How to Shop for a Car Loan: Don't Just Finance at the Dealer

Most car buyers spend long hours researching what car they are going to purchase -- but comparatively, little time researching how they are going to pay for it. They simply go to the dealer and negotiate a monthly payment that fits their budget.

Why is this a problem? Because negotiating by monthly payment makes it difficult to figure out whether you're getting the best deal possible. When you negotiate purely on payments, you are likely to pay hundreds or even thousands more than you ought to.

The Concept of Shopping for Money

When you take out a loan for a car (or for anything), you are essentially buying money, and the total amount of interest is the price tag. And it can be significant: A 3-year, $20,000 loan at 5% will cost you about $1,580 in interest. Extend that loan to 5 years, and while the payments drop significantly, the cost of the money jumps to $2,645. Bump up the finance rate by just one point to 6%, and you'll be paying an additional $555 in interest.

Some of what you pay for your money is pure profit for the dealer. A dealership may offer you a 60-month, $20,000 loan at 8%, but they're reselling a loan they bought for 5.5%, bagging a cool $1,400 in profit. (This is the reason they were able to sell you the car at "just above invoice price".)

Dealers often offer super-low financing rates (under 3%). Such rates aren't necessarily too good to be true; we'll get to that in a moment. But they may require impeccable credit or be conditional upon buying the car at sticker price. Many buyers, enticed by a low finance rate, end up paying thousands more for their car than they had to.

How to Save Money on the Money You Buy

The solution is to shop for your money separately from your car -- in other words, look into arranging outside financing from the sources I've outlined below. You should get approved for at least one outside loan before you go car shopping. Not pre-approved, mind you -- apply for at least one loan and get approved. You may loan a car via myAutoloan if you need a car now and there till you finance a purchase. You may not use this financing, but having an approved loan puts you in the best position to get a good deal on your money.

Three Advantages to Outside Financing

1) With outside financing, you become a cash buyer, meaning you are negotiating the price of your car and nothing else. That makes the transaction quicker and easier, and it helps to keep you within your budget. It's also an advantage for the dealer -- cash deals may be less profitable, but they take up a lot less time, so the dealer can move on to other customers.

2) Outside financing is more transparent. Unscrupulous dealers attempt to baffle you with a barrage of numbers or offer to put you into a nicer car for "just a few more bucks a month" (and thousands more in payments and interests). Financial institutions, on the other hand, are selling just one thing: Money. Little pressure and no new-car smell are filling your nostrils. The rates are often pre-set and non-negotiable. You won't have to walk away wondering if you could have negotiated a better deal.

3) Outside financing provides a baseline to evaluate dealer financing offers. With outside financing, you can arrange a cash price, and then see what kind of rate you can negotiate with the dealer. If your bank approves you at 5% and your car dealer can finance the car at 4%, it's a good deal for everyone -- you save a couple of hundred bucks in interest and your dealer makes more money. (This has advantages and pitfalls; more on that below.)

Sources of Outside Financing

Banks. Most banks offer pre-set new car loan rates, and some may offer a discount if you have an account and use direct debit for your payments, but they often require a minimum down payment and will tack on ancillary fees. Another option is to take a home equity loan, which may allow you to take a tax deduction on the interest (ask your tax professional), although you may most likely have to pay the loan off early to save money on interest.

Credit unions. Credit unions are non-profit organizations that operate much like banks. They offer competitive rates and do not rely on ridiculous fees to squeeze out extra profits, although like banks they may require a minimum down payment. Most credit unions will require you to open an account before taking out a loan.

Finance companies. Third-party finance companies will often loan money to individuals who do not qualify for bank or credit union loans, although their interest rates are usually high. Like dealerships, they usually resell loans rather than loaning their own money, so they may be open to negotiation.

Relatives. Explore this option with caution, as no new car is worth family strife! If you have a relative who you know is open to such a sizable loan, this might be a good road to go down on -- especially if you offer to pay interest. Remember, though, that borrowing from a business allows you to improve your credit score; relatives don't.

Should You Use the Money You've Bought?

You've been approved for a loan from an outside source and have negotiated a price on a new car. Does this mean you should pick up your check from the credit union and buy your car?

Not necessarily.

Your dealership may be able to sell you the loan money at an even cheaper rate. The "factory-backed" rates you see on TV ads are often legitimate; the automakers subsidize the loans to keep the interest rates down. Even if these offers come instead of "cash back" rebates, they may still result in lower costs. Ask your dealer to check your credit and do a quick payment calculation. Since you know the cost of your approved loan, you'll know right away if you're saving money.

Even if there's no factory-backed program, a dealership may be able to beat your bank rate. Remember, dealers buy their money wholesale, so the same loan you buy at 6%, they may be able to get at 3.5%. If they sell it to you at 4%, they'll make a profit -- a slim one, granted, but it's still more money than they'll make if you paid cash. Dealers may also be able to negotiate a more flexible down payment. And by financing with them, you save the back-and-forth driving between the bank and the dealership.

Again, this only really works if you've pre-arranged financing because the dealers know that you know the fair price of the money you are buying.

A Word of Warning: Yo-yo Financing

If the dealer offers to beat your pre-arranged loan with a rate that sounds too good to be true, or if he tells you he can set up a lower rate in a few days but will let you drive the car home today, be cautious -- he may be setting you up for a "yo-yo financing" scam. Do not drive the car off the dealer's lot until the financing is approved, all contracts are filled out and signed, and the car is registered and insured in your name. If the dealer pushes you to take the car home before the deal is approved, forget it -- use your pre-approved financing to buy the car cash, or better yet, walk out and do business with a different dealer.

John J. Gregg is an experienced writer, who provides students with an opportunity to get high grades on essaywritercheap.org. Besides writing, he enjoys reading and playing the guitar. In addition, John J. dreams of traveling and visiting as many countries as possible in his lifetime.