On this week’s episode of Making it Count, hosts Cristina and Will get the inside scoop on the car buying process from two lending experts at Addition Financial – Kevin Algeo and John Langlois. They learn what it takes to secure financing, choose their dream vehicle, and drive off the lot without breaking the bank.
Will asks Question 1: "I want to start with a question that I think is at the top of the list for first-time buyers and repeat buyers. What’s the best way to figure out how much you can afford to spend on a car?"
Kevin responds: "If you plan to finance your car, we generally advise that buyers look at their monthly budget and determine how much they can afford to pay each month toward that loan. Typically between 30% to 50% of your monthly budget should be spent on those fixed expenses: housing, car payment, credit cards, etc. You can then plug that monthly amount into an auto loan calculator to get a rough estimate of what you can afford to spend on a vehicle."
Cristina asks Question 2: "That seems very straightforward, but are there any exceptions?"
John responds: "Of course. For example, if you have your house paid off, you’re not spending a large portion of your income on a mortgage. That money could go toward a car loan payment and would still keep you within that 30% to 50% range. We all calculate and pay our bills on a monthly basis, so really paying attention to how much will be coming out of your checking account each month to pay for that car is critical."
Kevin also responds: "Right. And if your income fluctuates from month to month, you should always err on the lower side. The months you make less should set the standard for how much you can afford, that way you have a cushion on months you make more."
Will asks Question 3: "What about trade-ins? How do they figure into the calculation?"
Kevin responds: "Research! Doing plenty of research before you ever set foot into the dealership is key. That way you know exactly what your vehicle is worth. Some websites we recommend using are: The National Automobile Dealers Association, Kelley Blue Book, and Edmunds."
John also responds: "Some dealerships, like CarMax, will even appraise your trade-in and within 30 minutes you’ll have a price guarantee for seven days. That’s a good way to know what a dealership is likely to pay for your vehicle."
"And if you plan to use those websites Kevin mentioned, make sure you are being honest with the condition of your vehicle. You don’t want to say it is ‘super clean’ when it might actually be a little rough around the edges. The best strategy is to lower the amount you see just to set your expectations in the right direction before you get into the dealership."
Kevin follows up: "Another number you want to take into account is how much you currently own on your trade-in. If you are still paying off your loan for that vehicle, you’ll need to know that number to factor into your new vehicle purchase."
Cristina asks Question 4: "Is there a right or wrong time to buy a car? I’ve heard a lot of conflicting information."
Kevin responds: "Holidays are a great time to buy a car because dealerships typically have a lot of extra incentives available during those times."
John also responds: "Very true. And because they have a lot more sales during those times, typically dealerships can be a little more flexible with each transaction. A dealer that is not selling very many cars is definitely not going to be as flexible as one that is. Not a guarantee, but it does help. Another time to consider is around end-of-model year."
Cristina asks a follow-up question: "And that falls around when? When does the end-of-model year usually fall?"
John responds: "It’s typically around the later end of the current year. For example, 2020 models will start to die out toward the end of 2020. Although, I’ve seen the next year models hit the dealer lots as early as June. Manufacturers like to get their shiny new toys on the lots as quickly as possible. So they ask the dealers to push the current year models off the lot using extra incentives. That’s how you get a good deal."
Kevin also responds: "One other time to consider buying a car, if you plan to finance, is when interest rates are low. Even a couple of percentage points could mean thousands of dollars over the life of your auto loan. So when rates are low, like right now, it’s a good time to apply for a loan and buy a new vehicle."
Will asks Question 5: "When interest rates are low, I’d imagine that’s also the best time to refinance a car loan. Is that right?"
Kevin responds: "Absolutely. Refinancing with a lower interest rate can lower your monthly payment and save you money over the life of your loan. Rates are so low right now, I’ve seen them drop 3% to 4%, which could lead to hundreds of dollars saved."
"Not only are interest rates lower currently, but you could be in a situation where you’ve been working on your credit over the past few years and you’re finally at a spot where you could qualify for a better rate. If you’ve worked hard and improved your credit score, it’s a great time to refinance as well. Say you’ve gone from a score of 660 to 720, you could definitely qualify for a better rate."
Cristina asks Question 6: "Okay, I want to talk more about car loans. When is the best time to apply? Should you do it before you start shopping?"
Kevin responds: "Yes, just like with figuring out how much your trade-in is worth, a critical step to take before actually shopping for a car is doing your research. You want to be an educated buyer, so look around at all the different incentives and offers financial institutions and dealerships are offering so you get the best rate on your loan."
"Also research how much the vehicle you are looking to buy is worth, what dealerships are selling it for, and what manufacturer incentives there are for that vehicle. Same goes for pre-owned, or used, vehicles."
John also responds: "I like to break it down to three key numbers to have handy when you’re in the car buying process: 1) how much my trade-in is worth (and how much I owe on that trade-in), 2) how much the new vehicle I’m considering purchasing is worth, and 3) how much I plan on financing."
Will asks a follow up question: "Can you trade in a vehicle you owe money on?"
Kevin responds: "Unfortunately, that happens to a lot of consumers. Cars depreciate so quickly that you can end up owing more money toward your loan than what you could actually sell or trade it in for. Statistics show that, on average, people only keep their vehicle for 29 months. You typically don’t pay enough of your loan in that amount of time to account for the depreciation."
"But yes, you can trade in a vehicle that you still owe money on – it’s called negative equity. The amount you owe gets rolled into your next car loan. Let’s say you still owe $10,000 on your auto loan and you plan to trade in your vehicle at the dealership that offers you $6,000. Your lender will roll that $4,000 you still owe into your new auto loan and you’ll be paying for it with your new vehicle."
"Obviously lenders won’t let you roll an endless amount of negative equity into your auto loan. We try to protect consumers from doing that over and over again because it can really add up."
John also responds: "I always recommend having some money for a down payment. You’re going to be upside down on your loan when you leave the lot, so the down payment can help offset that a bit."
Cristina asks Question 7: "What are some tips for negotiating with dealers? How should you talk to them?"
Kevin responds: "I know negotiating is a fear a lot of share because it’s uncomfortable. As a consumer you want to pay as little as possible for a vehicle, but as a dealer you want to make as much as possible; those are two opposite objectives. The best way to approach this situation is with research, like we’ve mentioned before."
"Another way to ease the negotiation process is to get pre-approved for an auto loan from your financial institution before you go into the dealership. That way you have all your numbers figured out and there’s not as much pressure the dealer could put on you to buy today based on financing deals."
"At Addition Financial, you can come into a branch and start the pre-approval process even if you don’t have a vehicle picked out yet. We’ll let you know how much you qualify for, the interest rate you qualify for, and what those monthly payments would look like. That way you go into the dealership knowing what you can afford within your budget and focus on the right vehicles."
Cristina asks a follow up question: "We talked about this in the last episode about home buying, but I want to confirm this is the same with car buying – if a buyer is approved for a $35,000 auto loan, that doesn’t mean they have to spend the full $35,000, right?"
Kevin responds: "Exactly. Sometimes you’ll be approved for more than what you would want to spend monthly, so you have to keep that budgeting number in mind as well."
John also responds: "Another thing to keep in mind as you totaling your costs for the vehicle is to add $1,500 to the car price for additional fees. That will cover your title and tag costs. Tax is another amount you want to add on, as well as any other additional products you want to purchase with the vehicle, like warranties or GAP coverage."
"Again, we recommend using a car buying calculator to help you estimate these costs before you go into the dealership. It can really affect which vehicles you consider buying because you might need to lower the car’s price range to account for these additional costs and keep you within budget."
Cristina asks another follow-up question: "So what is GAP insurance?”
Will responds: "I know this one, Cristina! But it’s not actually insurance, it’s GAP coverage – guaranteed asset protection. Let’s say you total your car and you now owe more on your auto loan than what the car is worth. Your car insurance company is not going to pay that difference, so your GAP coverage comes in and covers that amount."
Kevin also responds: "That’s correct, Will! For example, let’s say you total your car, but you still owe $15,000 on your auto loan. State Farm says your car is only worth $11,000, so you still have to pay $4,000 to finish out your loan. GAP coverage would cover that amount so you aren’t responsible for it. Of course, read your policy to know the specific details, but that is generally how GAP coverage is used."
Will asks Question 8: "You’ve done your research, you’ve added in all those additional costs, and you think you have a good price. How do you know what the dealership is presenting you is actually a decent price?"
Kevin responds: "Well if you’ve done your research as an informed consumer, you should have a good gauge on what is a fair price. You go in armed with your numbers and it’s really then just talking through them with the dealer to come to terms."
John also responds: "You really want to have your expectations in the right zone and be prepared to negotiate. Don’t be afraid to ask for a number that your research shows is fair. And remember you have every right to walk out until you’ve signed the contract. So if you don’t feel comfortable with the number the dealer is sticking with and you want to take some time to think about it, I recommend just walking away. It’s an important purchase and shouldn’t be something you just jump into because you’re feeling pressure from the dealer."
Cristina asks Question 9: "Okay, last question and this one is a bit divisive. What is better: buying or leasing a vehicle? What are the pros and cons?"
Kevin answers: "I wouldn’t say one is better than the other; it’s a very personal decision that is based on your lifestyle. So to break it down, leasing is like renting a car. Say you want to lease a car that is worth $20,000 and your contract lasts three years. The manufacturer thinks the car will be worth $12,000 at the end of your contract, so they want you to pay $8,000 over those three years to cover the depreciation. That’s generally what determines your monthly payments."
"At the end of those three years, you give the car back and you can lease a new vehicle, purchase a vehicle, or decide to go without a car for a while. Leasing gives you flexibility in that you aren’t stuck with an auto loan for six or seven years. There are some restrictions that come along with leasing, mainly with how many miles you can put on the car. You might be faced with pretty hefty fines if you go over the set amount."
"So if you are someone that drives a lot for work, has a long commute, or likes to go on long road trips, leasing probably isn’t your best option. Or if you like to hold onto your cars for seven or more years, then leasing isn’t the right choice. But, if you do like to keep vehicles for longer periods of time and know you will be putting more miles on it, then purchasing would be your best bet."
Cristina asks Quick Question 1: "How does applying for a car loan affect your credit score?"
Kevin responds: "Applying for an auto loan doesn’t really affect your score too much. Typically you have a 30 day window to shop around and apply for different car loans without it impacting your score every time you apply. I would recommend coming into your local credit union and getting preapproved before going all over town applying at different dealers where you happen to find a car you like."
Will asks Quick Question 2: "What are the benefits of getting a loan from a credit union instead of a bank?"
Kevin responds: "I’m a bit biased, but we typically see credit unions with lower interest rates and fees than the bigger banks. That makes them a great choice when it comes to financing."
Cristina asks Quick Question 3: "When should people consider buying a used car?"
John responds: "If you don’t have negative equity in your current vehicle, then buying a used car would be a good option. The manufacturer gives better incentives and rebates when you buy new, which can help cover that negative equity. But if you find a used car with low miles, it’ll probably end up being more affordable if you don’t have negative equity going into the transaction."
Will asks Quick Question 4: "Is it ever a good idea to pay cash?"
Kevin responds: "While my answer would depend on a case-by-case basis, I would say generally having cash on hand is really important. We are going through tough times right now and if you don’t have a lot of cash on hand, you could put yourself in a tough position by using it all to pay for a vehicle."
"Even if you do have a nice chunk in the bank, I would recommend only using part of it for a nice sized down payment and then finance the rest. You don’t want to be stuck with no money in the bank if an emergency comes up down the road."
"Another strategy is to take advantage of those rebates and incentives through financing that John mentioned and then use your cash to pay off the loan early if there are no prepayment penalties. That way you get the best of both worlds."
Cristina asks Quick Question 5: "Last question. What are some good questions to ask when you buy a used car?"
John responds: "I would start with: ‘Show me the CARFAX.’ Other things to consider would be the maintenance records and ask if the vehicle has ever been in an accident. Another thing to look out for would be a salvage title. And then of course you always want to test drive the vehicle before buying it."
Kevin also responds: "If you’re looking at used vehicles, make sure to ask if it is certified. This means the manufacturer has gone through an extensive checklist to make sure all the components are working properly on the vehicle and sometimes it means they’ll provide extended warranties to give you extra protection."
John follows up: "Usually that is referred to as CPO – certified pre owned."
Cristina asks about a recent Experian article: "Today’s story is about assistance for auto loans, something that I think is on a lot of people’s minds. I’ve read a lot about unemployment assistance and mortgage assistance, but not much about car loans. Do you guys have any insight into that?"
Kevin responds: "Unfortunately, there have been a lot of challenges in regards to paying bills during these times. What you need to know is that credit unions are here to help our members. Just because car loans aren’t federally insured like mortgages are, doesn’t mean there isn’t help available."
John also responds: "Right. For example, at Addition Financial, we offer members the ability to skip one loan or credit card payment within a 12 month period. If you’re having trouble paying your bills, talk with your financial institution to work through it; don’t avoid it."
Kevin follows up: "Yes, always maintain communication with any of your creditors if you’re having struggles. Like I said, we are here to work with our members and go through the variety of options available that don’t lead to you going delinquent. If you’re upfront with us, we can offer payment extensions, skip-a-pays, and other options to help."
"I would also say if your loan payments are getting to be too much each month, look into refinancing. If you’ve made three years worth of payments, you could refinance at a lower rate and significantly reduce your monthly payments. I’ve seen it cut a $500 payment in half."
John also follows up: "That’s great advice. And I would say shop around for car insurance. You might find a better policy with a different company that significantly reduces your monthly payment."
On this episode we shared four resources to help you during your car buying process: