the final terms of the purchase are not final until the loan is approved, and he has your down payment and/or trade-in. A couple of days later you receive a call from the dealer telling you that your loan application was declined and you are asked to either return the car or sign a new loan document with less favorable terms, i.e. higher interest rate. If you choose to return the car, chances are you won't get back your down payment or your trade-in.
  • Buy Here, Pay Here Dealers: These dealers know that their buyer prospects can't otherwise qualify for a car loan, so, they entice them with easy financing. In doing so, they also mark up their prices significantly. In most cases, the dealer requires that the payments be delivered to the lot each month, and, because nearly a third of these buyers can't maintain the stiff payments, the dealer profits even further by repossessing the car and reselling it.
For most people, buying a car is the second biggest purchase they will make in their lives, which is why it is so important to keep the cost of ownership down as much as possible. If you have to finance your purchase, every effort should be made to understand how auto financing works as well as the pitfalls that can turn your car buying experience into a financial nightmare.