Auto Financing 101: A Guide for First-Time Car Buyers

Cars are major purchases, and take a backseat only to homes as far as most-expensive buys.

A report by the National Automotive Dealers Association found that 1.5 million new cars were sold in December 2014, up 10.7 percent from November. While auto loan rates saw a temporary spike in mid-December, they are still at historic lows.

The average new car loan rate as of January 14 is 4.07 percent on a 60-month loan, and 5.02 percent on a 48-month used car loan, according to Bankrate. WalletHub.com data shows the average rate was 7 percent just five years ago. Gas prices may also be a factor in the surge, with the price per gallon lower than it’s been since mid-2008.

Despite national numbers, the rate and price you get on a car purchase will depend on several individual factors. The following tips will help put you in position to get the best terms on the car of your dreams.

Assess Your Financial Situation

Financial advice blog Interest.com has the simplest formula to determine whether you should be considering a new car purchase — the 20/4/10 rule. The down payment should be at least 20 percent, the loan terms should not exceed four years and the total monthly costs (including payment and insurance) should not exceed 10 percent of your gross monthly income.

Some dealerships offer auto loans with no money down, but you should avoid these. A new car depreciates in value almost 10 percent as soon as it’s driven off the lot, and another 10 percent after one year, according to Edmunds. By placing 20 percent down, you are essentially staying one year ahead on anticipated depreciation. You will also put yourself in position for the best terms because of the equity the down payment represents.

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Credit Issue

A $20,000 loan at 5 percent interest will ultimately cost $22,108 after 48 months. That same loan would cost only $20,827 after 48 months at 2 percent interest. The only way to get a better rate is to improve your credit score.

The two most important parts of your FICO score (which accounts for 65 percent of the aggregate) are payment history and the amounts owed on open accounts. The more credit card accounts you have at or near the limit, the lower your score will be. It makes more financial sense to pay down credit card balances before applying for an auto loan. Pay down the oldest accounts first, as length of credit accounts for another 15 percent of your score.

A clever way to free up extra funds to pay off credit cards is to add more exemptions to your W4 form at work. This will cause the federal and state governments (where applicable) to withhold less money from your paycheck, though you may have a tax bill, rather than a refund, at the end of the year. The idea is to do this for a few months at the beginning of the year, then change exemptions again in the summer or fall to make up the difference. You could easily increase your credit score by 150-plus points in a year simply by paying off and paying down credit cards.

New or Used

The advantages of buying a brand-new car are that you’ll be the first person to drive it and it will be covered by a full warranty. Used cars save you a lot of money (particularly with that aforementioned depreciation) and also provide more room for negotiation. Unfortunately some of the cliches about used car salesmen ring true, so some precautions should be taken.

E-learning website Driving-Tests.org recommends buying only certified used vehicles. But keep in mind there are two types of certification: dealer- and manufacturer-certified. The primary difference is that manufacturer certification means all dealerships of that brand must honor it, whereas the other is dealer-specific. Both usually come with some kind of extended warranty, but what they cover varies. Make certain to read the fine print before paying the premium for a certified used vehicle. It’s also is worth it to pay $40 for a Carfax or Autocheck report on the car’s VIN number.

About the Author: Brian Wilkins is an Arizona State University journalism grad who has worked as a radio broadcaster and banking industry professional. He is an independent journalist, blogger and small business owner who loves life. He lives off the grid and has not owned a TV in more than six years.

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