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Cutting driving costs: financing

By Claes Bell · Bankrate.com
Wednesday, April 27, 2011
Posted: 1 pm ET

For many drivers, driving off the lot with a new or used car means taking on a hefty auto loan. Americans carried $408 billion worth of auto loan debt in 2010, according to CNW Research, up from $379.7 billion in 2009.

For those with auto loans, paying interest on that debt is a significant part of the cost of car ownership. According to the AAA study that touched off this continuing series on cutting driving costs, financing charges account for $823, or 9 percent of the $8,776 AAA says it costs to drive the average American sedan for a year.

Now $823 isn't even close to the $3,728 the AAA says drivers forfeit to depreciation every year, but that doesn't mean it wouldn't be nice to hold on to a little bit of it you can. Here are some ideas to help you reduce financing charges.

  • Shop for cars and auto loans separately. Many auto buyers choose to get their auto loans the same place they get their cars: the dealership. The problem with that approach is dealers and borrowers are often working at cross purposes. A borrower's main focus is  getting the lowest interest rate possible, since that both lowers their monthly payment and their overall auto costs. But dealers are oftentimes paid a "dealer reserve," or a sort of commission, to sell customers on a loan from a particular auto lender that may have a higher interest rate than the customer might otherwise qualify for. To make sure you're getting the best rate you can, it pays to shop for an auto loan before you even set foot on a dealer lot. In the end, the dealer may be able to offer you a better rate, but if they don't, you'll have another offer standing by to ensure you don't pay too much.
  • Buy a cheaper car. It may seem obvious, but all things being equal, the bigger the auto loan, the bigger the finance charges you'll eventually pay. For instance, say you buy a car for $20,000, putting 20 percent down and ending up with a 60-month auto loan for $16,000 at the Bankrate national average rate of 5.58 percent. By the time the loan is paid off, you'll have paid out $2,372, or about $40 per month, in interest, according to Bankrate's auto loan calculator. In contrast, raise that loan principal to $30,000 and you'll pay $4,448.60 in financing charges.
  • Pay off your loan more quickly. Taking out a loan with a shorter term can yield two interest-saving benefits: a lower auto loan rate and a quicker amortization. But don't take my word for it. For instance, let's look at that $16,000 loan. If you financed it with a 36-month loan at the Bankrate national average, you'd end up paying $1,385 in interest over the life of the loan. With a 60-month loan, which is actually lower than the national average, according to the Federal Reserve, you'd end up paying $2,372 in interest, an increase of nearly a grand, for those keeping score at home.
  • Put more money down. More money down means a smaller principal, which translates to lower financing costs. If you buy a car with no money down, you can expect to pay significantly more in interest charges over the life of your auto loan.
  • Refinance to a low-interest auto loan. Average auto loan rates are at all-time lows in Bankrate's weekly survey, so if you got a high-interest auto loan a few years ago that you're above-water on, it may make sense to look for an auto loan refinance. Shaving a couple of percentage points off your loan probably won't make you rich, but it will result in lower financing costs, provided you don't extend the term of the loan.
  • Buy a car with cash. Of course, the best way to cut out financing charges altogether is buying a car with cash. While this option is probably out of reach for many new-car buyers, used-car buyers may be able to swing it, giving a little more ammo to all the used-car advocates out there. Those that can manage to buy with cash it will opt completely out of that $823-a-year cost projected by the AAA, which could become $5,110 invested at 8 percent return over the typical 5 years people spend paying off their auto loan.

What do you think? Anything I missed?

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