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Many financial advisers suggest that your total monthly
vehicle payments — whether you own one vehicle or
more than one — should not exceed 10 percent to
20 percent of your monthly net income. This amount
should include loan or lease payments, fuel costs,
maintenance, repairs, insurance premiums, other annual
payments and fees associated with your vehicles.
Paying Cash
Paying cash is often the simplest and least expensive
way to buy a vehicle if you:
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Have ample cash available.
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Want to avoid paying interest and finance
charges on loans and leases.
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Are not worried about missed investment opportunities.
Financing
Financing may be a good idea if you intend to
keep your vehicle for a long time or you do not
have the cash to purchase the vehicle. At the
end of the financing period, the vehicle will
belong to you. There are drawbacks to financing.
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You will pay more for your vehicle in interest and
finance charges than you would if you paid cash.
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Your vehicle may depreciate faster than your
loan is amortized. You may owe more on your vehicle
loan than you can get from it if you sell it before
the loan is paid in full.
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Because your vehicle loan is one of your debts,
it may also increase your debt-to-income ratio and
disqualify you from financing another asset such as a home.
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Financing may encourage you to buy a more expensive
vehicle than you should consider for your income
and obligations.
When financing a vehicle, most lenders keep the
legal title in their name until the loan is paid
in full. If you default (do not make payments as
required in your loan contract), your lender may
be able to repossess the vehicle.
Three Financing Options
Direct Lender
As a current customer, you may be able to get
a better interest rate than you would from
another lender or a dealership. Interest
rates are not the only point of comparison
when you are shopping for financing.
- Compare the amount that the lender is willing to finance,
the down payment required, the loan period, grace periods,
other fees and charges, terms and conditions and requirements
such as insurance coverages.
- Does the lender offer the service of automatic online bill payment?
- The best loans are those that charge simple interest and have a
low annual percentage rate (APR) with no prepayment penalties.
- Consider prequalifying for the best loan available from financial
institutions before you negotiate with a dealership. Prequalification
simply enables you to understand your true borrowing power and
gives you the security of knowing that you already have funds
ready to make the best possible deal. Making too many
applications can drive down your credit score.
Home Equity Loan
You may be able to use the equity in your
home — the difference between the market value
of your home and the amount of your mortgage
debt — as collateral on a home equity loan.
By tapping into that equity you can get the
funds to buy a vehicle for cash. Generally,
you have a choice of taking a lump sum through
a second mortgage or by refinancing your first
mortgage and taking out cash. Or, you can take
a home equity line of credit, borrowing only
when you need cash and repaying it like a credit card.
The interest on a home equity loan is generally
deductible for federal income tax purposes. Also,
rates are typically lower than some other
types of loans because the loan is secured
by your home.
But there are risks as well. Borrowing against your
home is a poor choice when the price of housing
is falling. If the equity you use as collateral
disappears, the lender may suspend or terminate
access to your home equity line of credit or, upon
default, foreclose and take possession of your home.
Dealership Financing
Most vehicle manufacturers and many dealerships offer
their own financing. These loans can be tempting because
they may offer low interest rates and an easy application
process. If you can find manufacturer or dealership
financing that is superior to any other financing
available to you, consider it strongly. However,
dealerships’ low financing rates are often offset
by other costs negotiated by the dealerships. Be
cautious and read the fine print for all terms and conditions.
Protecting Your Investment
When you finance a vehicle with a loan, you are usually
required to buy insurance coverages to protect the lender.
Auto Insurance
Most states require you to carry a minimum amount of
liability coverage and many states require uninsured
motorists coverage. Most lenders do not require liability
insurance but do require comprehensive and collision
coverages to repair or replace the vehicle if it is
damaged or stolen. Make sure all coverages are in effect
before you take possession of the vehicle.
Credit Life Or Credit Disability Insurance
These policies continue your loan payments if you
become disabled and will pay the loan in full should
you die while your financing is in effect. Coverage
may be optional but can be essential for you and your
family if your financial assets are limited.
GAP Insurance
This insurance covers the difference between a
vehicle’s stated value in a finance contract
and the amount an insurer would pay if the
vehicle is damaged beyond repair or stolen
before the end of the finance period. You
can purchase GAP coverage from the dealer
or lender, which usually costs between $200 and $600
for the term of your loan.
Debt-Forgiveness Coverage
Sometimes called debt-elimination coverage,
this product offers the same (or similar) benefits
to the borrower as credit life insurance. It
eliminates the debt if the borrower dies or it
cancels or postpones the monthly payment if the borrower
becomes disabled, unemployed or suffers some
other hardship. It is issued directly by the
lender not an insurance company.
Extended Warranties
These warranties lengthen the period covered
by a manufacturer’s warranty on the entire vehicle
or on individual parts and systems. Because most
regular full warranties provide coverage for
3 to 4 years, or 36,000 miles to 50,000 miles,
depending on the manufacturer and the model, you
may not need an extended warranty. However, you
may want an extended warranty on items that are
not covered by the original warranty or are only
covered for 1 year or less.
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