3 Common Financing Mistakes to Avoid When Buying a Car

Car dealerships lick their chops when prospective buyers make these three critical financing mistakes.

Feb 1, 2014 at 10:20AM

I admit it – when I was a broke college student I must've made every car-buying mistake in the book when I went car shopping. I was naïve and really didn't know what to expect, and I wound up paying practically full price for my car with a whopper of an interest rate spread out over five years. The lending rate is literally so high I'm embarrassed to put it into print, even now.

However, this shopping experience taught me a few key lessons about becoming a smarter consumer. It's been more than a decade since that car-buying experience and I've certainly come a long way from those early mistakes. Yet, there are still countless ways that auto dealerships still to this day coerce information out of consumers to gain the upper hand when it comes to ultimately financing the purchase of a car.

Honda Dealership Tmf

While every situation is unique, there are three common financing mistakes that prospective car buyers repeat over and over to the delight of auto dealerships. My goal today is to increase your awareness of these mistakes so you don't run into the same traps that I and countless other consumers have run into.

1. Playing the "purchase price" versus "monthly payment" game
The greatest tease of any car dealership is to utilize the allure of low monthly payments to get you into the showroom. Ultimately, what should matter to the consumer is the final price of the vehicle, but car dealerships are very good at shifting the focus away from the actual price of the vehicle and instead focusing on what consumers are willing to pay on a monthly basis.

Dealerships have a lot of maneuverability when it comes to shifting loans out from what used to be a traditional three-year loan to five, six, or even seven years in order to make monthly payments come down into a range that makes consumers comfortable. Unfortunately, as Credit.com points out, a $25,000 car with a five-year loan and a $16,000 car with a three-year loan may have the same monthly payment, but you'll end up paying about $2,500 more in interest for the more expensive car with the longer loan terms. Plus, playing into the monthly payment game gives you little flexibility on lowering the final purchase price.

Do this instead: Focus solely on the purchase price of the car and worry about auto loan payment calculations later. Unless you're buying a one-of-a-kind car, you don't have to make your car purchase that very moment. Go home, weigh your options, and take your time.

2. Not shopping around for the best financing rate prior to your purchase 
The second common mistake that consumers often make is assuming that the dealer's financing option is the only option available. This was my fatal flaw when I was a college student and purchased my car.

Tearing Money

Source: Tax Credits, Flickr.

The problem with relying solely on dealer financing is dealerships can manipulate loan rates and loan length as they see fit to each customers' individual situation. In other words, if the dealership realizes you haven't done your homework by looking elsewhere for loans, they'll still use your credit score to determine your overall lending rate, but it'll almost always be a higher loan rate or less favorable terms than if you were to shop around at your local bank or credit union.

Do this instead: Prior to looking for a car, sit down and figure out exactly how much you're willing to spend each month for your vehicle. Once you have that calculation, as well as how much you're willing to put down, start shopping around with your own bank as well as local credit unions for a good deal.

Another secret to getting the best deal is knowing your credit history! I can't emphasize this enough. Understanding what's in your credit history can give you the negotiating power to command better lending rates and more favorable terms.

3. Financing any loan longer than 36 months
The last common car financing mistake builds off the previous two, and that's financing any loan for longer than 36 months.

There was a time many moons ago where 36-month car loans were standard. Then auto dealerships discovered that 60-month loans lowered monthly payments, and consumers really didn't care if they paid more in interest as long as they had their new car. Thus was a born a deceptive cycle of perceived lower payments with higher cumulative interest paid.

The problem with loans that are longer than 36 months is that vehicles begin to depreciate heavily after the third year, based on their age and the amount of miles driven on average per year. Add cumulative interest paid on the loan into that depreciation and any financing beyond the three-year mark really doesn't make much sense.

Do this instead: Really this should be the first step you take, but sit down and hash out exactly how much you're willing to pay for a car. This includes not only what you want to pay on a monthly basis, but your down payment as well. If you can't afford to finance your car over a three-year loan, it may be best to save longer for that car of your dreams, or perhaps trade down to a less expensive model, if possible.

You could save $1000's on your next car purchase by following a few basic steps
You don't know it yet, but you probably spent $1000's more than you should have on your vehicle. In fact, the auto industry can be such a dangerous place for consumers that our top auto experts are determined to even the playing field. That's why they created a a brand-new free report: "The Car Buying Secrets You Must Know." The advice inside could save you thousands of dollars on your next car, so be sure to read this report while it lasts. Your conscience, and your wallet, will thank you. Click here now for instant access.

Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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