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Stupid Money: The Weird Complexities of Car Financing, Explained

What’s a good deal when you’re shopping for a car, and how do you get it?

For most of us, the whole process of car buying is a mystery. That, of course, is partly by design — after all, knowledge is power, right? Which explains the whole put-upon drama and bizarre ritual at the car dealership: The misleading advertising; sitting at a small desk in a small office with the door closed; that bewildering list of paperwork; the salesperson coming and going from the room, etc.

By the time you’re done and you’ve finally agreed on a deal, whether it’s a purchase or a lease, how do you even know if you got a good one? What is a good deal, anyway? And should you buy, or should you lease? With the help of Bronson Argyle, a finance professor at Brigham Young University who studies car financing and other things, we attempted to figure it out.

So, how do you get a good deal?

It’s hard to broadly define what a good deal is because it’s all personal. In other words, a good deal for someone with a low FICO score (your credit rating) living in Utah might not be a good deal for somebody with a different FICO score living in L.A. It’s all about how risky you are to lenders. “Right now, interest rates on auto loans can range anywhere from a little more than 2 percent to 10 percent,” Argyle says. “If you’re getting an 8 percent loan, that’s not necessarily a bad deal if you’re a really risky borrower. That might be a good deal for you because you can’t get anybody else to lend for you.”

More specifically, “If you have a FICO score in prime range, above 700 to 720, it’s realistic, even for a four- to five-year loan, to be able to get a loan in the 3 to 4 percent range,” Argyle says. “Anything lower is probably a really good deal; anything higher and you’re probably being taken. If you’re down around 650, you can expect an interest rate in the 4 to 5 percent range. And if you go below 600, you’re going to see even higher interest rates.”

The other factor at play here, though, is the length of the loan: Your interest rate will be higher for a longer loan as, since you’re taking longer to pay a lender back, they’ll charge you more money for it (we’ll get to that later).

Okay, what about the price of the car itself? Isn’t that still negotiable, usually?

It sure is! And there can be a huge difference in price, both in new and used cars, according to Argyle’s research. Even within the same city, the price of the same car — same make, model, year and trim — can vary by as much as 5 percent. So let’s say you’re looking for a 2017 Honda Civic LX: That can be a difference of $1,000 for a $20,000 car, according to Argyle. That suggests some dealers are willing to sell for much less than others.

Ultimately though, says Argyle, it probably costs about the same, economically, to pay what the dealership asks for versus spending a couple Saturdays driving all over town and price shopping. You could be doing a lot of other things with your time — but then again, you might also find a car that’s $1,000 cheaper.

Well, that’s nice.

It gets better: Argyle and his colleagues’ research into car loans suggests you can shop around for financing. Forget about taking the dealership’s finance officer’s terms: You can save a lot of money by shopping around for loans at various banks and credit unions. Many lenders calibrate their rate sheets (that’s like a table with set interest rates, based on how much you’re borrowing and the maturity of the loan) slightly differently. So with your same FICO score, you may be able to get a lower interest rate at one lender over another just based on their individual rate sheets. For those of you with bad credit, the advantages to shopping around are even bigger.

One thing to keep in mind here: Argyle’s research focused on people who sought loans ahead of time, before sitting in the dealership’s office and haggling over the price.

Say I don’t apply for a car loan ahead of time and I’m stuck in the dealership. What can I do?

When the finance officer at the dealership is pushing their terms — well, really what they’re pushing is a monthly payment — just tell the person you want to check interest rates really quick. Pull out your phone and Google “auto rates.” For example, you can enter your data into Bankrate, and it’ll tell you what various lenders are offering. At the very least, it’ll give you much more negotiating leverage.

Usually the salesperson asks how much I want to pay per month. Is that some kind of trick?

It kind of is… or at least, it can be. Obviously it’s natural to think about how much you can afford per month, since we calculate most of our expenses on a monthly basis, and it’s a good starting point. “But if that’s the only thing we think about, you can end up paying a lot more to finance a car than maybe you should,” Argyle says. In other words, you may have low monthly payments, but you’ll be paying over seven years rather than five. That can be a huge difference in total cost when you factor in how much you’re paying in interest.

“One thing I’d tell people is, don’t let the smokescreen of the monthly payment keep you from knowing what the interest rate is,” Argyle says. “Because the interest rate is really what you’re paying to borrow money from your lender.”

And if the folks at the dealership are discouraging you from making a large down payment/paying the full amount in cash, pushing their financing on you instead, it’s likely because the car company’s lending arm stands to make money on you borrowing from them (via whatever interest rate they’re going to charge you). Which is a pretty rotten thing for them to do.

So ideally, you’d make a huge down payment and finance as little as possible, right?

Well… sure, in an economist’s ideal/unrealistic world, if you had $20,000 in savings and wanted to buy a $20,000 car, it would be financially optimal to just pay $20,000 in cash and borrow nothing. But in the real world, that’s an insane thing to do. What most people want to have on hand is liquidity (cash, in other words). Because in the real world, shit happens: Your water heater breaks; your roof leaks; you get a large hospital bill; your kid gets accepted to an expensive-as-hell school (congratulations, but that’ll cost you). You’re gonna need money for a rainy day, in other words.

How the hell do I know how much I should finance, then? The person at the dealership isn’t gonna help me figure that out.

No, they aren’t. It’s really up to you: Obviously you want to finance as little as reasonably possible, but you need to figure out what reasonable means in this case. Argyle tends to shun the hard-and-fast rule-of-thumb sound bites that financial-guru-celebrities like to spout. Instead, he recommends:

  1. Assessing your situation and your possible future expenses (are you in a new house with stuff under warranty, or an old house? Do you have kids, or not? How’s your retirement savings? Etc.)
  2. Planning a monthly budget. Figure out what you need to save for rent/mortgage, food, insurance, retirement, plus rainy-day stuff, then how much you want to spend on entertainment and leisure. Whatever you have left over from that, how much of it do you want to spend on a car payment?

The right mix of financing will involve as much money as you can put down while still saving enough for future events, plus a monthly payment you’re comfortable with at the lowest possible interest rate you can finagle.

What if I just avoid all this and lease a car instead?

“Leasing is almost always a bad decision,” Argyle says. “It’s obvious, but you’re essentially renting the car. At the end of your lease, you don’t have any equity. The advantages are a lower monthly payment, but that’s because you’re not buying anything, just renting a car. The other advantage is you’re able to have the newest car and technology every three years. If it’s really valuable to you to have the newest car, leasing can make sense. Or if you’re moving overseas and know you’re gonna have to sell your car in three years, why not just lease it? Those are the only situations.

“Otherwise, the disadvantages are pretty big,” Argyle continues. “You don’t end up with a car at the end of your lease, so you have no equity; there are usually mileage limits; and the lease is conditioned upon return stipulations (like cleaning or repair fees). So for most people, leasing doesn’t make sense. If you buy the car, even though your monthly payment will be higher, at the end, you will have a car you can sell or trade in, and that will always make sense. I’m sure we can find situations where there are teaser rates, or a lease price that makes sense, but in vast majority of cases, it doesn’t make sense.”

Anything else I should know about car buying?

Argyle mentioned this before, but he wants to reiterate: “Don’t get caught in the trap of only caring about monthly payments. Dealers will extract as much as they can from individuals! I don’t blame them for that, but don’t get caught up in thinking that the monthly payment is the only thing that matters. It may be a low monthly payment, but there’s a big difference between paying a loan for five years and six years. Or even five and a half years. The interest rate is ultimately the number that tells you how much it’s costing you to borrow.”