For most new car buyers, the question of whether or not to finance their purchase is academic — with the average new car price approaching $30,000, some sort of loan is usually necessary. But the type of loan or financing can vary considerably, with different payment terms, interest rates, and other costs. That’s why it pays to know your financing options before you buy a new car.

Shop around for the best price on a specific model car, you should also comparison shop for the best deal on a car loan. Talk first with banks or credit unions, which usually offer set, nonnegotiable rates, often less expensive than dealer financing. Also consider getting a preapproved loan to help you in your bargaining efforts once you’ve decided on a make and model.

Dealer financing offers a convenient option, and rates can be very attractive for certain models with promotional discounts. But be certain it’s not a promotion requiring extra insurance or service and that the payoff period is not too short.

Some nontraditional financing options include drawing down your home equity line of credit or borrowing against your investments, passbook savings account, or cash value life insurance. With all of these options, however, remember to get the shortest payback time you can comfortably handle. While monthly payments can be reduced by stretching them out over more time, only a lower interest rate, a smaller loan, or a shorter term will lower the total expense.

Unless you’re among the minority of people who pay cash, you need to quickly become an informed consumer on the subject of financing if you’re considering buying a new car. For most new-car buyers, one of the biggest costs of purchasing a new car is interest on the loan that makes the purchase possible. But there are a variety of ways to finance a car, and knowing your options can help save you money.

Preapproval Can Be a Plus

Just as you want to pay the best price for a car, you should also comparison shop for the best deal on a car loan. And the ideal time to shop for a car loan is before you shop for a car.

Getting your loan preapproved before you start looking for a car is like shopping with cash. You can drive the car right off the lot no more waiting for the loan to be approved and disbursed and taking the check back to the dealer. In most cases the loan can be approved by your lender in a couple of days.

Shop Around for Financing

All lenders are not alike. You can save hundreds of dollars by shopping around to find the best financing deal. Before you sign anything, talk with several lending institutions so you’ll know their current loan rates. Then see if a dealer can give you a better rate.

And even if you get a low loan rate, perhaps a promotional rate, watch out when the financing salesperson starts selling. You probably don’t need the extra life insurance, extra accident or health insurance, or extra protection for their rustproofing and undercoating.

Borrow From a Dealer

Convenience is the word here. With many car companies having their own lending affiliates like Ally (formerly GMAC or General Motors Acceptance Corporation) you can choose a car and a loan in one application process. The process is usually quicker than applying for a bank loan, and dealers are more likely than banks to qualify buyers with less-than-perfect credit ratings. They also usually help customers with special needs, like first-time buyers and recent college graduates. Best of all, car companies sometimes offer low-rate promotional financing on certain models. (But don’t expect discount financing on popular models.) The downside? Dealer financing can be more expensive, particularly for poorly informed buyers. (Dealers can sometimes make as much on the financing as on the sale itself!)

Negotiate the car’s price before you talk about the terms of a loan, so the dealer can’t hike the car’s price to give you a lower-rate loan. Even if you get low dealer financing rates of 2% to 5%, there’s a catch: these loans are usually short term. Since many must be repaid in 24 months, monthly payments can be steep.

Borrow From a Bank, Credit Union, or Finance Company

Banks and credit unions usually offer set, nonnegotiable rates, often less expensive than dealer financing. (They are also less likely to push the unnecessary expense of credit life insurance, which ensures that the loan will be paid off if you die prematurely.) Membership credit unions that offer auto loans typically offer lower rates than banks and finance companies. But finance companies – often the most expensive of all – may accept borrowers who are greater credit risks.

The Quicker the Payback, the More You Save

If you take out a loan for a car, get the shortest payback time you can comfortably handle. While monthly payments can be reduced by stretching them out over more time, only a lower interest rate, a smaller loan, or a shorter term will lower the total expense.

A $15,000 loan at 8% for five years, for example, will cost $3,240 in interest. You would save $672 if you paid an extra $62 a month for the same size loan over four years. The total interest cost would drop to $2,568.

Points to Remember

1. When you have a preapproved loan it’s like shopping with cash.
2. Talk with several lenders such as banks, credit unions, or finance companies.
3. If you discover a lower rate from a car dealer, be certain it’s not a promotion requiring extra insurance or service, such as rustproofing.
4. When taking out a loan, get the shortest payback time you can comfortably afford.
 
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