Preventive Law: Car Purchases and Financing Traps By: CPT Daniel A. Papajcik Before I go to the dealership to buy a car, do I need to know my cost of financing by shopping around for interest rates? Yes, to protect yourself and to find the best offer on financing, you should compare different rates. This article is designed to help you understand how car dealers profit and thus better prepare you to avoid common pitfalls when purchasing a car from an auto dealer. How car dealerships profit Car dealerships profit from two transactions: selling you the car itself and financing the purchase of the car. Dealers profit on the difference between the price they pay for a car and the price they sell you the car. Car profit is not where the bulk of profits are made though. Dealers earn a substantial profit on the money they lend you to enable you to purchase the car. Dealers attempt to lend you money at a high interest rate. After you sign the car contract, they sell your financing to a financial institution who gives them a lower interest rate based on your credit score. The difference between the high interest rate the car dealer offers you and the low interest rate the car dealer sells your contract for gives the car dealer a profit. Below are two common pitfalls consumers should avoid when making a car purchase. Common pitfall #1: Consumers do not shop for the best auto loan interest rates Do you know the interest rate a bank will charge you for borrowing a particular amount of money? Interest is the amount of cash you pay to borrow money. Many consumers do not investigate how much money they can borrow for a car purchase and at what interest rate. Before you enter the dealership, find out the interest rate other banks will charge you to borrow the anticipated purchase price of the car. Since, you will be financing your car, consider sources other than the dealer to finance your purchase. This means you will need to apply for a car loan from other financial institutions (i.e. a bank, credit union, or financing company). Before contacting the bank, you should have an estimate of how much you will need to borrow to purchase the car. While car values vary, you can gain a reasonable estimate by finding out the cost of similar year, make and model vehicles in your market. After you tell the financial institution the amount you want to borrow, the financial institution will give you Truth-In-Lending Act (TILA) disclosures. TILA disclosures provide the annual percentage rate (the cost of your credit as a yearly rate), the finance charge (dollar amount the credit will cost you), the amount financed (the amount of credit provided to you), the total of payments (the total amount paid after all payments), and total sale price (the total cost of your purchase on credit, including your down payment). The financial institution will also tell you the length of the loan. Combined, these indicate your creditworthiness. It is better to have this information from two different financial institutions, so you can compare these offers against the dealership’s offer. When the dealership offers you financing, the dealership is required to give you the same TILA disclosures as the financial institutions. The dealership is required to allow you to leave the dealership with those disclosures on paper and in your hand. While these disclosures are often found in the contract of sale, that is not a reason to prevent you from leaving with the disclosures.
It is recommended you do not sign the contract of sale without comparing the cost of financing. Since many consumers do not have other offers for financing from a bank, they are unable to find out if the dealership’s offer is the best. Knowing your cost of financing from multiple institutions is the first step to protecting yourself. How do you know which financing offer is best? Because you have multiple financing offers from other banks, you can compare them to the dealer’s financing offer. The “total of payments” from the TILA disclosures is a good indication of the best loan. However, you should also compare the length of time for repayment to determine the overall best loan.
Common pitfall #2: Consumers negotiate monthly payments, not price Understand the total cost. A monthly payment of $100 over 6 months totals $600. A monthly payment of $90 over 7 months totals $630. While this math seems simple, many consumers do not take time to evaluate the total cost. As illustrated above, the lower monthly ($90 vs. $100) payment results in you paying more money ($630 vs. $600). If you understand this concept, you can make the right choice for your financing. You should examine the total cost of the financing and the car combined and compare it to your financial institution’s offer. Dealerships often try to negotiate the monthly payment and not the total purchase price of the car. It is recommended you always negotiate the total purchase price of the car and not the monthly payment. You will be a better consumer if you know your cost of financing and negotiate the purchase price when making your car purchase.