You may have seen some posts on social media where buyers are supposedly taking on some bonkers car payments on what should be very affordable rides. Every day, many buyers leave a dealership way over their heads on a bad car loan. They could have prevented this with a skill they learned in elementary school, using tools available on just about any smartphone.
The skill is called “math,” and the tool is your calculator.
Why Not Just Pay Cash?
Now, before I get into the “trick” on how to prevent this, I would like to address something. There’s a certain camp that likes to get on their high horse whenever they hear about someone getting hosed by a dealership: The “always pay cash” crowd. If you’ve saved a large chunk of change to buy a car outright, that’s great. I’m not disputing that methodology. However, to tell someone in desperate need of an affordable ride right now that they should “just wait and save” is about as helpful as telling an individual struggling with weight loss “just don’t eat food.” Our nation’s economic situation at large means that there is a sizable portion of the population perpetually just getting by on whatever income they have. They simply don’t have the luxury of piling up a large amount of cash. But they can manage a reasonable monthly loan payment on a car.
Don’t Shop for a Car Loan Based on Monthly Payment Alone
This brings me to the idea of a “reasonable” car loan. A lot of folks get fixated on the monthly payment amount, which is understandable — most people conceptualize their budget based on what comes in versus what goes out every month. For the most part, this is fine. But some dealers set a trap, giving you a monthly payment amount that works for your budget while saddling you with a loan where the balance is completely out of proportion to the value of the car.
Here’s what every car buyer should do before signing any auto loan contract: Take the monthly payment of the loan, and multiply it by the number of months in the loan term. That, plus whatever amount of money you put on a down payment, is the total loan cost.
Next, compare that cost to the purchase price of the vehicle. In many cases, the loan will be greater than the retail value of the car — obviously, because that’s how interest works. However, if the gap between the total loan cost and the car’s value seems extremely wide, that’s a bad sign.
How to Calculate the Cost of Your Car Loan
For example, let’s say we have a buyer looking at some used cars at their local lot. They tell the dealer they need the monthly payment to be under $300 per month. The salesperson shows them a car with an asking price of $12,000 and says, “We can get you into this one for only $289 per month for 72 months.” Rather than take the bait and be happy that they’re under budget on their payments, the buyer should run some quick multiplication on their phone to realize that $289 x 72 = $20,808. Assuming this buyer put zero money down (which is true for a lot of folks who get into predatory loans), this loan is $8,808 above the cost of the car!
This simple and quick act of multiplication should hopefully set off some alarm bells: either the dealer is adding a bunch of extra fees and/or the interest rate on this loan is really high.
How to Avoid a Predatory Car Loan: Final Thoughts
Unfortunately, when it comes to these crushing loans, dealers tend to take advantage of folks with less-than-ideal credit, or those who are desperate to get a working car. Since there’s no quick-fix way to bring your FICO score up by 100 points, I strongly recommend shopping the loans first, and the car second.
The last thing you want is to be at the mercy of whatever loan the dealer says they can get for you. Talk to your local bank or credit union; look into some online lenders. This will give you a realistic idea of what your interest rate will be, and you can establish a shopping budget accordingly. Having a pre-approval also gives you leverage against the dealer No matter what, always run the math before you commit to a contract.
Tom McParland is a contributing writer for Jalopnik and runs AutomatchConsulting.com. He takes the hassle out of buying or leasing a car. Got a car buying question? Send it to Tom@AutomatchConsulting.com