Buying a car is a big expense, but you could save money by finding the best financing option that works for you. Here’s some advice to consider before you head to new car dealers.
Choosing the right deal
Broadly speaking, there are five ways to finance the purchase of a car:
- Cash: The cheapest in the long run, because you pay no interest charges. As new cars depreciate immediately, borrowing money to buy one is bad debt. Pay cash, if at all possible.
- Loan: You can borrow the entire amount from a bank or lender. Then you’re in the same position as a cash buyer, but you will pay interest and the car will be used as collateral. A new-car loan is about one or two percent above the prime rate.
- Line of credit: If you have a secured line of credit (your home), you’ll generally pay about a half percent above prime.
- Dealer financing: This is a loan that either comes directly from the dealer or that the dealer obtains for you at a preferred rate from a financial institution that they regularly deal with. It works the same as other loans.
- Leasing: You pay a monthly amount to lease a car from a dealer. At the end of the lease period, you can either purchase the car or return it. What you pay over the term of the lease is calculated by subtracting your deposit and the buy-back value from the car price and then adding interest.
Paying for your car
- Check the details: Look at the annual interest rate and the length of the loan — not just the monthly repayments. Ask for the total — many finance packages turn a $10,000 car into a $12,000 car by the end of the loan.
- Loans vs. leases: With the last loan payment, you own your car, but at the end of the lease, you own nothing. You can drive a more expensive vehicle with a lower payment if you lease, but leasing only makes financial sense for those who wish to drive a new car every few years.
- Don’t be car-poor: Financial experts recommend spending no more than 12 to 15 percent of your after-tax monthly income for car payments.
- Short-term vs. long-term loan: Car loans used to extend for three to four years, but now we’re seeing loan payments stretch to five or six years. This lowers your monthly payment, but it lures you into paying more for a car than you probably should. By the time you’ve paid off the loan, it’s almost fully depreciated.
- Down payments: Try to come with the biggest down payment you can, as you pay interest only on the amount you have to borrow.
These days, there’s almost as many options on how to pay for your car as there are makes and models. But by knowing about all the different payment options, you could get a better deal on the car you want.