How to avoid getting into a lemon of a car loan
You've shopped, you've compared models, and you've negotiated for a good price on a new set of wheels -- and you might still walk out with a clunker of payment plan.
When driving away from the dealership, a car buyer’s biggest fear used to be ending up with a clunker. But these days, a car loan is as likely to be a lemon as the car itself.
Nearly 85% of new-car buyers in the second quarter signed up for a loan or lease to fund their purchase, according to data released this week by credit bureau Experian. That’s the highest level since it began tracking the sector in 2006.
Car dealers are driving the surge with incentives that include low-interest financing for the most creditworthy borrowers, but experts caution that shady lending practices remain in the marketplace, including interest rates or monthly payments that end up higher on the loan paperwork than what the lender and borrower verbally agreed to, and pitches for expensive add-ons (like extended warranties and rust protection) that raise payments. “There are still unscrupulous dealers out there — guys who are not going to live up to their promises,” says Alec Gutierrez, senior market analyst at Kelley Blue Book.
While consumers gained new credit card and mortgage protections following the economic downturn, car dealers are largely exempt from those financial reforms. They have access to a pool of lenders including banks and often the car maker’s financing arm. Unlike banks that dole out car loans, most car dealers aren’t within the Consumer Financial Protection Bureau’s jurisdiction.
Experts also caution that borrowers will find less transparency with dealers than with traditional lenders: For instance, when car dealers approve borrowers for financing, they often raise the interest rate the lender is actually offering and pocket the difference — a practice that does not have to be disclosed to the consumer, says Jack Gillis, spokesman for the Consumer Federation of America, a consumer advocacy group.
For their part, car dealers say markups are often made to cover their operating costs and that protections exist. The National Automobile Dealers Association says consumers who become victims of questionable lending practices should contact the Federal Trade Commission (which has oversight over this industry) and their state’s attorney general. The association adds that it’s “important to distinguish the limited number of . . . fraudulent transactions from the millions of legitimate” deals that occur each year.
Experts say consumers should shop around for loan approval before they arrive at dealerships. Gutierrez recommends consumers find out what interest rate they’d receive on a car loan from their local banks and credit unions. Borrowers can also cast a wider net for lenders by checking websites like LendingTree.com and Bankrate.com. They can then compare those loans with the terms the car dealer offers.
The dealer could still come through with the lowest rate -- but borrowers should look out for the following pitfalls before signing on the dotted line:
Bait and switch. Even after buyers and dealers agree on the loan’s interest rate, borrowers should review the rate (or monthly payment when applicable) on the paperwork before signing off.
Gutierrez of KBB says that while the industry has improved in recent years, there are still cases where borrowers find higher rates and monthly payments in writing than what they had agreed to during their discussions with the car dealer.
Yo-yo financing. Buyers should make sure they’ve completed the loan transaction before driving off the lot. In some cases, dealers will allow borrowers to drive away before financing is completed, only to call them back to the dealership a few days later saying that the deal fell through and placing them in a more expensive loan -- a tactic known as yo-yo financing. The NADA says it condemns these “fraudulent transactions” and that they’re limited in number.
Expensive add-ons. Before dealers finalize a car loan, they’ll often push add-on services, including extended warranties, protective coating for a car’s leather interior, and supplemental insurance, that can cause a borrower’s monthly payment to jump by up to $100, says Gutierrez. The NADA says these products are always optional. Consumers who think they’ll want such extras should consider shopping for them elsewhere (for instance, contacting their insurance company for policy quotes) before they arrive at the dealership.
More from MarketWatch:
- 12 most embarrassing cars to drive
- 5 ways commuting ruins your life
- 10 things credit bureaus won’t say
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