Personal Finance

July Fourth car shopping? Avoid these five big mistakes

Key Points
  • Exactly how much you’ll actually pay for any given model depends both on the negotiated price and the terms of your loan.
  • You should know what you're willing to pay and be armed with a pre-approved loan that comes with the best interest rate you can find.
  • Telling the dealer a monthly amount you're willing to pay could remove some of your ability to negotiate on the price.
Mistakes to avoid while car shopping

With Independence Day specials in full swing at car dealerships, it’s one of those times of the year when shoppers will flock to showrooms in search of a good deal.

If you plan to join them, do yourself a big favor: Do some legwork.

Despite a car being one of the biggest purchases that consumers will ever make, many people end up in showrooms without planning for the transaction. While things might go smoothly, it also could end up costing you more.

Source: Patrick T. Fallon | Bloomberg | Getty Images

The average price of a car today is about $34,600. Exactly how much you’ll actually pay for any given model depends on the negotiated price and — assuming you finance the purchase — the terms of your loan.

The average amount financed is $31,020, according to recent data from Edmunds, an online shopping guide. The average auto loan length is 69.5 months — just shy of six years. Generally speaking, the longer the loan term, the more you’ll pay in interest.

Here are some big mistakes that can lead to overpaying for a car.

Telling the dealer your monthly budget

Sure, you need to know what you can afford on a monthly basis. However, if you go into a dealership with that number instead of the price you’re willing to pay for the car, you’re basically eliminating some of your ability to negotiate on the price.

“You have to know what a fair price for the car is,” said Gary Guthridge, manager of the consumer lending portfolio at Navy Federal Credit Union. “The monthly payment is determined by the interest rate and terms of the loan.”

The cost of buying a car

Loan aspect March 2018 March 2013
Average length (in months)69.565.7
Average monthly payment$525 $455
Average amount financed$31,020 $26,533
Average interest rate5.70%4.40%
Total finance charges$5,474 $3,372
Total cost$36,494 $29,905

In other words, say you tell the salesperson you can afford $500 a month. You are shown a $31,000 car and told you can get a 72-month loan with a 5 percent interest rate and your monthly payment will be $499. Total interest would be about $5,000 over the course of the loan.

While the monthly amount would fit your budget, you could find out later that you could have gotten a better interest rate and that the car you bought typically sells for less than what you paid.

“Never tell the dealer what you want your payment to be,” Guthridge said. “Tell them what you’ll pay for the car and be willing to walk away.”

Not getting loan pre-approval

Before you even step foot in a dealership, you should secure pre-approval for a loan at the best interest rate you can find.

While many dealers offer their own financing, the rate might not be as good as the one you can get from a bank, credit union or other lender.

Auto loans hitting record levels

If the dealer rate is better, great. If not, you are prepared with the best rate available to you.

“If you don’t have that rate in your pocket to negotiate with, you won’t get the best offer from the dealership,” Guthridge said.

Not knowing your credit score

This ties into the pre-approved loan. The interest rate you’ll pay on your car loan depends at least partly on your credit score. The higher it is, the better rate you can secure.

How credit scores are viewed*

Excellent750 and over
Good 700-749
Fair 650-699
BadBelow 600

This matters, because many of the advertised rates for dealer financing are for consumers with excellent credit. Knowing where your credit score falls can help figure out whether you’re entitled to the best deal even if it’s not immediately offered.

Not paying off your old loan

Some consumers plan to trade in their car as part of their purchase, only to find out it’s worth less than what they still owe on it.

Of course, dealers are usually happy to roll that negative equity into your new loan.

Say your car is worth $6,000 and you owe $10,000 on it. Assuming you don’t have the $4,000 lying around to pay it off — most consumers do not — it would get added to the purchase of your car.

For a $31,000 car financed at 5 percent for 72 months, another $4,000 would add about $64 to your monthly payment.

While that might not bust your budget, it’s a slippery slope. Three or four years later when you want a new car, you will face the same situation.

“That cycle will keep going,” Guthridge said.

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Saying yes to dealer add-ons

Once you reach the finance office, you could be offered options like extended warranties or sealants or different types of insurance.

Generally speaking, they really aren’t necessary, Guthridge said.

“All it does in increase your payment,” he said.

However, one option typically offered could be worthwhile if you don’t already have it: gap insurance. If you total your new car, it will cover the difference between what your vehicle is worth and what you owe on it.

Standard auto insurance typically only covers your car’s value, not the balance on your loan. Because new vehicles lose some of their value right after they’re sold, gap insurance can come in handy if your car is totaled and you owe more than its value.

“If you don’t have equity in the car, this can be worth it,” Guthridge said.

Be aware, though, you might pay more for it at the dealer than you would elsewhere.