Auto loans: Negotiations salted with landmines

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Just gone toe-to-toe with an auto salesman and pleased with the price? Congratulations. But don’t relax now. It’s time to talk financing, and that exercise means dodging landmines.

Here’s a look at some of the tricks that lenders may try to slide by unsuspecting car buyers.

The monthly payment trap

Step into the financing office at most dealerships and all they’ll want to talk about is the monthly payment and just how low they can make it go. Beware. Super-low monthly payments mean longer terms, and that means more money sucked away as interest over the length of the loan. Walk in prepared to discuss interest rates, finance charges and the length of the loan. Customers who simply nod when a dealer ticks off a monthly payment amount often get stuck paying a higher rate than necessary.

On being upside down

Be especially wary of “special” deals that require no money down or that waive payments for three months.

“There’s no such thing as too good a deal,” said Burke Leon, a car dealer in Southern California and author of
The Insider’s Guide to Buying a New or Used Car.

Those who opt for no down payment, or a low one, and lower monthly payments stretched over a term of, say, five or six years, may get caught “upside down.” That means a year or so into a loan the borrower may actually owe more on the car than it’s worth. That’s right. The outstanding principal on the loan will be greater than the actual value of the car.

“It’s called being in a hole,” Leon said.

To avoid this fate, most experts recommend making a down payment of 20 percent or more and financing the remainder of the cost in the shortest loan possible. At the same time, auto loan payments should fit, but not strain, a person’s budget.

The dealer as middleman

Experts also urge people to shop for auto loan rates before setting foot in a car dealership. Check out local banks and credit unions. Shop online. Head into the auto dealership with approved financing in hand.

“Instead of you having to try to prove you’re credit worthy, they have to try to beat the rate. It changes the whole game,” Leon said.

And as W. James Bragg points out in
The Car Buyer’s and Leaser’s Negotiating Bible, the car dealer is little more than a middleman when it comes to financing. Often dealers bump up the loan rates of the banks and finance companies that they do business with.

“Every year hundreds of thousands of car buyers who could have qualified for direct auto loans at lower rates end up paying a lot more money
to the same banks, with the difference going to the car stores,” Bragg writes.

The Rule of 78

While most banks and credit unions offer consumers auto loans with simple interest, many loans done through dealers calculate interest differently. The loans are weighted so that all of the interest is paid off in the first year. This type of financing is called the “Rule of 78.” These loans are bad news for a person who wants to cut into the principal by prepaying and for anyone who wants to sell the car before the loan term is up. People with these loans run the risk of getting caught “upside down.”

Those lovely little add-ons

Sometimes dealers will try to add charges of as much as $100 for shuffling a few papers back to the lender.

“What a dealer is trying to do is maximize the profit on each sale. One of the techniques is to throw these charges in,” said Jack Nerad, co-host of
America on the Road radio show and author of
The Complete Idiot’s Guide to Buying or Leasing a Car.

“Identify every cost you’re being charged. It’s like going over a check in a restaurant,” Nerad says. “Ask for a reasonable explanation. And if you don’t get it, say you won’t pay. If you hold their feet to the fire, eventually they’ll back down.”