6 common car loan mistakes that cost you money
If you want to save money on your next car purchase, you will need to do more than strike a good deal with the salesperson on the sticker price. A mistake when taking out a car loan could cost you money and erase the savings negotiated on the purchase price.
Unfortunately, it’s not all that uncommon, especially among borrowers with high credit scores. An investigation from Consumer Reports revealed that 3 percent of prime and super-prime borrowers received auto loans with APRs of 10 percent or more, which is more than double the average rate for their credit scores.
Not shopping around for the best deal on auto financing is just one mistake you want to avoid. Here are some others to avoid if you want to land the best deal possible.
1. Not shopping around
Dealership financing is an easy and convenient way to get a car loan, but it also comes at an added cost. Dealers often mark their rates up by a few percentage points to ensure they profit.
Before visiting the dealership, shop around and get a few quotes from banks or credit unions. Doing so will give you an idea of the interest rates available for your credit score and ensure you get the best deal. Keep in mind that banks’ requirements may be stricter than credit unions’, but they may offer better rates than you’ll find at the dealership. If it’s your first time purchasing a vehicle, look for financing programs for first-time buyers at credit unions.
Once you are preapproved for a loan, you can negotiate with the dealership more effectively. After all, if the dealership isn’t willing to beat the rate you already have, you don’t have to rely on their financing to get the car you want.
Preapproval will guarantee you get the best rate available and give you leverage to negotiate.
2. Negotiating the monthly payment rather than the purchase price
Although the monthly payment on your car loan is important — and you should know in advance how much car you can afford each month — it shouldn’t be the basis of your price negotiation.
Once volunteered, a monthly car loan amount tells the dealer how much you are willing to spend. The salesperson could also try to hide other costs, such as a higher interest rate and add-ons. They might also pitch you on a longer repayment timeline, which will keep that monthly
payment within your budget but cost you more overall.
To avoid this, negotiate the vehicle’s purchase price and each fee the dealer charges instead of focusing on the monthly payment.
Never purchase a car based on the monthly payment alone; the dealer could use that number to place negotiations at a standstill or upsell you.
3. Letting the dealer define your creditworthiness
Your creditworthiness determines your interest rate, and 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 could save hundreds of dollars in interest paid over the life of the loan.
Knowing your credit score ahead of time will put you in the driver’s seat in terms of negotiation. With it, you will know what rate you can expect — and if the dealer is trying to overcharge you or lie about what you qualify for.
What is a bad APR for a car loan?
New auto loans had an average rate of 6.84 percent in the second quarter of 2024, according to data from Experian. People with excellent credit qualified for rates around 5.25 percent, while people with bad credit had an average new car rate of 15.77 percent.
Rates for used cars were higher — 12.01 percent across credit scores. And the average rate for bad credit was a sky-high 21.55 percent.
So, a “bad” annual percentage rate for a car would be on the upper end of these numbers. Seek a lender that offers you an average rate for your credit score or better.
Shop around with many different lenders to get an idea of your estimated interest rates and take any steps to improve your credit score before going to the dealership.
4. Not choosing the right term length
Car loan terms range from 24 to 84 months. Longer terms may offer tempting, lower payments. But the longer you spend repaying your loan, the more interest you’ll pay. Some lenders also charge a higher interest rate if you opt for an extended repayment period since there’s a greater risk you’ll become upside-down on the loan.
To decide which is the best option for you, consider your priorities. For example, if you are the type of driver interested in getting behind the wheel of a new vehicle every few months, being trapped in a long-term loan might not be right for you.
On the other hand, if you have a limited budget, a longer term might be the only way you can afford your car. Use a car finance calculator to understand your monthly payment and decide which option is best for you.
A short-term loan will cost you less in interest overall but will have high monthly payments; a long-term loan will have lower monthly payments but higher interest costs over time.
5. Financing the cost of add-ons
Dealerships profit from add-on sales — especially aftermarket products sold through the finance and insurance office. If you want an extended warranty or gap insurance, these items are available at a lower cost from sources outside the dealership.
Wrapping these add-ons into your financing will also cost you more in the long run, since you’ll be charged interest on them. Question every fee you don’t understand to avoid unnecessary additions to your purchase price.
If there is an add-on you truly want, pay for it out-of-pocket. Better yet, check if it’s available outside the dealership for less. Buying from a third party is often cheaper for aftermarket products, extended warranties and gap insurance.
In the long run, financing add-ons will lead to more interest paid overall. Come prepared to negotiations knowing which add-ons you truly need and which you can find cheaper elsewhere.
6. Rolling negative equity forward
Being “upside down” on a car loan is when you owe more on your car than it is worth. Lenders may allow you to roll over that negative equity into a new loan, but it’s not a smart financial move. If you do, you will pay interest on both your current and previous car. And if you were upside down on your last trade-in, chances are you will be again.
Instead of rolling negative equity into your new loan, try paying off your old one before taking out the new one. You can also pay off your negative equity upfront to the dealer to avoid paying excess interest.
Don’t roll negative equity on your vehicle forward. Instead, pay off as much of your old loan as possible or pay the difference when you trade in your vehicle.
The bottom line
The key to success when taking out a car loan is preparedness. This means negotiating the monthly payment, knowing your credit score, choosing the right term length, being aware of add-on costs and avoiding rolling over negative equity.
Keep potential mistakes in mind while you negotiate, and with luck, you will walk away with saved money and time.
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