Driving away in a new car is an excellent feeling. However, all that leads to it - the financing, negotiation process, and shopping around - is stressful. It's a big decision. There are lots of considerations. Therefore, you must consider every single potential pitfall. Any mistakes you make now will likely stick with you for the next few years of your car loan.
Table of Contents
- Not knowing your credit score
- Not calculating your budget
- Not shopping around
- Making too many loan enquiries
- Not going to a car finance broker
- Roll negative equity forward
- Not having pre-approval before car shopping
- Paying too much attention to interest rates
- Sacrificing loan term for monthly payments
- Not refinancing
Yet, don't panic. We'll list the most common car loan mistakes to avoid. The car loan process should be smooth and straightforward with careful planning and consideration. With our tips, you'll be driving your dream car in no time at all. So, here are the top ten car loan mistakes to avoid.
1. Not Knowing Your Credit Score
Firstly, knowing your credit score is essential. Financial institutions use credit scores to assess your reliability to pay back the loan. Not knowing your credit history puts you at a disadvantage. You're blind to your own financial situation. Your credit score will give you a good idea of which loans you qualify for and put you in a better place to negotiate.
Moreover, if your credit score is relatively low, you might decide to wait to improve your score. A higher credit score usually means you'll get a better interest rate. To find out your credit score, request a report from a credit-reporting agency, such as Experian, Equifax, or Illion.
Your credit report will present information about your financial situation, debts, and payment history. That said, bad credit isn't always a sign of poor financial decisions. Instead, low credit scores are out of your control a lot of the time. For example, if you don't have much of a credit footprint, it will be lower than those who have paid back multiple loans. Consider how you might improve it.
A low-interest rate makes a big difference. Even shaving just 0.5% off your car loan interest rate will save money in the long term.
For instance, let's say you have a $50,000 car loan with a loan term of six years. With an interest rate of 5.5%, you'll pay $8,824 in interest throughout the loan. However, an interest rate of just 5% will see only $7,960 in interest. You could save almost $1,000.
Accordingly, waiting a few months to improve your credit score could see vast savings in the future. To improve your credit score, get in the habit of making payments on time. Late payments stay on your credit report for up to seven years. Can you hold off on buying a new car until they disappear? Try to pay off any outstanding debt. Finally, avoid taking out too many loans in a short period.
While you're at it, check your borrowing power. Essentially, borrowing power indicates the strength of your financial position. It's a combination of the credit report, income, and down payment. Not all car loans require a deposit. However, if you have a poor credit history, a down payment may strengthen your application.
You can begin shopping around when you know your credit score and borrowing power. Find which lenders have competitive interest rates within your budget.
2. Not Calculating Your Budget
It's all very well knowing your credit history and borrowing power. You also need to know your budget. Before taking out any auto loans, you need to consider your position. You need to make sure that you can afford to pay back the debt. If you don't take the time to plan out your monthly payments, you might default on a payment.
Unpaid or late paid car loan repayments might result in thousands of dollars owed in interest. Moreover, it'll do severe damage to your credit score. Therefore, you would harm your ability to take out a new loan in the future.
Here are some tips for calculating your budget.
Calculate the Car Payment
How much you should spend on a car loan is challenging to assess. It all depends on your income. Ideally, you want to spend no more than 10% of your monthly income on your car payments. For example, if your take-home pay after tax is $3,000, aim to spend less than $300 each monthly payment.
Additionally, you need to consider the loan term. How long can you afford to pay $300 a month? Try to aim for three-year loan terms for used cars and five years for a new car. Longer loan terms will reduce each monthly payment. However, you'll find yourself paying more interest.
Calculate the Car Payment
Now that you know what you can afford to spend each month, you need to assess how much you can borrow. We covered borrowing power earlier. In addition, you need to consider the sort of car you want to buy. For example, new car loans have lower interest rates but are more costly overall.
Set a Target Purchase Price
The loan amount you're eligible for might not necessarily equal the price of the car you can afford. Unless you're making a down payment or trade-in an old car, you may have to limit your expectations. On top of the auto loan, car buying includes additional fees, such as sales tax.
Once you determine an estimated car loan amount, you can begin to see a realistic purchase price. Remember to take extra fees into account. Then, it's up to you to start the negotiation process.
3. Not Shopping Around
Just as you wouldn't buy the first car you see from the car dealer, you shouldn't opt for the first lender or financing deal you're offered. Luckily, it's easier to shop with multiple lenders. Instead of traversing car dealerships, car loans are found online. Find a car loan aggregator like Ausloans Finance, where you can apply for a loan online and get access to more than 40 different lenders. You don't even need to leave your home.
Getting a good deal on a car loan is as essential as finding a reasonably priced car. Lenders offer different interest rates and other features. Additionally, they are likely to have different criteria for deposits, loan to value ratios, income, and other requirements. You must find a car loan lender that suits your situation.
Car loan interest rates differ all the time. In fact, they can change daily depending on demand or promotions. Therefore, you mustn't make a hasty decision.
Furthermore, you need to think of the many different car loan options. Firstly, consider whether you want a fixed rate or variable interest loan. The former means that each monthly payment will have the same interest rate for a set period. The main benefit of this is that you can budget more efficiently. On the other hand, a variable interest rate is when the rate fluctuates from month to month.
The RBA sets the cash rate at the beginning of each month. Lenders base their interest rate on this. Sometimes, you'll pay lower monthly payments when the interest falls. Other months, you'll pay a higher interest rate. Taking the time to assess which of the different loan types suits your situation is essential.
- Make sure you know everything about your situation. We've already addressed the importance of knowing your credit score, borrowing power, and budget. Determine how you can frame your position in the best possible light.
- Consider a deposit. Not all lenders require one. However, proving that you can save will go a long way in helping your negotiations.
- Finally, if you're struggling to secure the low-interest rate you want, consider whether it's worth readjusting your expectations. Opt for a cheaper car or older model. Alternatively, you could get a co-signer. With two incomes behind your car loan, you'll be more likely to succeed in negotiations.
4. Making Too Many Loans Enquiries
This may seem counterintuitive. We just told you that it is good practice to shop around for your car loan. However, the flip side of this is that too many applications or enquiries will result in hard credit checks. This goes on your report. Subsequent lenders will be able to see that you have applied for multiple loans, which isn't a good look.
Multiple loan applications suggest your financial health isn't in great shape - even if that's not the case. As a result, it's best to avoid making too many applications. That's not to say you shouldn't look at different lenders. However, if you request any quotes, ensure that their credit check is not a hard inquiry. Stay clear of lenders who make hard credit checks in the initial stages.
5. Not Going to a Car Finance Broker
Yes, you can shop around for a car loan yourself. Yes, you can negotiate a better deal. However, of all the common mistakes, not consulting a broker is one of the most significant. Imagine saying no to free advice - you often don't have to pay your finance broker. Typically, the lender pays them on commission. For example, when applying for a loan with Ausloans Finance you get a dedicated car finance broker that will take care of your application until settlement.
Let's check out the reasons you should talk to a broker.
Insider Knowledge
The chances are, you're probably not an expert on car loans. No matter how much research you do, you're unlikely to have the experience and insider knowledge a finance broker has.
A broker will know the ins and outs of different loan types. Beyond variable and fixed interest loans, there are also Hire Purchase (HP), Personal Contract Purchase (PCP) agreements, balloon payments, and more to consider.
Your broker can talk you through these different options and help you find a lender who is likely to approve your application.
In addition, brokers often already have established relationships with their panel of lenders. This means that they can sometimes negotiate preferential terms, discounts, and interest rates that you may not be able to find elsewhere.
Save Time
Researching and shopping around is time-consuming. Firstly, you need to get to grips with all the jargon. Secondly, you create a list of all lenders. Not all of them are included on the leading comparison sites. Then you'll need to check whether you meet their criteria. This process can take hours, at least. In addition, it's very stressful.
That's not even including taking the time to make the application, assess your finances, and create a budget.
However, a broker will do all the hard work for you. They'll compare loans and put you in touch with appropriate lenders.
Specialist Lenders
We mentioned a few ways to deal with a poor credit score earlier. Remember that it's not always a sign that a person is terrible with money - self-employed people, those with little credit history, and someone who made a late payment five years ago may all have low scores. A broker knows which lenders are more likely to be amenable to those with lower scores.
Plus, they will help you frame your application in the best possible light. You want to highlight your financial strengths to convince lenders of your reliability.
6. Roll Negative Equity Forward
Rolling negative equity forwards is when you owe more on your car loan than the car is actually worth. It's also known as being upside down. This usually happens when a loan term is too long, and interest rates are too high. Plus, as the value of your car decreases over time, it is possible to owe more than it's worth.
Ideally, you want to gain positive equity (pay off the majority of your loan) by the time you trade it in. A good way to avoid going upside down is to negotiate a shorter loan term or make a larger down payment.
The danger is that sometimes car dealers tell upside down customers that they can fold the negative equity from their existing loan into the new car loan. Therefore, the negative equity is added to the car's purchase price - you'll essentially be paying for two vehicles with only the benefit of one. As a result, the higher cost you have to pay increases the interest rate.
While a dealer can frame it as an attractive deal, you'll pay a lot more money overall. If it sounds too good to be true, it probably is. Instead, ensure that you pay off your old loan before getting a new vehicle loan.
7. Not Having Pre-approval Before Car Shopping
Getting pre-approval on your car loan application is vital to avoiding common car loan mistakes. With pre-approval, you'll have a strong advantage from the moment you enter the car dealership.
When you apply for your loan, the lender will offer you pre-approval, or conditional approval, if you meet their criteria. However, it's important to note that this is not a 100% guarantee you will receive the financing.
A pre-approved loan offer essentially means that you're able to negotiate with a clearer idea of your financial situation. You won't feel the pressure to accept the dealer's first offer. Additionally, you'll have a target price - or set benchmark - that the dealer has to beat if they want your custom. With a solid idea of what you can afford, you'll find you're negotiations more confident and strong.
Some dealerships are known for combining all components of car buying into one package. For instance, they'll bundle the vehicle cost, the financing, and the trade-in of your old car. In return, you pay them one monthly repayment. Yes, it does make the process more straightforward. However, it's not necessarily the cheapest way of purchasing a car.
By mixing all the costs together, it's unclear whether the dealer has shifted the numbers to make it look more attractive than it is. Whenever the customer is confused, the dealer can often take advantage.
On the other hand, if you have your own financing pre-approved and ready, it'll better equip you to spot any devious deals. With one of the variables sorted, the process should be less confusing.
Remember, the dealer isn't necessarily interested in your financial health. They're trying to sell you a vehicle and don't have your best interests at heart. In contrast, lenders focus on supplying you with a financial deal that you will be able to repay. The latter should be your priority.
8. Paying Too Much Attention to Interest Rates
When it comes to financing, everyone talks about interest rates. Indeed, a low-interest rate will save money. However, it isn't the be-all and end-all of car loans. A lot more comprises a car loan than just interest repayments.
Instead, take the time to consider the comparison rate. This includes all fees associated with the loan. For example, on top of interest, you'll need to pay application fees, documentation charges, stamp duty, and the car loan processing fee. Some car loans that have attractive looking interest rates are more expensive elsewhere.
Try to work out how much you'll spend on the loan over its entire lifetime. For example, with a car loan of $50,000 over five years, a fixed rate of 6.49%, the total cost will be $58,680. If we add the service fee of $10 a month, this quickly adds up to an extra $600.
Furthermore, consider other ongoing or upfront expenses. Stamp duty differs from state to state but could easily cost $1,350 or more depending on the vehicle. Some dealers add stamp duty directly to the price of the car. If they don't, remember to factor this cost into your calculations.
Additionally, you need to consider registration. This is a large ongoing cost and differs depending on your local vehicle registration centre. Then, think about insurance. Again, this varies from car to car and person to person. It's sensible to shop around for the best car insurance deal you can find.
Finally, the costs of running a car are worth thinking about. Petrol, maintenance, breakdown cover, road tolls, tyre replacements, and repairs are all expensive.
While it's sensible to shop around for a competitively low-interest rate, don't forget that solely focussing on interest might result in higher costs elsewhere. Think about the overall cost of the loan.
9. Sacrificing Loan Term for Monthly Payments
It can be tempting to get the monthly repayment as low as possible. When you budget, you think about what you can afford to spare on a monthly basis. As most sources of income and expense are calculated month by month, it's easier to budget this way too. However, the risk is that you lengthen the loan term in order to get the cheapest monthly repayments.
Accordingly, remember to take into account the total car price. You might be able to get a car that is above what you can reasonably afford with a loan term of seven or eight years. You might be able to meet each monthly repayment, but the overall cost of the loan will be very expensive and financially risky.
This is because more interest accrues over a more extended period. Moreover, longer loans are riskier for the lender. Therefore, they'll likely charge higher interest rates. Essentially, you'll pay more interest for a longer period. This could quickly add up to extra unnecessary thousands of dollars.
Upside Down
We mentioned that you shouldn't roll a negative equity loan into a new finance deal. Well, as most new cars depreciate quickly during their first few years, you'll end up being in a position where you owe more than the car is worth.
The problem here is that if something happens to your vehicle - for instance, it is stolen or written off - you still have to continue making payments to your lender. Your insurance company will only cover what the car is worth, not the additional interest repayments. Therefore, you'll have to make up the difference yourself.
Of course, this is a risk with all car loans. However, the longer the loan term, the more you'll have to pay off.
10. Not Refinancing
If you do make a mistake on your car loan, it's not the end of the world. The best thing to do is to get out of it. You can do this by refinancing your loan. You may need to wait a few months or a year before refinancing, depending on your loan. However, with some, you can refinance the next day.
Make sure you check the fine print of your car loan to see if there are any early repayment fees. If this is the case, you'll need to wait until the prepayment penalty period is up. Otherwise, you could end up losing more money. Similarly, another reason to hold off on refinancing is if you have poor credit. You're unlikely to get a better deal than you did with your first loan.
After a year of making monthly car payments on time, your credit score should improve.
When you decide to refinance, make a list of what you expect from your new loan. Setting your sights on "lower interest rates" is often the wrong way to go about it. It's too vague, and you'll likely end up disappointed when the rate isn't significantly lower.
Instead, try to set a reasonable benchmark. Say your current interest rate is 8.5%. When you refinance, try to find a loan that is only 8%. Along with interest rates, think about whether you can cut the loan term shorter. You might also be able to negotiate additional features, such as a redraw facility that will help you pay it back quicker.
It's a good idea to approach a car loan broker to refinance. They'll be able to assess your current loan and offer you expert advice on your options.
Bottom Line
Approaching your car loan finance with a clear head and realistic expectations is the best thing you can do. Ensure that you know all you can about your own situation (your budget, credit score, and borrowing power) as well as the vehicle you wish to purchase.
Remember to consider the entire cost of the loan. While it can be tempting to make each monthly payment as low as possible, it's not worth extending your loan term to ridiculous lengths. A low-interest rate is beneficial, but there are other factors to consider. Speak to a finance broker about your situation. They'll be able to offer personalized advice about where to find a suitable car loan.
You should also note whether you need to change the expectations of your car purchase. If the loan is too expensive, perhaps find a more affordable model. It might seem like a long, complicated road until you're in the driver's seat. However, with a bit of preparation, it should be smooth sailing.
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