Getting A Car Loan?

Spring is traditionally a busy time for car dealerships. Automakers have just showcased their newest models at auto shows across the country and want to clear dealer lots to make room for their new cars. Motivated by warming weather and advertised deals, consumers are primed to buy.

This year will be no exception. Auto sales were slightly up in March, led by unprecedented sales of SUVs and sales of luxury vehicles. Hoping to increase this momentum, automakers launched new incentives in early April. Car shoppers will find increased cash rebates and new offers of zero-percent or low-interest financing.

But before you decide to buy a car or truck, The Early Show financial adviser Ray Martin has some advice to offer.

Deals May Not Apply To You
The average rate on new and used car loans currently hovers around 7 or 8 percent. No wonder 0, 2 and 3 percent financing deals offered by dealerships sound so tempting. But potential buyers need to know that unless they have stellar credit, they may not qualify for these offers. As a matter of fact, 40 percent of people who recently went to a dealership to explore 0 percent financing had to pay a higher rate, according to a research company quoted in Consumer Reports.

Dealers Can Up Your Rate
When shopping for a car, most people decide to obtain a loan through the car dealership itself. It's certainly the most convenient option, and dealerships promise you the best available rate. However, don't assume they are telling you the truth. Dealers simply offer to arrange financing for you. They are not actually putting up the money themselves. Once they find a financial entity to loan you the money, they ROUTINELY add percentage points to your loan rate.

For instance, let's say you qualify for a loan at 7 percent interest rate. The dealer may tell you that you actually qualified for a 10 percent rate. You pay the 10 percent, and the dealer pockets the extra 3 in the form of a lump-sum payment from the finance company. This is an accepted practice among dealers - and it's legal.

The Consumer Federation of America released a report in late January, revealing that this practice costs consumers up to $1 billion annually, adding at least $1,000 to the cost of an individual's auto loan. About 1 in every 4 consumers gets hit with a marked up rate. The CFA report found that this happens more often to African-Americans and Hispanics.

• African-Americans are hit with higher rates 53 percent of the time, versus 28 percent for white borrowers.
• African-Americans pay an average of $412 more on auto loans.
• Hispanics pay about $266 more per loan than non-Hispanics.

Consumers should also realize that the finance folks at the dealerships typically earn commission from any additional interest they tack onto a loan. In other words, their interests are in direct conflict with consumer interests.

While there are no laws regulating rate mark-ups, auto companies and groups are making some voluntary improvements. General Motors declared in February that dealers could only mark up rates 3 percent. Members of the National Automobile Dealers Association must now tell buyers that interest rates are negotiable.

Finance Alternatives

• Credit Unions - So if you can't be sure you're receiving a good rate at your dealership, where should you get a car loan? Many sources claim that credit unions offer the best rates.

  Recently, credit unions have been teaming up with dealerships to offer loans. "Automotive News" explains the partnership.

  "About 1,300 of the nation's 9,500 credit unions engage in indirect lending, enabling their members to apply for financing with the credit union at a dealership ... Most credit unions that do indirect lending have a list of dealerships they recommend to their members. In return, those dealerships provide loans to those members at the credit union's interest rate, without a markup." (March 29, 2004)

  Although there is no rate markup, dealerships still manage to profit from these partnerships. Credit unions typically pay a "finders fee" of $50 to $200. Also, because you are getting such a good rate, the dealership will try and convince you that you can now afford additional insurance products or other "extras."

• Banks - Banks may not offer you the cheapest rate on an auto loan, but at least you know what you're paying for. Banking regulations require disclosure about all rates and fees, making it easy to comparison shop.
• Home equity loans - Of course you don't need an auto loan to finance your purchase of a car. You can also obtain the money you need through a home equity loan. If you have significant equity in your home, this might be a great option for you. Equity loans are available at low interest rates and are tax deductible.

While there is no one-size-fits-all piece of advice here, Martin does recommend shopping around for loan rates. It's okay to get your financing through a dealership as long as you know what you're getting into. Studies show that consumers who are armed with their own research are much less likely to fall victim to rate markups. However, the best strategy is to be pre-approved for a loan before you even step onto a car lot. That way you can negotiate the best price on a car without worrying about the financing.

No matter which option you choose to finance your car, be sure to avoid "loan stacking." Many people will be trading in their current cars for a new car. If you are one of these people, chances are good that you still owe money on your current car loan - and your car is not worth enough to pay off the loan. In these situations, car salesmen are trained in a technique they call "stacking loans." They offer a loan that pays off your old loan AND finances your new car. If you accept the offer, you will owe more on your new car than it is actually worth - you will essentially be taking out a loan for up to 120 percent of the new vehicle's purchase price. Unfortunately a growing number of consumers are in this position and need to know to avoid the situation.

Avoid this problem entirely by agreeing to repay your loan in four years or less.