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Auto Financing Guide: How to Zero In on Your Best Options

New automobile-financing options, such as longer loan terms and new lending sources, drive up the cost of loans. Although we welcome increased federal oversight for automobile loans, new guidelines also could lead to additional costs for consumers.

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Buying a new vehicle is twice the hassle when you finance your purchase. In 2015, the factors that influence the type of deal that you get on an automobile loan are more mystifying than ever before. Consumers increasingly encounter terms and offers that appear to be attractive at first glance but are riddled with financial consequences.

In particular, lenders increased the amount of time that consumers have to repay a loan. We found loans that give you up to 8 years to repay, although 7 years is a more typical extreme. Of course, such loans deliver the lowest monthly payments, but they drive up the overall cost through additional interest payments. Likewise, we found that a new automobile-financing option—so-called peer-to-peer financing—typically costs more than what banks and credit unions charge. Meanwhile, automobile-financing companies and the dealers who originate automobile loans face tougher scrutiny from the federal government to decrease the likelihood that such companies will rip you off, but new federal guidelines might lead to additional costs for borrowers.

Finally, concerns that subprime lending for the automobile market could lead to another bubble burst appear to be unfounded, experts tell us. Subprime loans are loans that are approved for people who have a credit score that’s typically lower than 640. Although a subprime bubble burst in automobile lending could make it more difficult for all consumers to secure an automobile loan, experts whom we interviewed indicate that the concentration of subprime automobile loans leveled off to about 30 percent at press time from a high of 38 percent in 2009.

LONGER LOANS. Nearly 1 in 4 automobile loans have a term that’s between 73 and 84 months (or 6–7 years), which is at least 13 months longer than the previous high of 60 months, says Melinda Zabritski, who is the senior director of automotive finance at Experian Automotive. Securing a loan that gives you as many months as possible to pay off your vehicle purchase might be attractive to keep monthly payments as low as possible. However, you’ll pay more for the vehicle over the long haul because of the accrual of interest. In other words, the longer that you have to pay off an automobile loan, the higher your total cost.

Breaking Down Your Loan

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For example, a $25,000 automobile loan that has a 4.59 percent interest rate for 60 months results in a $467 monthly payment and a total cost of $28,020 over the life of the loan. If you borrowed $25,000 on an automobile loan that had the same interest rate but got 84 months to pay it back, your monthly payment would be only $349, but your total cost would rise to $29,278. Consequently, you’d pay an extra $1,258 to get the lower monthly payments on an 84-month loan.

Furthermore, Zabritski says, consumers typically pay a higher interest rate on a 73- or 84-month loan than they would on a 60-month loan. For instance, if your credit rating were “poor” (below 640), you could pay as much as an extra percentage point in interest on an 84-month loan compared with a 60-month loan. Using the aforementioned comparison, a 5.59 percent interest rate on an 84-month loan would make the total cost $30,267, or $2,247 more than what you’d pay for the same vehicle on a 60-month loan.

Zabritski recommends that consumers evaluate how many years that they plan to own their vehicle before they sign on to a long-term loan to determine whether they’d be upside down, or owe more than what the vehicle was worth, on that automobile loan. Vehicles can depreciate up to 23 percent in their first year, according to Bankrate.com, and the vehicle will depreciate around 15 percent each year thereafter.

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