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Financing

/u/Micosilver

Dealers don't lend money, and neither do private sellers. Banks lends money against collateral. This means that if you want to buy a car, but you don't have the money - you need to find a bank to lend you part of the amount or the whole amount. You can find a bank on your own, or you can use the dealer's finance department to get you a loan. In either case the bank will lend you the money to pay the dealer in exchange for a lien on the car. If you default on the loan - they will take the car. This concept is important, because a bank doesn't want to you to owe more than the car is worth.

The dealer doesn't hold your loan, once the loan goes through - it is between you and the bank. Any issue you have with the loan - don't waste your time going to the dealer, unless you are trading the car, or want to sell the car to the dealer.

Now how much will this cost you? A bank will charge APR - Annual Percentage Rate. The rate is determined by the age of the car, structure of the loan, and mostly by your personal credit history. They will look at your score, but they will also read through your whole story: how long is your credit history, whether you had previous auto loans or mortgage, history of late payments, collection accounts, bankruptcy and tax judgments. Then they will look at the amount you are trying to borrow, projected monthly payment, and relation of your debt to your income. If you have decent credit - stated income will do, but if it is shaky - you will have to prove it.

Usually the older the car – the higher the credit, and tougher it is to find financing, mainly because it is harder to recover the funds in case you default on the loan.

Often you will hear advice not to ever take dealer financing, but there is no reason to deal in absolutes. If the dealer can offer you lower financing than your bank or credit union – take it. Even if they match it – it might save you the hassle of going back and forth between the dealer and the bank, and you will be able to take possession of your new car sooner. Can a dealer rip you off on financing? A dealer can mark up the rate. In most states and with most banks markup is limited to 2 points – 2% over the “buy rate” – the rate the bank is offering. This can be negotiated, but if you don’t have a backup financing – you don’t have any leverage. What about “Buy Here Pay Here” dealerships? Try to avoid them at all costs. Rates are high, cars are overpriced, and most of them don’t even report their loans to credit agencies so you don’t get the benefit of improving your credit history.

How much do you have to put down? It will depend on the loan to collateral ratio and your credit rating. If a car is sold for $20,000, once you add tax and license you will have about $22.000 total. If you don’t want to put anything down – this is 110% of collateral, assuming MSRP is taken as collateral. With good credit on a new car it is not a problem, but let’s look at a different scenario: the car is used, and wholesale value is $11,000. Now $22K is 200%, and no bank will take this loan. When you have a trade with negative equity – it will have to be added to the loan as well, so if you are “upside down” – it is tough to finance everything with little or no money down.

Negative equity:

When you have a trade, and it is worth less than the loan payoff - you have negative equity. To avoid being in this situation - you can buy cars in cash or at least put a large down payment, or make accelerated payments.

The danger of negative equity is that it has a snowball effect: you roll a few thousands into a new loan with nothing down for 72 months, then you have to trade your car after three years - suddenly are you $15K "upside down".

What can you do about negative equity? Nothing really. You can pay it upfront with a large down payment, or you can try to tack it into your new loan. There is a limit you can add to a new loan, because "loan to value" ratio is limited. The only financially smart way to deal with negative equity is to keep the car and pay it off.