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Paying For Your Vehicle

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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:
  • Have ample cash available.
  • Want to avoid paying interest and finance charges on loans and leases.
  • 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.
  • You will pay more for your vehicle in interest and finance charges than you would if you paid cash.
  • 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.
  • Because your vehicle loan is one of your debts, it may also lower your debt-to-income ratio and disqualify you from financing another asset such as a home.
  • Financing may encourage you to buy a more expensive vehicle than you should consider for your income and obligations.
  • You can lose your vehicle if you cannot make the payments.

Most lenders keep the legal title to financed vehicles 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.

There are three options available for financing your vehicle.

1. Direct Lender

Talk with your 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.
  • Consider the ease of doing business with a lender. Does it offer online services such as bill payment? Can you access a service representative when you want to discuss your loan?

Remember that 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 does not mean that you are obligated to accept a loan, unless you sign a contract. It 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.

2. 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.

Because the interest on home equity loans is generally deductible for federal income tax purposes, you may also get a valuable tax deduction for your interest payments on the loan. 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. If you cannot make your loan payments, the lender can foreclose and you can lose your home. Before you borrow, make sure you can make the payments. 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. Look for no-fee home equity loans offered by financial institutions and credit companies.

3. 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.

You may be required to:
  • Relinquish a rebate or make a larger down payment to get the financing.
  • Pay a higher price for a vehicle.
  • Buy additional services or merchandise to qualify for the loan. The best rates may be offered only on certain less-desirable models or for a limited time period. There may be limits on the length of the loan.
  • Make a balloon payment.
  • Pay extra points as part of the loan. If you decide to accept a dealership loan, read your contract and your sales invoice to make sure you understand all the terms and conditions.

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