Personal Finance Insider writes about products, strategies, and tips to help you make smart decisions with your money. We may receive a small commission from our partners, like American Express, but our reporting and recommendations are always independent and objective.
- Like many people, I’ve always secured auto loan financing from the dealership at the time of my car purchase.
- But I recently learned that securing financing from a financial institution before buying a car can save you money.
- Dealerships can add more to the interest rates offered by their partner banks, sort of a “convenience fee” for acting as the intermediary on the loan.
- If the loan I took out on my daughter’s last car had been 2% lower, I could have saved $435 over the life of the loan.
- Sign up to get Personal Finance Insider’s newsletter in your inbox »
I must have purchased at least 10 vehicles over the past 20 years, all of which have needed to be financed. I learned how to shop and buy a car from my parents. You go to different dealerships to compare prices, take test drives, and get a feel for what will be the right fit.
When you’re ready to make a choice, you talk to the dealer about finance options and they take care of everything right there on site. It wasn’t until I was 38 and my 19-year-old daughter totaled her first car that I learned there is a much smarter way to go car shopping — and that I’ve likely thrown away thousands of dollars over the years.
Getting a loan through the dealership
I made a deal with my daughter, who for years had been hard-working and very responsible. If she could afford a monthly payment and the increase in my insurance policy to cover herself and a car, I would cosign on a loan with her so she could get something used. We both scoured the websites of our local dealers looking for something within her price range. She found one she liked at the Toyota dealer I had purchased my current car from.
When we met with a salesperson at the dealership, my daughter gave him the details of the exact vehicle she was interested in test driving. It was an older model Nissan with decent mileage, a good price, and a clean Carfax report.
After a quick test drive, we were ready to talk about money. We completed some paperwork, gave our Social Security numbers, and awaited the loan offers from the finance department. My credit was good and hers was, well, new, but I didn’t anticipate any issues securing a loan.
The salesperson came back with some disconcerting news: None of the banks they work with would finance that vehicle without a large down payment. We were told that the age of the car was the main issue. However, there was a newer-model vehicle we could look at that would be able to be financed within our budget and ability to make an immediate $500 down payment.
The new option was a Nissan Versa without power locks or windows; a very stripped-down model with a standard transmission. I knew how to drive a standard, but my daughter didn’t. Still, the price was right and I knew she could learn, so we decided to buy the car.
The dealership ran the numbers and we agreed to a loan offer with a 9.75% APR from Carolina Trust Federal Credit Union, which was a local institution we were happy to support. The interest rate was much higher than the 4% I was paying on my own car, but I attributed that to having someone with a small amount of credit history on the loan. Within a few hours of entering the dealership, we were making an appointment to pick up her first new-to-her car.
Getting a loan from a credit union
It took a few months for my daughter to get the hang of driving a car with a standard transmission, but she got it eventually and was enjoying her increased mobility. Unfortunately, bad luck and sun glare struck and the car was totaled within six months of our purchase.
The insurance paid off the loan and gave us some money to buy another vehicle. I started the car search process once again and found a decent candidate. This time, I called the credit union’s loan office to ask if they could offer me a loan on this new used car instead of contacting the dealership. I was shocked at the response.
The loan officer told me they’d be happy to finance the car at an interest rate and monthly payment that was significantly lower than the one from the loan we’d just paid off. The car I was interested in was comparable to the one that was lost, so I asked why there was such a difference between the rates between the two loans. After all, they were both financed through their institution.
That’s when I learned that car dealerships can add a markup to the interest on a loan. According to the Consumer Financial Protection Bureau, when a dealer runs your financial information to find offers for your auto loan, they receive a set interest rate from banks willing to loan you the money. A dealership isn’t obligated to disclose or offer you this “buy rate,” nor does it have to give you the best rates possible.
Dealerships do have the option of increasing the interest rate from the rate offered by the lender and pocketing the difference as compensation for handling the financing. I see it as paying for the convenience of being able to immediately secure a loan and close on a vehicle purchase. And an expensive one at that.
Tim Carlisle, president and CEO of Carolina Trust Federal Credit Union, confirmed to me that they do have agreements with the local car dealerships about marking up the interest rates offered to consumers. He says the maximum amount a dealership might add is about 2%, but every lender has its own agreement with the dealers they work with.
“You’re always better off if you do your homework before you ever walk on the lot. Once you walk on the lot, the dealerships are very good at trying to accommodate you in making sure that you’re ready to purchase a car on the spot because they know that if you leave the lot, you may or may not come back,” he says. “If you do your homework upfront, you know what to expect and you know if you’re getting a good deal or not.”
Carlisle added that a dealership may offer gap insurance or warranty coverage, which would be added on to the amount of your loan. Your lender may also offer those products at a lower cost, so it’s something you’ll want to ask about if you shop around for auto loans.
My original loan was for $7,500 at 9.75% APR over 60 months, which amounted to $2,006 in total interest. If I had gone directly to the credit union for the loan and gotten an APR of 7.75% (applying the maximum average markup), I would have saved $435 in interest over the life of the loan.
This was an expensive lesson to learn, but I’m glad I know better now. Though my own car is paid off, it is six years old and has high mileage. I may find myself in the market for a new vehicle sooner rather than later. At least now I know my first step should be to call my credit union and some other banks — because you should always shop around — to see how much I can afford and what my payments would be before talking to a salesperson.