"The big mistakes are made in the financing office," says Phil Reed, the senior consumer advice editor at Edmunds.com, the auto research website. "Making the right decisions can save thousands over the life of the loan."
Here are Reed's five car loan mistakes that can cost you money:
1. Negotiating the monthly payment rather than the purchase price. Reed warns that buying a car based on the amount of the monthly payment is a trap. Although you should know what you can afford each month, don't provide that figure to the salesperson. If you do, you will forfeit your capacity for negotiating a lower purchase price. "Don't let them turn you into a monthly-payment buyer," he says.
Once volunteered, a monthly car loan amount tells the dealer how much room is available to hide other costs such as a higher interest rate and add-ons. Reed says to negotiate the price of each cost category separately. "Minimize the individual pieces of negotiation—price, trade-in and car financing," he says.
2. Letting the dealer define your credit worthiness. Reed explained that your credit worthiness determines your car financing interest rate. Your credit score (300 to 850) is your credit worthiness as a rating and is based on your credit report with credit reporting agencies. A borrower with a high credit score qualifies for a better car loan rate than one with a low score. Shaving just one percentage point of interest from a $15,000 car loan over 60 months would save hundreds of dollars in interest paid over the life of the loan.
Reed emphasized knowing your credit score before you set foot on the dealer's lot. "Most people think their credit score is worse than it is," he says. "When people don't know their credit rating, the dealer can tell them almost anything."
Reed recommended consumers check their own credit by obtaining preapproved car financing. They should go to a bank or credit union and apply for an auto loan before visiting the dealership. Even if they intend to take advantage of a deeply discounted interest rate offered by the auto manufacturer's lending agency, consumers can find out how much vehicle they can buy and the interest rate they qualify for by getting a preapproved car loan. "It's another way of checking your credit," Reed says.
Erin Downs, a spokeswoman for San Francisco-based Wells Fargo & Co., says, "We consider your credit rating, your payment history and the amount of debt you already have."
3. Making the wrong choice between cash rebate and low interest-rate loan. If you want to take advantage of a manufacturer's offer of a cash rebate or a low interest car loan, do your homework before deciding. Reed cautions that the method netting you the most savings varies from offer to offer.
Bankrate has a calculator that simplifies the comparison. Manufacturers' low-interest car financing isn't available to everyone, so it will help to know your credit score before talking to a finance manager. "Your credit must be very good to get the low-interest financing," Reed says.
4. Rolling negative equity forward. "Upside down" is the term used to describe owing more on your car than it is worth. The difference is "negative equity." When a dealer tells an upside-down consumer that he can fold that negative equity into the car financing of the next deal, he means that he will add it to the purchase price of the new car.
You will be paying interest on that negative equity for the term of the new loan. Moreover, if you were upside down on your last trade-in, chances are you will be that much more upside down next time. "It's a horrible practice and should be avoided," Reed says. "They are just making the problem worse. It's because people are buying more car than they can afford. Live within your means!"
5. Financing the cost of add-ons that you can buy separately. According to "2009 F&I Statistics" published by Torrance, Calif.-based F&I Management and Technology magazine, nearly 29 percent of the average gross profits earned in new- and used-car sales departments were generated in the F&I, or finance and insurance, office through aftermarket add-ons.
"Just say no" is good advice. "They are really there to make extra profit for the dealership by increasing interest rates, and selling extended warranties and add-ons such as fabric protection and paint sealant," Reed says.
Even if you want an extended warranty or credit life insurance, these items are available at a lower cost from sources outside the dealership. Folding them into your car loan and paying interest on them for the life of the loan can add hundreds of dollars to the amount you pay. Further, question every fee you don't understand.
"Dealers can write other fees into the contract and give them official-sounding names," Reed says.
"These fees are another attempt to take profit on the back end of the deal when the buyer's guard is down."