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How They Work and When to Get Them
When financing the purchase of a new car, there are lots of organizations available to
help you find money. Banks, thrifts and loans, credit unions, finance companies, car
dealerships and the automakers all want the job of providing you with money for your new
car purchase. They do this because they will earn interest and fees on the money you
borrow and in the case of the automakers, make it easier for you to buy their specific
cars.
Anyone can get a loan these days, even people with poor credit histories and very little
income. The car market is so competitive that even people normally considered poor
financial risks can get a loan -- they will just be charged a higher interest rate for the
privilege of borrowing money.
Who Loans Money?
In most cases, car buyers deal with financial institutions that take on the transaction
responsibility, that of moving the money from their financial institution to the
dealership's bank and then creating the loan relationship with the buyer. While there is
nothing wrong with this scenario -- it is both commonplace and mature -- it reduces the
buyer's control over the financial relationship with the dealership and diminishes her
negotiating position. If you don't have the cash in hand at the time you are negotiating
and once you decide on the car you want, you still have to go through the financing
process at the dealership. That generally is not a pleasant experience and can increase
the cost of the car purchase.
What happens is this: the buyer selects a car, the dealership either provides their own
financing if they are large enough, uses an automaker's financing (called "captive
financing") or an outside financial institution. Some examples of captive finance
companies are General Motors Acceptance Corporation (GMAC) and Ford Motor Credit (FMC). In
either case, the dealership is paid a commission on the loan. They generally receive
between 1 and 2.5 percent. That commission comes from an increase in the percentage of
interest the buyer is charged. The more the dealership demands in the way of a commission,
the higher the interest payment. Conversely, the dealership may set the rate of the loan,
for example 10%, and then sell it to a lender at 9%, making 1% in addition to the profit
on the car sale. In this situation, you may not know the lending institution that ends up
financing your car purchase and you may find the terms unacceptable. While this is a very
important process to go through so that you know the going rate of car loans, it is often
time consuming and inconvenient. Unlike mortgages, the savings that may come from finding
the best rate may be small. For example, the difference between payments on a 48 month,
$20,000 auto loan at 8.50% and 8.25% is just slightly more than $2 a month -- $492.97
versus $490.61.
When borrowing from a lending institution what
happens is this: the buyer selects a car and contacts a lending institution, applies for a
loan and waits for approval. When the car is to be purchased, the buyer can pick up a
check, have money transferred or the lending institution works with the dealership on the
transfer of funds. The best preapproval is one where you are handed a blank check with a
funds limit and an expiration date.
There are generally fees involved with loans, although not all lending institutions charge
them. Each financial institution has their own fees and they vary. Some have few. Some
have many. The only way to find out the fees is to ask. Some examples of fees are:
application, processing, loan origination and bank processing. All of them are different.
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