For most of us, a car is the second biggest purchase we’ll make, next to a home. The average price of a new car in July 2022 was $48,182, according to Kelley Blue Book®, up 12% over last year. But sticker price isn’t the only thing to consider when budgeting for new wheels. There’s also insurance, maintenance, gas, and depreciation.
Depreciation may not be front of mind for many car buyers. But in fact it’s a major factor in determining how to finance a new car. We’ll explain why, review different loan options, and recommend steps you can take to help you get a great deal.
How To Assess the Value of a Car
You may already know what you want in a new car: the gas mileage, capacity, features. Just as important, you know what you can afford. Or do you? Before heading to a dealership, you’ll want to extensively research the cars you’re interested in.
Once you have an idea of the makes and models you want to test drive, there are a number of services that can offer a baseline estimate for the car’s worth. Edmunds offers a True Market Value (TMV®) guide; Kelley Blue Book provides suggested price ranges based on things like year, model, condition, and mileage (particularly useful for used cars). The National Automobile Dealers Association’s guide focuses on dealers’ sticker prices, and Consumer Reports provides detailed reviews and reports about specific cars.
None of these resources will necessarily tell you the exact price you’ll get, but they can give you some context. It may be helpful to look at listed prices for similar cars in your area. You can even call around for price quotes from dealerships and private sellers, so you’re better equipped by the time you walk onto the car lot.
Got a car to trade in? Here’s how to find out how much your car is worth.
How the Value of Your Car Changes Over Time
A car’s value changes almost from the moment you purchase it: This is called depreciation. Generally, the cost of depreciation is spread over a five-year period. A new car can lose, on average, 60% of its value in the first five years, or about 12% each year.
Some models depreciate more than others. For instance, cars typically depreciate faster than trucks, and midsize cars depreciate more quickly than smaller cars. It’s smart to research the projected depreciation on the makes and models you’re interested in. Lower depreciation could become a deciding factor when all else is equal.
Recommended: SoFi’s Personal Loan Calculator
Car Financing Options
One of the biggest car-related costs is the loan itself. Car loans can come either from a traditional bank or through a dealership. Here are a few car financing options:
Car loans can be offered directly from a bank or online lender, or can be arranged through the car dealer. The average five-year (60-month) loan for a new car had a 4.07% interest rate in 2022, and the average loan amount was $39,340. A strong credit score, along with a solid financial history, can help borrowers qualify for a competitive interest rate. Learn how to check out your credit score for free.
Car loans are “secured” by the car, which means that the car is used as collateral on the loan. Until it’s paid off in full, you don’t own the car outright. So if you default, the lender can seize the car. The qualification process can also be difficult because banks must verify the collateral (think: more paperwork).
When getting a loan through the dealership, the dealer typically collects your information and takes it to prospective lenders to find you a financing offer. Car dealerships are good at helping customers get a car loan quickly, sometimes even without great credit. You may be able to sign a loan and drive off in your new car the same day.
Auto Loan from a Private Lender
Banks, on the other hand, may offer more competitive interest rates or more favorable terms when applying with them directly. However, the application process can be more involved and take longer. Usually, borrowers getting financing from a bank or credit union will get pre-approved for a car loan prior to heading to the dealer.
Another option is to skip car loans entirely and take out an unsecured personal loan. Common uses for personal loans include home repairs, debt consolidation, and other large purchases. On the flip side, a car loan can only be used to pay for a car.
Usually, buying a car with a personal loan is not the best course of action. But there are rare circumstances where it may make sense, such as if you plan on restoring an old car as a passion project. Cars in need of repair can be difficult to finance with a traditional auto loan.
For most car buyers, however, interest rates on any type of personal loan are typically higher than on car loans. Another thing to consider is the repayment period. In general, car loans extend over seven years, whereas a personal loan is repaid in three to five years.
Getting your personal loan approved can take time, but pre-qualification is available. Many people get pre-qualified before going into the dealership, so they have an idea of how much buying power they have.
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Strategies for Getting a Car Loan
As you look for a car loan that meets your needs, here are some strategies that can help.
Do Some Research
Before heading to the dealer, shop around for loans to see the interest rates and terms you may qualify for. Lenders review factors like a borrower’s credit score and financial history to inform their borrowing decisions. So part of your research will go into understanding (and maybe boosting) your credit score.
Recommended: What Credit Score Do You Need to Buy a Car in 2022?
Prepare a Down Payment
A larger down payment can save you money on your loan. Down payments reduce the amount you have to borrow, which reduces what you spend on interest over time. Trading in a vehicle of substantial value accomplishes the same thing, while reducing the down payment you need to put up.
A higher down payment is helpful for another reason: It’ll help you avoid a situation down the road where, due to depreciation, the balance of your loan is greater than the value of your car. This is variously called negative equity, being underwater, or an upside-down loan. To avoid this situation, run the numbers to make sure your down payment (or trade-in) is high enough to offset the expected depreciation on your vehicle.
That said, negative equity isn’t usually a bad thing. It only becomes a problem if your car is stolen or totaled, and the payout from your insurance company isn’t enough to pay off your loan balance. (Gap insurance is designed to cover your remaining debt.) Some drivers are comfortable with being upside-down for a short period, while others prefer not to take a chance.
Consider Getting Pre-qualified for a Loan
Getting pre-qualified for a car loan helps the borrower understand what kind of car payment they can afford. Pre-qualification can also be used as a tool in negotiations with the dealer. In some cases, the dealer may be willing to offer a more competitive financing option.
Just keep in mind that pre-qualification isn’t a done deal: The loan offer is still subject to change.
For many people, buying a car outright with cash isn’t an option. With an auto loan, the car acts as collateral to secure the loan. A higher down payment can save you money on interest over the life of the loan. It can also help you avoid “negative equity” down the road — where the value of the car is less than the balance of your loan. However, this is only a problem if your car is stolen or totaled, and your insurance company’s payout doesn’t cover your loan obligation. In some circumstances, it’s possible to use an unsecured personal loan to purchase a car, such as when you’re looking for a vintage car to fix up as a passion project.
Why get a SoFi Personal Loan? Borrow up to $100K for a low fixed rate for those who qualify. The online application process is simple, with live customer support available 24/7. And if you lose your job, we’ll temporarily modify your payments.
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