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How to finance your new or used car purchase

Thinking about getting a sweet new ride lately? You aren’t alone. The automobile industry in America had its biggest sales year in history during 2015, delivering over 17.5 million new cars and trucks. The previous high water mark was set back in 2007, just before the bottom fell out of the housing market and took the rest of the economy with it. After slumping along for seven years, the industry is back and sales are booming. Early indicators point to 2016 being just as good as last year, assuming that the stock market and all our jobs hang on.

Some of the reasons for the boom are pretty easy to identify, like a recovering economy, low gas prices, and a whole lot of pent-up demand as people finally replace the old cars they’ve been nursing through the recession. But the biggest hidden factor? Confidence. People who are pretty sure that they will have a job going forward are willing to take on some debt to get a new car.

People who aren’t sure tend to put off big purchases. Right now we’re pretty confident, at least on average. If you’re one of the 17.5 million people with your head held high who are thinking about some new wheels in 2016, you have some homework to do, but don’t worry, we’re here to help.

Unless you’re doing well enough to pay cash for the new car of your choice, you’re going to be financing the purchase. To get the best possible deal, you need to shop for money just as carefully as you shop for your new car. That means evaluating the specifications, looking at your comfort level, and really just figuring out what you can afford. Like any sales process, there are many companies competing for your business and they stand to make a lot of money from your decision. It’s important to read the fine print and run the numbers to make sure you’re getting the best deal. Say it again with me, now: “run the numbers.”

Does This Deal Pencil Out?

Car dealers and finance companies throw a lot of numbers at you. Maybe they ask how much you’d like your monthly payment to be? That makes sense because most of us live on a budget, and a lower payment means more money for other things. Sometimes they’ll pitch you on a low interest rate, or cash back, or something else. Here’s a good rule to remember: Car dealers and finance companies need to make money on every sale, and they will never offer you a deal where they don’t make money. If they don’t make money on the interest rate, they’ll make money on the purchase price. That’s not a bad thing, but it’s up to you to figure out the details.

Car dealers and finance companies need to make money on every sale, and they will never offer you a deal where they don’t make money.

If you assume that the purchase price of the car is fixed, you can get a lower monthly payment by extending the term of your loan. You’ll pay less every month on a six year loan than if you pay the same amount back in just three years. But if you total it all up, you’ll pay more overall for the longer loan. Don’t worry about your math skills. There are calculators online to help you with the arithmetic. Wallethub.com has a good one here.

For example, if you borrow $32,000 for three years at three-percent interest, you’ll make 36 monthly payments of $931. At the end of three years, you will have paid $1,502 in interest and a total of $33,502 for your car. But if you take the same loan and pay it off over six years, you’ll make 72 monthly payments of $486. At the end of six years, you will have paid $3,006 in interest, and a total of $35,006 for your car.

There’s no right answer to which loan you should pick. Monthly payment amounts are important, and maybe $1,500 extra interest dollars over the next six years is no big deal. The important thing is that you should run the numbers on every competing finance offer so that you know what you’re signing. The variables are always the same: the purchase price, the interest rate, and the length of the loan.

Related: In the future, buying a car involves no pressure, no lies, no leisure suits

Before we go on, what about the so-called “zero-percent” loans you see?  Let’s be real: no one is going to give you money for free. The profit on that deal is baked into the price of the vehicle rather than in your interest rate.

Where To Get The Best Loan, and Where to Avoid

Even though you’re going to run the numbers on any loan you consider, there are a few handy rules you can use to narrow down your choices. According to the 2016 Auto Financing Report from Wallethub, the best sources for financing are the automakers themselves or your credit union. The reasons are simple. The automakers really need to sell you a car, so they have a strong incentive to give you a good loan because they make their money on the car’s purchase price. Your credit union knows you’re good for the money and has lower costs, so they can offer you a good deal, too.

Dealership

If you can’t get money from either of those sources, your next-best bet is a big national bank, but these are a distant second. Jill Gonzalez, an analyst at Wallethub, told Digital Trends that loans from automakers run about 33 percent below national average interest rates, and that credit union loans run about 32 percent below average. In comparison, national banks run about two percent below the average, and regional banks run a whopping 33 percent above average.

Gonzalez also has some advice about places to avoid.

“Consumers should stay clear from community and small banks, which have the highest loan interest rates for used cars,” she says.

Here’s a final tip: if you walk into a dealership with your credit union financing already approved and understood, you have a much stronger negotiating position on purchase price because there are fewer variables on the table.

The Dreaded Credit Score

OK, here’s where it gets nasty. Every adult in America has a credit score, and your credit score more or less dictates how much interest you have to pay on any given loan. Because a lower credit score means a bigger chance that you won’t be able to pay back the loan, lenders charge a higher rate to cover that risk. But here’s the thing: different lenders have very different loan options for people with less-than-excellent credit, so if you’ve got a few financial skeletons in the closet, running the numbers on every potential loan becomes even more important.

Gonzalez has some advice for people who are still restoring their credit after the recession.

Use common sense. No one is going to give you money for free.

“The best option is to build or rebuild their credit score as much as they can before buying a car. The average interest rate for buyers with excellent credit has fallen nearly 32 percent since the beginning of 2014. Overall, buyers who have fair credit will end up spending about six times more to finance a vehicle than someone with excellent credit, which equates to $6,176 in additional interest payments over the life of a $20,000, five-year loan,” she tells Digital Trends.

Credit scores are set in a range from 300 to 850, and they’re tracked by several corporations. A score of 300 means someone who is really in trouble. A score of 850 means you’re financially angelic. For reference, Wallethub says an excellent credit score in 2016 is considered to be more than 720. Wallethub says fair credit is about 620-659. But it’s important to note that different organizations draw the fair, good, and excellent lines in different places, and where they draw the lines can have a big impact on the rates they want from you. Credit scores aren’t always accurate, either, so it pays to check. Always run the numbers, starting with looking up your credit score from at least one service.

Will This Boom Last?

Everyone hopes the boom will last. Booms are fun and lots of people make money. But financiers are cold-eyed assessors of risk and reward, and they always look at the big picture.

“Auto loan debt is going to increase in the next couple of years as the economy is strengthening and pent-up demand is being met, but the high share of car loans from subprime borrowers might affect interest rates in the years to come,” Gonzalez says. “This is a cause for concern – America’s collective car debt has now reached $1.05 trillion, clearly proving that this is a trend based on low gas prices and low interest rates.”

So, if interest rates rise and the price of gas goes up, or if there’s a general stock market crash and consumer confidence is destroyed, things could change quite rapidly. That doesn’t mean you have to buy today, but rather that you should keep an eye on the market while you take your time and seek out the very best deals you can get. If consumer confidence crashes and sales collapse, that could lead to lower prices and lower rates as automakers scramble to sell cars. If gas prices stay low while the economy continues to grow, interest rates and sales prices could rise. You’d have better luck predicting spring weather, so concentrate on your own situation and get the best deal you possibly can.

Oh, and do be sure to run the numbers.