Financing a car 101: things you should know before you sign

You've searched, compared and haggled, and finally you've settled on the car you want at the price you're willing to pay. But, you still have to line up a loan to pay for it. Before you sign the financing sheet your dealer puts in front of you, you need to put the same effort into obtaining a loan. By shopping around and reading the fine print, you can potentially save yourself significant money, for years to come.

Shop around
You likely looked at several cars, in-person or online, before you settled on the car you wanted to buy. You should do the same thing when it comes to your financing options. Each financial institution and dealership has slightly different criteria that they use to determine whether to offer a loan and what interest rate to charge. By having multiple offers to compare, you can make sure you're getting the best deal on financing.

You may have heard that each time you apply for credit an inquiry appears on your credit report, which also dings your credit score. However, if you submit all of your applications in a short period of time — between 14 days and 45 days depending on which credit scoring formula is used — it will only count as one inquiry for credit scoring purposes. For example, if you apply for a loan from two banks, a credit union and the dealership within a 10 day time frame, that will only count as one inquiry.

Benefits of a cosigner
If you don't qualify for a loan, or can only get a loan with a high interest rate, ask the lenders if having a cosigner would help. A cosigner makes the loan less risky for the bank; if you don't make the payments, your cosigner is on the hook. As a result, the bank may be willing to make a loan, or offer a lower interest rate, than it otherwise would have. However, it may be difficult to find someone willing to take on that responsibility because of the risks it carries to the cosigner.

Term of loan
The term of the car loan makes a big difference in the amount you pay each month and the total cost of the loan. Long-term loans offer the temptation of a lower monthly payment. However, because you're borrowing money for a longer period time, you'll typically pay more interest over the life of the loan. In addition, the longer the term of your loan the more likely it is that you will be upside down, meaning you will owe more on your loan than your car is worth. Your car's value depreciates over time and, unless you pay down the principal on your loan quickly or have a significant down payment, the loan balance will exceed the car's value. With longer term loans, this is more likely because a smaller amount of each payment goes to principal.

Know how interest is calculated
On many car loans if you pay down your balance early, you'll owe less in interest because the amount of interest you owe is calculated each month based on the remaining balance of your loan. However, if your car loan uses pre-computed interest you pay the same amount of interest even if you pay it off ahead of schedule, because the interest is calculated up front and assumes you pay the loan off as scheduled — with no adjustments.

If you're certain you won't pay off your loan ahead of schedule, having a loan that uses pre-computed interest isn't a huge issue because, according to the Consumer Finance Bureau, there's little difference between simple interest and pre-computed interest. Also, if you have any desire to pay off your loan early, compare the early payment penalties, if any, imposed with each loan.


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