If you buy a car from a dealer, the seller might ask you to speak to someone at the Department of Finance and Insurance (F&I) or the business office. This is the dealership office that offers loans and ancillary services to customers after they agree to purchase a vehicle from the dealership.
The F&I department may ask if you want to buy other things like an extended warranty, vehicle service contract, credit insurance, or Guaranteed Auto Protection (GAP) insurance. Before you decide to buy any of these products, think about your needs and what it will cost. If you decide to finance ancillary services as part of your loan, this will increase the loan amount. You’ll pay more interest on the loan because you’ll be financing more money over the term of the loan. Remember, the dealer is not the sole supplier of most of these products. If you decide you do want one of these products, shop around until you find the best price.
You don’t have to finance your auto loan through the dealer, and you should also find out if you can get better interest rates through a bank, credit union, or other lender that you can contact other than the dealer.
How should I decide on how much to borrow in a car loan?
It can be very useful to divide the process into several steps. For example:
Assess your financial situation by creating a monthly budget.
Here you will find a budget spreadsheet and some information on how to make a budget. You can use this information as you think about how much you can borrow to buy a vehicle. If you’re not sure how to do this, ask a nonprofit credit counselor for help.
First, add up all of your fixed expenses (these include: rent/mortgage, utilities, phone, and other recurring monthly bills, amounts you save each month, child support payments, insurance premiums, and utility bills) of existing loans, including outstanding credit card payments).
Second, estimate your estimated out-of-pocket expenses for food, fuel, entertainment, emergencies and unexpected expenses, and anything else that isn’t a fixed monthly expense.
Third, if you didn’t have a vehicle before, don’t forget that you’ll also have to pay for vehicle insurance, maintenance, and registration. Shop around for car insurance before you buy a vehicle to get an idea of how it might affect your budget. If you go from a used vehicle to a new one, the price of insurance may be higher.
Fourth, if you’re trading in a vehicle but still owe money on it, be sure to find out how much you owe on that loan. If what you owe is more than the value of the vehicle you want to trade in or if it is more than the amount you can get through private sale, you will need to consider how you are going to pay that amount. The loan amount, monthly payment, and total interest cost will be higher if the old debt is included in the new vehicle loan.
Now, subtract all expenses from your take-home pay and any other income you regularly receive each month. Your car loan payment will need to be less than the amount you have left.
Check your credit history.
One of the first things you should do before applying for a car loan is to review your credit report at one or all of the major credit reporting agencies: Equifax, Experian, and TransUnion. You are entitled to a free copy of your credit report from each of these bureaus every 12 months, and you can request the free report at www.annualcreditreport.com or by calling (877) 322-8228.
Check your credit report and dispute any errors you find. A serious or negative error on your credit report can affect the interest rate when you apply for a car loan and could cost you hundreds or thousands of dollars.
Any negative information on your credit report (such as late payments, delinquencies, judgments and debt settlements, or bankruptcy) will affect your ability to obtain a loan or obtain a lower interest rate.
Tip: Most correct negative information on your credit report has to be removed after seven years and bankruptcy information after ten years. If you find something negative on your report that should have been removed, you should dispute it.
Save for a down payment.
It’s important to know how much down payment you can afford before you call and compare loans or visit the dealer. This will help you decide the size of the loan that you can afford. Remember that the larger your down payment, the less you will have to borrow.
Research loan options and consider getting pre-qualified or pre-approved.
It’s a good idea to shop around for loans before you go to a dealer. You may want to consider pre-qualification or pre-approval for a car loan at a bank, credit union, or other lender before visiting a car dealer.
In some cases, taking out multiple loans over a long period of time can lower your credit score(s). However, the money you can save by shopping around for the best auto loan will likely outweigh any impact on your credit history from shopping around for the best rate. Many of the commonly used credit scoring models count auto loan credit checks as a single inquiry if they occur within a 45-day period. This means that making loan comparisons during that time will count as one loan application. You can minimize any negative impact on your credit score by doing all of your shopping in a short period of time. And, knowing you have options will help you negotiate a better deal overall.
When offered different loans, compare all loan terms. You should look at:
- The amount you want to borrow;
- The interest rate and the Annual Percentage Rate (APR);
- The duration or term of the loan (number of months);
- The monthly payment (and whether you will be able to afford the payment based on your budget)
A higher interest rate or a longer term loan will increase the interest costs of your loan.
Tip: Before you sign, don’t forget to read the fine print in the loan agreement. Check to see if your loan has a “prepayment penalty,” which means you will have to pay a penalty if you pay your loan in full before the loan term ends. Even if you don’t plan to pay off your loan in full by the end of the term, you may want to avoid loans that have a prepayment penalty, in case your situation changes. Check the amount you are borrowing to make sure it is the correct amount. Make sure that you are receiving the amount of credit that was agreed upon for your trade-in vehicle.