This is a guest post from Andrew Latham, content editor at SuperMoney.
If you have an auto loan, chances are you’re overpaying in interest. That’s sad. We all have better things to spend our money on. We’re not talking about chump change, either.
The average cost of a new light vehicle (cars and light trucks) hit a new high of $31,790 in 2016, according to the Office of Energy Efficiency and Renewable Energy. That's a bargain when you compare it to the average price for a new truck, $35,829. That’s a lot of dough. Particularly when you consider the median income in 2016 was $59,039, per the U.S. census.
[The Average Price of a New Light Vehicle 1970 – 2016]
The good news is you can save big on your next car – or even on your current auto loan – by avoiding two common mistakes we'll outline in a minute.
Of course, two major influencers of how much you spend on an auto loan depends on your credit and the cost of your car.
Let’s say you’re buying a brand-new car — the Toyota Camry, which has been the top-selling car in the U.S. for the last 15 years — and decide to splash out on a top-of-the-line XSE V6 Sedan. That will set you back about $32,000. Those monthly payments can vary greatly depending on the terms of your loan, but if you follow the two tips spelled out in this article, you could easily save $5,000 on your financing costs.
Tip one: Commit to negotiating the rate of your auto loan
This may seem obvious advice but a Federal Reserve survey found that less than one in three (32%) car buyers negotiate the interest rate on their loans. It’s not that Americans don’t enjoy a good haggle. The same survey indicated that three out of four (76%) auto buyers do negotiate the purchase price of their vehicles. Finding the best interest rate possible for your auto loan is just as important – maybe more important — than negotiating the purchase price.
[Most important factors for auto buyers]
Tip two: Choose the shortest auto loan term you can afford
One of the easiest ways to save money on an auto loan is to choose a shorter term. For example, you could save more than $2,000 on a $32,000 auto loan by choosing a 36-month term instead of a 72-month term.
A shorter term will increase your monthly payments, which could limit the vehicles that fall within your budget. However, if you can’t afford the monthly payments, you may want to look for a less expensive car anyway.
[Financing cost comparison by loan term ($32k)]
How much can you save by shopping around for an auto loan?
The annual percentage rate (APR) of an auto loan can vary substantially from one lender to another. It’s not unusual to see rate differences of three to four percentage points for the same car and borrower. Finding the lowest possible rate is particularly important now that auto loans with terms of 72 or even 84 months are becoming more common.
Over a 72-month period, a 3% reduction on a 7% APR could save you $4,781 on a $32,000 loan.
[Financing cost comparison by loan term ($32k)2]
In case you’re wondering, a 72-month loan is not an extreme example. In 2016, one in three auto loans for new cars had terms of 73 to 84 months, according to the State of the Automotive Finance Market report from Experian, released in March 2017.
If comparing rates and getting shorter loans can save you so much money, why don’t buyers do it more often? These are three common reasons:
- Shopping for rates from multiple lenders can be slow and time-consuming.
- Some consumers don’t understand how auto financing works or the savings you can get from negotiating lower rates and shorter terms.
- Many consumers want to get the best car possible while staying within their monthly budget, even if it means paying more over time in interest rates.
According to the Federal Reserve survey mentioned earlier, 27% of consumers the cost of the monthly payment was the most important factor when shopping for a car loan. In contrast, only 6.1% considered the interest rate of the loan as most important.
How can you save money when you don’t have time for rate shopping?
Again, three steps:
- Shop around for the best rates.
- Choose the shortest term you can afford.
- Don’t overstretch your monthly budget.
The problem is that applying and comparing rates takes time. It’s not always obvious what terms and rates you’ll qualify for when you complete an application, and it can take days or even weeks to get a reply.
But there are options to help you simplify the process. For example, SuperMoney’s auto loan offer engine allows you to apply with multiple lenders without hurting your credit. Instead of filling dozens of online applications or visiting banks and credit unions, fill in one form and get lenders to compete for your business. After a few seconds you’ll see what loan offers you prequalify for. You can then compare apples to apples in one screen and see which loan offers have the best rates and terms.
Whatever method you decide to use, it's extremely important to compare the total cost of the loan, not the monthly payment. The monthly payment of a loan may determine what you can afford, but the total cost of the loan will tell you which is the best deal.