The value of a new car drops dramatically as soon as you drive it off the
lot. That's because it then becomes a used car. It doesn't matter that you only
used it for five minutes - it's still used and is worth much less because of
This depreciation is an important concept to understand when dealing with
financing because while the value of your car drops immediately, your loan
principal drops more gradually. So if you try to sell the car too soon, you may
end up owing more on it than you can sell it for. That's called negative equity.
You can avoid getting into negative equity situations by following these
- Keep your car until it is paid off completely. Obviously, no matter
how much your car depreciates, you won't have negative equity if you
don't owe anything.
- Don't buy a car that is too expensive. If you struggle too much to
make the payments, you may decide to sell the car earlier than is
- Don't drag out your payments. You might get a slightly better
interest rate and your monthly payment will be smaller. But it will
staple you to that car for the financing term. Five years later you'll
still be paying for a car that may no longer fit your needs.
- Make the biggest down payment you can. This will help offset the
effect of depreciation and start giving you some positive equity.
Just because you've figured out what you can afford, it doesn't mean lenders
will agree. That's where your credit report comes in. Lenders decide how large a
loan you qualify for strictly by looking at your credit report. It's nothing
personal. They don't care what you look like, what you think about the status of
your personal finances or how nice you are to small animals. They only care
about the numbers that appear on your credit report.
The credit report will tell them your credit worthiness (How well have you
paid past debts?), financial means (Do you have sufficient income to repay a
loan?) and debt load (Do you have too much debt to be able to take on more?).
Many lenders will pre-approve a certain loan amount based on your income and
credit history. You'll know exactly how much car you can afford and be able to
leverage your financing deal against financing offered by the dealership.
- Dealer Financing The big advantage of dealer
financing is convenience. You buy and finance the car all at once. But
if the dealer is just reselling a bank loan to make a profit, the rates
won't be the best. Occasionally dealers offer special rates to get rid
of overstock, especially at the end of a model year. So make sure you
ask them about financing and compare their offer to your prearranged
- Banks You can usually get a lower interest rate at
a bank than a dealership, especially if you are an existing bank
customer. They'll probably require a 10-20% down payment to cover the
depreciation of the car in case you default on your loan and they need
to repossess your car. Smaller banks offer personal relationships, which
are important, but may not be able to compete with rates of bigger
- Credit Unions Credit unions have lower overhead
costs than banks which allows them to offer lower financing. Sometimes
it can be a full percentage point lower.
- Home Equity Loans You need to own a home to get a
home equity loan. You use your home as collateral for the loan - which
is a little bit scary. If you can't pay the loan, they can take your
house. But if you're sure you can afford it, a home equity loan is a
great way to go because not only can you get a lower interest rate, your
interest is tax deductible!
- The Internet As with everything else these days,
you can shop for car loans on the Internet. You miss out on any kind of
personal relationship, but you can get quick approval and very
- Trade-In Your old vehicle is basically a very large
coupon that you can trade for a discount when you buy a new vehicle. If
it's worth enough, you may be able to use it as a down payment.
Trade-ins are a convenient way to use the car you already own to help
purchase a new one.