Financing a car – how to proceed
Choose your financing
Before buying or leasing your new or used car, you need to choose a type of financing. Options, concepts, advice, traps to look out for… Read through this first step to learn all you need to know about the two types of financing available to you.
Dealer financing
Most dealers offer their own finance plans. This is a practical solution that many people choose. Here are a few tips to ensure you’ll be fully informed when you go to the dealer.
Prepare for your financing
Set a monthly budget: Always keep in mind the maximum monthly payment you can afford. That amount must correspond to your financial capacity and take into account all other car-related expenses. A basic reminder, but essential!
Consult online solutions: Manufacturer’s websites, financial institutions and some used-car dealers offer online tools to help you put your financing together. Avail yourself of them! Use them as a starting point and print out the results. They may come in handy later, if you’re negotiating financing at the dealership.
Learn the terminology: Don’t know the difference between interest rate, credit rate and finance charges? Well, the seller does! Learn and understand these terms to help clarify your decision… and avoid nasty surprises.
The interest rate is the “yield”, for the lender, on the amount they are lending: in other words, their profit.
When you finance a vehicle at the dealer’s, you’ll have to pay finance charges. The credit rate is the value, expressed as a percentage, of those finance charges. Note that by law, the credit rate must appear in your finance contract.
Unlike the interest rate, the credit rate specifies, as an overall percentage, all of the finance charges.
Finance charges include:
The interest charges, if applicable
The various administration charges related to the loan
The value of the reduction awarded if you pay cash
The cost resulting from “options” that you may add to the loan contract (e.g., insurance, winter tires)
Be aware of “little” details
Understanding the terminology of financing is essential… but after reading the points below, you’ll also be better prepared for the steps to follow.
Beware of “unbeatable” rates
Using splashy advertising, dealers will often promote their financing and affordable interest rates (often as low as 0%). These “unbeatable” rates don’t tell the whole story. Your invoice could be a little meatier than expect, because you have to take the credit rate into account: once you’ve included it, the rate could be a long way from 0%!
Interest rates and options
If you’re thinking of including optional purchases in the total amount of your financing, think hard. For example, at 9% interest over 5 years, an $800 set of mag wheels will end up costing $996; that’s 25% more. This kind of calculation applies to anything you might be tempted to add.
This year’s model, better rate!
Dealer financing rates offered for used cars are generally higher than for new cars (this also applies to bank loans). Financing a used car is therefore more expensive, and here’s why: when reselling a used car (if the buyer stops payments), the lender will recoup a smaller portion of their investment. That risk is offset by the higher interest rate. If you see an offer of zero percent financing on a used car, it’s probably too good to be true.
Learn the steps of financing
When you choose dealer financing, expect to have to run a gauntlet of steps. It can be confusing, so here’s a summary of what to expect:
Step 1: The dealer offers you a payment plan
First off, the dealer will offer a loan spread out over a given period of time—unless you intend to pay off the car right away. This type of financing is the most common.
Step 2: The dealer contacts a financial institution
To offer you the loan, the dealer will contact a financial institution or an automaker’s financing firm.
Step 3: They check your credit record
The offer is now conditional on verification of your credit history (you may have seen the expression “financing subject to approved credit”). This is a document that shows your current level of debt—and, especially, whether you have a history of paying off your debts.
Good to know: You don’t have to agree to the dealer checking your credit record… but if you don’t, it will probably put an end to the transaction!
Step 4: You sign the contract
If your credit application is accepted by the seller, you’ll sign the sales contract or the leasing agreement for your car. Read it carefully before signing; there can be no changes to it after the fact.
Step 5: You start repaying the loan
If the transaction has taken place, you have to start paying back the loan, obviously.
Good to know: The dealer remains the owner of the car until you have paid for it in full. Its value serves as a guarantee that you will repay the loan. In the event of default, the car can be repossessed and resold.
Avoid unpleasant surprises
Whether you’re buying or leasing, here are a few tips that will help you evaluate the actual costs of financing through a dealer.
Be wary of low monthly or even weekly payment amounts. You’re not buying numbers, incentives or bonuses, you’re buying a car! Boiling everything down to a monthly payment won’t tell you much about the total amount you’ll be spending: some “easy” payment plans end up costing more in the long run… You don’t get something for nothing!
Read the fine print on the advertising and documentation that the dealer gives to you. That’s usually where you’ll find the conditions of sale and the actual costs. For example, a down payment may be required to be eligible for the low monthly payments.
Ask the seller: is the interest rate the same as the credit rate that will appear in the contract? Even if the answer is yes, check: read your contract and look for the “credit rate” line. Unless you’ve chosen “extras”, your rate should be the same as the advertised rate. If in doubt, of course, don’t sign anything.
These days, consumers have access to financing over 6, 7 or 8 years. This is most common with new cars, but these types of offers exist for used vehicles as well. The specialists at CAA-Quebec advise against choosing a term longer than 5 years: their study on the subject revealed that if you do, you’ll lose money, especially you want to resell the car before the end of a 72-month (or longer) term.
Why? Because a car depreciates at a much faster rate than the capital repayment rate. After four years, a car will have lost about 40% of its value, and that depreciation continues. When financing is extended and you want to change cars, the final payment due can often be higher than the car’s market (i.e., residual) value.
That shortfall translates into a debt that is added to the second car loan for the new vehicle… and you are (unfortunately) well into a cycle of debt.
Many dealers offer second-string lender’s services to customers who have no credit file (that’s the “first chance” at credit) or to people with money problems that have impaired their credit rating (those who need a “second chance” at credit).
These lenders specialize in delicate situations, but not for free: they charge interest rates proportional to the risk they carry. On these contracts, rates of 20% or even 30% are not unusual, and that’s not including other conditions and fees that sometimes apply. These “chance” loans therefore cost a lot of money… Consider them only as a last resort for auto financing.
Example of a 20% loan: At a rate of 7%, a $15,000 loan will be paid back over 48 payments of $359 each, for a total of $2,241 in finance charges. With a 20% rate, the payments rise to $456 and the interest adds up to more than $6,900!
Follow our lead for leasing
Signature of a long-term lease agreement constitutes a debt, just as if you had bought your car on credit. Like a purchase, it’s an major transaction that must be well thought out. Here are three valuable pieces of advice for you to follow:
1: Ask for the buy-back price
Advertisements often tout the peace of mind and low interest rates that leasing offers. Remember, leasing is worth it if you plan to change your car often and the interest rate is attractive. But if you intend to buy the car at the end of the lease term, that’s different, and you’ll need to know what the total cost will be.
2: Put no money down
Never make a down payment when leasing. In case of a write-off, theft, or breach of contract, this amount will be lost—and simply irretrievable. Even if the down payment lowers your monthly payments, the savings aren’t worth the risk of losing your deposit.
Stick with higher monthly payments or, if you insist on keeping them lower, make multiple security deposits (MSDs). This will get you a better interest rate, and you will get the deposits back at the end of the lease (unless you dip into them to pay off a bill for excessive wear and tear on the vehicle).
3: Don’t forget anything important
If you choose leasing with a buy-back option, find out all of the following information; each point is important:
The total cost of the vehicle
The amount of each payment
The number of payments and the term (duration) of the financing period
The total kilometre limit and the price per kilometre for exceeding that limit
The cost of the buy-back option
The guaranteed residual value of the car; in other words, its market value at end of your lease term
Personal financing
If you are buying or leasing a car from a dealer, nothing says you have to finance it with them. And if it’s a private sale, you won’t have access to financing unless you ask for a bank loan (personal loan, car loan, or home equity line of credit). Here are the three main options available to you:
Pay out of your savings
To buy a car for less than $10,000, the best way to go is to save up and pay cash. You’ll avoid all the finance costs, and the money you would have spent on monthly payments will be available to cover maintenance, gas, and so on.
Borrow from a relative
If a family member is ready to help, they can surely give you a loan with a better interest rate than a car dealer or a bank.
Go through a financial institution
First step: make an appointment with a financial advisor. They will ask some questions to help build a credit profile and, with your consent, check your credit history. Depending on the situation, they will offer you one or more of the following options:
To finance a lower-cost vehicle (less than, say $10,000 to $12,000) through a financial institution, the only solution is often a personal loan. These loans are usually more expensive in terms of finance charges: the car isn’t valuable enough to serve as a guarantee for the loan, so the bank covers itself by charging a higher interest rate.
Banks provide this kind of loan for more expensive cars, with the vehicle as a guarantee. The interest rate is lower than that for a personal loan, which lowers the overall finance costs.
If you own property with some equity in it, using it to pay for your purchase will no doubt be more affordable than a typical car loan.
This type of financing is convenient, but pay attention to the interest rate.
The best of both worlds
Buying your car from a dealer? Borrowing from a bank, while taking advantage of the dealer’s “on the spot” rebate for cash payment, is often the best financing strategy. Compare the rates offered by the dealer and your bank, and do the math!
Clé no 8
Une nouvelle auto, c’est emballant, mais je garde la tête froide: je prends mon temps pour comparer les diverses formes de financement et ce qu’elles me coûteront. Pas question de payer trop cher pour rien!
Carry out your transaction
You’ve chosen the type of financing—perfect! Now it’s time to carry out your transaction.
Terms and conditions, sales pitches, negotiations… find out all you need to know about the transaction that applies to you.
Transaction with a dealer
Negotiating with a dealer is nothing like talking prices with a private seller.
Get the best conditions
If you buy a new car from a dealer, they won’t give you the moon and stars… but don’t hesitate to ask for a discount.
Tip: To have a reasonable price in mind, add $700 to $1000 to the cost price of the car (transport and preparation included), if you know it.
Know the sales pitches
When you buy from a dealer, you will meet two people. Take note of their titles… and their roles:
Depending on the age of the car, this person will offer you groups of optional extras and all kinds of “a la carte” products—mag wheels, carpeting, stone deflectors, tinted windows, etc.
This person will confirm all the terms negotiated with the salesperson and offer you financing. Be aware, they are a sales specialist… Their goal is to convince you to add products and services like:
Replacement insurance
Life and disability insurance on your monthly payments
An extended warranty
Rustproofing
Fabric protection
Anti-theft engraving
Etc.
Negotiate the extras
Rustproofing, a block heater, insurance and other add-ons often cost more at the dealer. And if you buy without financing, they almost certainly will.
Tip: Shop for your extras elsewhere to be able to negotiate with your dealer. Then it’s up to you to pick the best option. Remember: pick your extras carefully. It’s easy to waste all those negotiations with the dealer or even lose the savings you would have realized with a used car (compared with a new one).
Key No. 9
Stack the odds in your favour by negotiating realistic but beneficial purchase conditions and being proactive to avoid unnecessary expenses and headaches.
Transaction with an individual
With a private seller, you’ll have fewer options when it comes to financing and personalizing your car… but more latitude when it comes to negotiating the price.
Negotiate the lowest price
Always offer a lower price than the seller’s asking price. You have nothing to lose, and everything to gain.
Tip: Justify your offer with information you have collected:
The current value of the model based on age, condition and odometer reading;
The results of the inspection (cost of repairs).
Sign a contract
Private transactions always involve some risks. To avoid them, CAA-Quebec members can download and print out our Contract for the private purchase or sale of a vehicle (PDF - 39kb).
Important: Once signed by you AND the seller, this contract becomes your legal document in case of any dispute.