Auto Financing - The myths, math, and minutia!
Auto Financing - The myths, math, and minutia!
Last week I went over how to find the best deal on a car. If you need a refresher (or just a jump to the link) it's called: Buying a Car in the Digital Age.
This week I'll cover how to purchase that car using someone else's money.
But first, a couple of caveats and exclusions. You are looking to finance a car using a Simple Interest Loan (not compounding). The loan amount includes taxes, registration, and any and all doc fees minus your down payment. (These should be disclosed before signing any paperwork... or walk out!) and will typically add another $2,000 to the price of the car. Are you looking for a $10,000 car OR a $10,000 loan? A $10,000 car will have a loan amount around $12,000. And a $10,000 loan would be for a car around $8,500. So with those items in mind, on to the Myths of financing a car.
Auto Financing Myths:
Myth 1: The interest rate that the bank quotes is the rate I must pay... you can't fight the system.
WRONG - The system is designed to be fought. It's asking for a fight. Bank/Credit Unions are looking to cover their costs.
Strategy: Negotiate for a better rate! Show that you pay bills on time and that your job is secure (if you do pay your bills on time... you do pay your bills on time, right?)
Effectiveness: Low - Most banks pull "credit" information from the same sources. Showing that you pay your cell phone bill on time has already been taken into consideration before they called you back with the rate. But it does show that you are prepared and that you aren't going into this loan half done.
Myth 2: I bank with my bank so I can't get a loan at any other bank.
WRONG - It is true that you will need to set up a checking account with the bank that is providing (servicing) the loan, but most banks/credit unions require $10 dollars or so to set up the account.
Strategy: Shop around for better rates!
Effectiveness: High - Almost every month there will be a bank or credit union that is offering a sale on auto rates. This is one case where you can literally save by shopping.
Myth 3: The terms that they offer are the best I can hope for.
WRONG - Most banks/credit unions have a "table" that they use to determine the number of months that you can finance the car (terms). This table shows that as the loan amount increases the number of months increases. Hence, the more you finance, the longer you can take to pay it off. The longer you take to pay it off, the lower your monthly payment.
Strategy: If needed, ask for a longer term. Your loan amount may be just below the threshold and they may give you an extra year to pay it off just because you asked.
Effectiveness: Maybe - It just depends on how close your finance amount is to the cut-off limit. All they can say is no. CAUTION: I don't recommend extended terms for used cars. Some of their life-span has already been used.
Myth 4: The monthly payment amount the bank quotes me is the amount I must pay for the loan.
WRONG - Here is where the banks make their money. The thing is, a bank loan is simple. However, the banks want to cover their risk as much as possible so they add extras into the loan. These extras benefit the bank, but you pay the fees.
Strategy: In Auto Financing Maths, I outline how to catch the bank in this small little con. But ask for these extras to be removed from the loan. GAP insurance on a brand new car is the only extra that I recommend you pay for. I call this one a "stupid tax" for buying a new car instead of quality used one.
Effectiveness: High - Asking for the life insurance policy and other "extras" to be deleted from the loan will definitely lower the monthly payment. After all, just a Quarter a day is $7.75 a month, $93 a year.
Auto Financing Maths:
A Simple Interest Loan means that you have a fixed interest rate and a fixed time period to pay the loan off. Calculating a car loan is... simple. If you have a cell phone calculator you can start saving money on your next auto loan.
Your loan is made up of three parts.
The loan amount (Principle)
The interest rate (Rate)
The number of months that you will pay on the loan (Time)
Mathematically, your auto loan is expressed as:
Payment = Principle X (1+Rate) / Time OR I = P X (1 + R) / T
Suppose you were borrowing $9,000 for 36 months at 12% interest.
Pmt = $9,000 X 1.12 / 36
Pmt = $280.00
You will be paying $1,080 in interest PLUS the original $9,000 back over the course of the 36 months for a total of $10,080.00. (9,000 X 1.12)
Auto Financing Minutia:
When the bank calls you back with the loan approval information they are going to supply you with three pieces of information: The interest rate, the term, and the payment.
The thing is... the math wont work. When you take the loan amount, multiply it by 1 plus the provided interest rate, then divide it by the months, the answer will be significantly less (like $50 a month less) than the quote from the bank. Why? Math is math. It should be the same, except the bank has added Extras. See Myth 4.
Extra #1, GAP Insurance: Not needed if the value of your car is greater than the depreciated cost of your car. Typically needed on new cars. Not needed on cars where blue book value is significantly greater than the loan amount. If you are confident that the value of the car is greater than the loan, ask the bank to delete GAP insurance.
Extra # 2, Life Insurance: The bank wants to take out a life insurance policy on you so if you die the insurance company will pay the bank money. This disturbs me on a personal level. I understand there are exceptions to the scenario that I present, also, in the event of your death the car must be paid for. Let's say that your death comes at the hands of an auto accident and that the car is totaled. In this case the auto insurance will issue whoever owns the title (the bank) a check for the blue book value of the car the moment before the accident. The bank would, at this point, be paid for the totaled car. So, what point is there in the bank receiving a double payment for your death through the life insurance policy. Call me cynical but it just seems a bit wrong for the bank to make extra money through my death.
Extra #3, Roadside Assistance: Most auto insurance companies add this into their insurance quote for around $10/ month anyway. So, if you already have Roadside or AAA then you don't need dual or even triple coverage through your loan. Besides, how many people think about their auto loan's roadside assistance when you have a flat tire on the side of the road. Auto Insurance YES... Auto Loan NO.
Extra #4, Dent Insurance: I don't know what to say about this. If its a used car... well then its a USED car. It probably already has a ding or two. Life is life deal with it and move on. Dents are just stories without words... or something like that. Now, if you bought a new car.... See the above. It's a car. Life Happens. Or... pay yet another "stupid tax" for buying a new car.
If you finance through the Dealer expect to find even more or different extras!
Just remember, you don't need to buy extra's that you don't want. If you feel like you really don't want to buy anything except the car, keep telling the financier "NO" until your calculated payment and the banks/credit unions quote match. $15,500 * 1.045 / 60 = $269.96
In the end financing a car is a lot like going to a World Buffet.
There are lots of options; some taste good, some taste bad, but you always have to pay the bill.
Questions:
1. Are you the type of person that would tell a bank "no"? Why?
2. How is getting an auto-loan similar to preparing to run a marathon?
3. How old and how many miles would be on a 3 year old car that you financed for 60 months, if the car had 36,000 miles on it and you added 11,000 per year for the 60 months? Would you keep the car for an additional three years?
Resources:
PowerPoint: Car Loan Experience