Get Pre-Approved Before You Shop
Obtain a pre-approval from your bank or credit union before visiting a dealership. This gives you a baseline rate to compare against dealer financing and prevents you from negotiating the monthly payment -- a tactic dealers use to obscure the total cost -- instead of the purchase price.
How Dealer Financing Works
Dealers act as middlemen between you and a lender. The lender sets a buy rate (the minimum rate at which they will fund the loan), and the dealer can mark up the rate and keep the difference as dealer reserve. A dealer offering 7% when your creditworthiness qualifies for 5.5% earns the spread on every payment you make. Having a competing pre-approval counters this practice.
Total Cost vs. Monthly Payment
Dealers focus negotiations on monthly payment because a small change ($490 to $520) can represent thousands of dollars in cost over a 72-month term. Always negotiate the purchase price and financing terms separately, and calculate the total cost (principal plus total interest) rather than optimizing for the monthly payment alone.
New Car Incentive Financing
Manufacturers periodically offer incentive financing rates (0% or near-0% APR). These deals are worth taking when they apply to the vehicle you want. However, incentive financing is sometimes offered in lieu of a cash rebate -- calculate both scenarios before deciding.
Leasing vs. Financing
Leasing typically offers a lower monthly payment than financing the same vehicle, but you build no equity and face mileage limits and wear-and-tear charges at lease end. Financing costs more per month but builds ownership -- once paid off, you have a vehicle with no further loan payment, and no mileage restrictions. Leasing tends to suit drivers who want a new vehicle every few years; financing tends to suit drivers who plan to keep a vehicle well past the loan term.
Common Auto Financing Mistakes
Rolling negative equity from a trade-in into the new loan. If you owe more than your trade-in is worth, that shortfall gets added to the new loan balance, compounding the negative-equity problem.
Skipping a test of the payment against a full budget. Confirm the payment plus insurance and fuel fits comfortably alongside your other expenses before signing, not just that the dealer approved you for it.
Frequently Asked Questions
Is dealer financing ever the best option? Sometimes -- manufacturer incentive rates can beat outside financing, particularly on new vehicles. Compare the dealer's best offer against your outside pre-approval before deciding.
Can I negotiate the interest rate at a dealership? To some extent -- dealers can mark up the lender's buy rate, so a competing pre-approval gives you leverage to push back on an inflated rate.