Purchasing a vehicle is a decision that should only be made after careful consideration; and for most consumers one of those major considerations is: how to finance the purchase.
The majority of consumers borrow money for a vehicle purchase. Some choose to use a personal line of credit or arrange financing at their own financial institution but many have the dealer arrange financing.
Having the dealer arrange financing often makes sense—dealers have access to numerous lenders that may provide terms or rates unavailable elsewhere. But this doesn’t mean consumers shouldn’t carefully consider what is being offered and take steps to ensure they are getting the best possible finance rate and terms.
Understanding Your Creditworthiness
The terms and rates available to a vehicle-buyer will be based largely on the vehicle being purchased and the buyer’s creditworthiness (credit score). Individuals with a good credit score are typically offered, or can negotiate, the best rate/terms available. Before applying for a loan, consumers should learn their credit score by consulting a credit bureau.
Two commonly used agencies (credit bureaus) in Canada are:
Before visiting the dealership, consumers are advised to contact their bank/financial institution and inquire about the terms and interest rates it can offer (they can vary between lenders). This allows consumers to comparison shop with the financing available at the dealership.
Are All Credit Offers the Same?
If the dealer is arranging financing, he/she may submit the consumer’s loan application to one or more financial institutions or lenders; therefore, a consumer could be approved by multiple lenders, potentially on different terms or at different interest rates.
Consumers should ensure they know who their application was submitted to. If the application was submitted to multiple lenders, consumers should enquire about each lender’s offered terms/rate. Important note: Multiple credit applications can negatively affect a borrower’s credit score.
It is also important to understand that dealers are commonly paid a fee, often called a reserve, by lenders for arranging financing; these fees can vary significantly. Loans with higher interest rates often provide dealers with higher reserves. Consumers therefore need to make sure they are getting the best financing rate and terms possible, not necessarily the rate/terms that provides the dealer with the most lucrative fee.
Credit Applications – Verify the Information’s Accuracy
Credit applications at dealerships are usually completed electronically. It is important that the information provided in the application be accurate. There have been instances of dealers (and/or consumers) inflating incomes or minimizing debts in an effort to ensure an application is approved. This is not only unethical, it is illegal. Consumers should therefore ask to carefully review the information on the application before allowing the dealer to submit it. Consumers should also request a copy of the loan application.
It is common to sign the actual loan agreement/contract when taking delivery of the vehicle. Consumers should carefully read the entire agreement and ensure the stated terms and rate on the contract match what was promised.
If a dealer or salesperson makes a verbal promise (e.g. if all payments are made for the first 12 months the loan term/rate can be renegotiated), GET IT IN WRITNG! Make sure the promise appears on the contract that you sign. This provides transparency and protection.
Long or Extended-term Loans – are They Right for Everyone?
Many consumers mistakenly shop for a vehicle based on a low monthly payment rather than the actual price. Often referred to as “monthly payment junkies”, some of these consumers find themselves financing a vehicle over extended terms (84-96-108 months). Before agreeing to an extended term car-loan consumers should consider:
- How long they keep vehicles. Do they usually trade them in before paying them off? This often leads to negative equity (when more is owed for the vehicle than it is worth).
- What would happen if the vehicle was stolen or destroyed and there was negative equity involved? Insurance companies will reimburse the vehicle’s value, not necessarily what is owed on the purchase loan. Note: some dealers sell “Gap” insurance that pays off the negative equity in these situations.
- How much they drive. Will the vehicle reliably last the term of the loan?
- The overall cost of the loan. Longer terms may mean lower monthly payments, but they also usually mean higher overall costs of borrowing.
To learn more about the potential dangers of long-term auto financing and negative equity click here