4 Rules for Getting a Car Loan

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Americans are buying cars again in a big way, with new car sales expected to be up 30% year-over-year in May, continuing the trajectory of rising demand that’s been going strong all year. Given that most of us aren’t going to walk into a dealership and plunk down $35,000 in cash on the desk, a run on new cars means a surge in auto lending. According to the Federal Reserve, the category of credit that includes car loans had a monthly jump of over 7% jump in April, so it’s clear that a lot of us are financing our new wheels.

Of course, shopping for a car loan isn’t as much fun as shopping for the vehicle itself — but it’s equally as important. Here are four basic guidelines everyone should follow.

Know Your Credit Situation

If you’re in the market for a new car, “Review your credit reports from each of the three major credit bureaus long before you apply for a loan,” the FDIC advises in a recent consumer newsletter. Go to annualcreditreport.com and pull one or all of your three free annual credit reports. If there’s a mistake — such as a paid-off debt being listed as outstanding, or an item in collections that doesn’t belong to you — you want to get that straightened out, or you could wind up paying a higher rate. Even if your credit is blemished, knowing where you stand is half the battle.

If your credit is good, you still should not assume that you’ll qualify for the 0% financing offers many dealers dangle in their TV and radio ads, says Rosemary Shahan, president of Consumers for Auto Reliability and Safety. She says roughly nine out of 10 buyers never qualify for that and wind up paying a higher rate.

(MORE: A Non-Profit Car Loan is Still a Car Loan)

Shop Around

“Our number-one piece of advice for consumers is never, ever get your loan from the dealer,” Shahan says. It’s advice other consumer advocates echo.

“Get preapproved for financing before you set foot in the dealership,” says Chris Kukla, senior counsel for government affairs at the Center for Responsible Lending. Check out your local banks and credit unions. Although multiple inquiries can drag down your credit score — the last thing you want when trying to get a good rate on a loan, you have 30 days in which multiple lenders pull your credit and it will only count as a single inquiry.

Dealers are legally allowed to add to your interest rate in order to compensate themselves, Kukla says — in effect, hiding the size of their profit from the buyer. The only way you’re going to know if you’re getting the best rate out there is if you’ve gotten quotes from other lenders. If you’ve been preapproved by another lender, you can also use that as a bargaining chip when the dealer presents an APR.

The FDIC also warns that consumer should be cautious about dealers who offer to pay off’ the loan on your trade-in. In some cases, the agency says, when dealers tell you they can make your existing loan go away, they pay it, then turn around and bury that cost in your new loan. The old loan doesn’t disappear — you just don’t see it because it’s been added to the new loan.

(MORE: 5 Things to Keep in Mind If Buying or Selling a Used Car)

“Dealers say all the time, ‘We have multiple lenders,’” Kukla says, but they leave out the fact that they’re really looking for the loan on which they can get the biggest cut. “About 75% to 80% of people have no idea dealers could do that,” he says. For people with good credit, not shopping around could add as much as two percentage points to the loan APR; for people with poor credit, it can mean a five percentage point difference — which adds up to serious money over the life of the loan.

Don’t Get Upsold

The profit margin dealers make on actual cars has decreased thanks to a better-informed public that compares prices online before setting foot on the showroom floor. To make up for this, sellers rely to an increasing degree on their service departments and other ancillary services that they pitch to people once they sit down in the financing office, says Kukla.

“About 50% of a dealer’s profits come from the finance office,” he says. As a result, car salespeople pitch things like rustproofing, undercoating, gap insurance, extended warranties and a whole slew of other add-ons.

Do you really need all — or any — of these? That’s a topic for a whole other article, but the bottom line is that you don’t need to decide any of this in the financing office, no matter what they tell you. “For those add-on products, it’s really difficult to compare,” he says.

Kukla says if you’re feeling pressured by the sales pitch, keep in mind that you can buy any of these extras after the fact, although the dealer will try to discourage this by pointing out that you won’t be able to roll the cost into your loan.

(MORE: Car Shoppers’ Decisions Most Influenced by … Person Trying to Sell Them Cars?)

Avoid the Yo-Yo Trap

Kukla says the Center for Responsible Lending fields a steady stream of complaints by car buyers who have been taken in by this bait-and-switch tactic, which involves offering “conditional” financing so buyers can take home their new vehicles on the spot. In a so-called yo-yo scam, the dealer leads the customer to believe that the financing has been squared away, when in reality, it never was. Then, days or even weeks after the customer has “purchased” the vehicle, the dealer calls to say there’s been a problem with the financing — and that they have no choice but to pay a much higher interest rate or forfeit the car and pay hefty “wear and tear” or “rental” fees.

“The dealers use very coercive tactics to get them to sign the new contracts,” Kukla says. “Many were told their trade-in couldn’t be returned or the down payment was nonrefundable,” he says.

Kukla says there’s a simple way to avoid this scam: “Say you won’t take delivery of the car until the financing is final.”

MORE: Why Small Cars Are Suddenly Big Business

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