The report cards are in for first-time car buyers, and at least half of them are getting failing grades in one subject: Vehicle financing. In general, consumers have become the honor students of the auto business, doing their homework and taking home better deals as a result. But many first-time buyers are flunking the financial end of the deal, a recent survey commissioned by Capital One Auto Finance shows.
The survey found that nearly half of first-time car buyers do not know the interest rate they are paying on their loan. Only one-third checked their credit score -- a key determinant of their rate, the overall cost of their credit, and the size of their loan -- before making their purchase. Furthermore, nearly 60 percent failed to discuss financing options with a knowledgeable party. Only 20 percent of respondents did research on financing options online, and more than half did not know that they could have applied for a loan on the web, the survey found. The results were based on a national poll of 700 consumers in May.
All this almost certainly translates into higher car payments, lending specialists say. Many consumers simply aren’t targeting the lowest possible rates. As a result, lending specialists believe many car buyers are shouldering rates a couple points higher than necessary.
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“It doesn’t completely surprise me, but it’s unfortunate, especially with so much fabulous press out there about doing your homework,” says Lea Anne Broseus, consumer lending manager at the KEMBA Financial Credit Union in Columbus, Ohio.
With some consumers paying too little attention to this area, it’s no accident that dealerships’ financing and insurance operations, the proverbial “back office,” have become their real profit generators. Shopping for the vehicle itself is a different story, as many buyers have managed to tip the scales in their direction, by being armed to the teeth with pricing information and unafraid to shop around. As a result, dealers have seen vehicle profit margins erode, money that has to be made somewhere else -- and that’s often accomplished by “marking up” interest rates on financing.
First-time buyers’ poor performance on the financial end doesn’t surprise Gail Cunningham, a spokesperson for the National Foundation for Credit Counseling in Silver Spring, Maryland. She told AOL Autos that millions of consumers do not know even the rate they are paying on their home mortgages, a sign that financial irresponsibility is not restricted to car buying.
There is little mystery as to how interest rates get lost in the shuffle at the dealer. The salesman typically starts things off by establishing a monthly payment the buyer can afford. Both parties leave the interest rate aside, at least for a while. “When you go to a car dealership, they don’t ask you what kind of interest you want,” says Broseus. “They ask what kind of payment are you comfortable with. Then they will try to fit you into the payment you told them, regardless of the rate behind the scenes.”
After contemplating a car purchase for months, buyers may be fixated on the size of the payment, too. But there are major benefits to getting low rates. A reduction of one to two points could save a buyer hundreds or thousands of dollars over the life of a contract, says Linda Stephens, vice president, consumer lending, at Wright-Patt Credit Union in Fairborn, Ohio.
At the right rate, consumers may even find they can afford a better car than they thought, she says. “For example, interest rates are lower for a new vehicle than for a used car. We may be able to help put them in a new car with a payment that was less than the used car they were looking at,” says Stephens.
If the interest rates and the payment end up too high, unwary consumers may end up paying for their mistake for a long time. The most serious problem is that they may end up “upside down,” owing more than their car is worth. This can be an absolute calamity when they want to sell it or trade it in, resulting in having to come up with thousands of dollars to pay off the old vehicle, which limits the amount of money that can be put down on the next car. Or, worse yet, the extra debt gets folded into the next loan. Either way, the buyer ends up saddled with extra costs for a long time, which means paying even more out in interest.
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But consumers have options to reduce their interest rates. Preparations to arrange financing should start early. Consumers should check their credit report at least three months before their purchase, pay any unpaid bills that it shows, and correct any errors in the reports. Buyers should also schedule their loan application for the time of the month when their credit card bills are mostly paid, according to Cunningham. For instance, if you regularly load up large sums on your credit card for business purposes but pay them off every month, you want your credit score to be calculated when you have no balance, she says. That will tend to reduce the total amount of debt showing up on their credit record. That in turn may lead to a lower rate.
After deciding on a model and the ideal monthly payment for it, she recommends that consumers undertake a little experiment to see if they can really handle the expense. For several months before the car purchase, they should “pay themselves” an amount equivalent to the payment they expect to make. If they expect to have to pay $368 a month, for example, they should put that sum into a savings account. “They should pay themselves to prove that they can do it,” she says. “It is no fun to have every cent spoken for and always be scrambling.”
Personal finance experts universally recommend that consumers shop around for the right rate as well as the right car. Broseus says people should phone ahead or check websites to get a rough idea of the rates that a bank or credit union is offering. That is preferable to applying for a large number of loans. In this way, lenders won’t be making too many inquiries about their creditworthiness. “More than about six inquiries in a month’s time frame is going to suggest the individual is desperate for money. This would actually drive down a credit score,” she says, adding that consumers should ask about any additional fees, “so you can compare to apples to apples. See if there is a credit bureau fee, an application fee, a loan generation fee, or a closing fee.”
Buyers may also qualify for discounts, too. KEMBA, for example, offers them if consumers make their loan payments with automatic deductions.
If a model is being offered with both a rebate and low-rate financing, line up your own financing first and then take the rebate, says David Adams, CEO of the Michigan Credit Union League. Adams has a rule of thumb to calculate how much buyers can afford to pay. Their total payments on their debt, everything from home mortgages to car payments and credit cards, should not exceed 40 percent of their gross monthly income. He also says buyers should try to stay away from long contracts if possible. They invariably increase financing costs.
“I personally don’t think that people should finance a new car longer than 60 months. It’s probably more prudent to go 36 or 48,” he says, adding that for a used car, it is even more important to shorten the term of the loan.
“If you can’t afford to stay within those parameters,” he says, “you probably should not be buying a car.”