Top 8 Hidden Costs of Taking Out an Auto Loan
Unless you won the lottery or have been budgeting diligently for years, chances are you’ll need an auto loan before buying a new car. And although you know the new car price, the down payment amount and what your monthly loan payments should be, the less obvious expenses that accompany a car loan might surprise you. Understanding these eight hidden costs will help you identify and avoid them when taking on a car loan.
The Interest Rate
The interest rate is the biggest factor in answering the question, “How many cars can I afford?” Financing through the dealer might cost you more than going through a bank because the dealer might add a fee on top of the rate that the lender will charge you. On the flip side, you might be able to negotiate auto loan rates with the dealer.
With good credit, you can shop for a better car loan interest rate from a credit union or bank before you go to the dealer. You have a better bargaining position with the dealer if you’re pre-approved for a low-interest car loan. Use an auto loan calculator to compare loan rates and terms.
Negative Equity
If you’re trading in your current car on a shiny new ride, you might owe more on your current loan than the car is worth. This situation is known as negative equity, and it means that you’ll pay more for your new loan.
Suppose you have a $5,000 balance on your car loan. The dealer tells you the trade-in value of your car is $4,000, so you have $1,000 in negative equity. If you’re buying a $20,000 car, you’ll be financing $21,000 on a $20,000 car.
Learn: How to Get Out of a Car Loan You Can’t Afford
GAP Insurance
Speaking of owing more than your car is worth, you might be encouraged to purchase GAP insurance. GAP stands for Guaranteed Auto Protection insurance, and it covers the difference between the amount your auto insurance will cover and the amount outstanding on your loan if your car is totaled or stolen.
Prepayment Penalty
Though you might need a car loan to buy a new vehicle, there’s always the chance that you’ll want to pay your loan off early with cash or by refinancing into a low-interest loan. In this case, watch for a hidden cost known as a prepayment penalty, which is a fee for paying a loan off before the term is up. Then, add that to any fees associated with the refinance auto loan to determine the true cost.
Opportunity Cost
The best time to buy a car is when you can afford it, and that means taking into account the opportunity cost. Opportunity cost refers to the financial opportunities you give up by choosing to spend your money one way over others. So, for auto loans, the opportunity cost is whatever you won’t be able to spend your money on because you’re making monthly payments on a car loan. Depending on your financial situation, this could mean that you won’t be able to grow your long-term savings as quickly or pay down your other debt as fast as you’d like.
Find Out: 30 Biggest Do’s and Don’ts When Buying a Car
Extended Warranty
Extended vehicle warranties cover the costs of expensive electrical or mechanical vehicle issues that aren’t covered by a manufacturer warranty. Car dealers that offer to finance also typically offer extended vehicle warranties, which might add to the cost of your car loan and monthly payment. These warranties are not required, so think carefully before agreeing to one.
Credit Insurance Protection
Credit insurance protection covers your car loan payment in certain situations, such as being laid off or becoming disabled. It can be pricey, so check your existing insurance coverage to see if you already have provisions for paying your bills under these circumstances.
Taxes and Fees
When you buy a new car, the sticker price is just the beginning. You’ll also pay a registration fee, sales tax and a documentation fee. Sales tax and registration fees cannot be avoided, and they’re regulated by the state. The documents fee, or “docs fee,” might be up to the dealer’s discretion and can run upwards of $500 in some cases. Try to negotiate it down or pay for it in cash.
See: This Is How Often You Can Refinance a Car Loan
These hidden fees and charges are costs that everyone financing a car has to deal with, but few people talk about them or factor them into the true cost. Although these costs might be hidden, by knowing what to watch for and what questions to ask, you’ll reduce your chances of being surprised by some unintended fees when shopping for your next car loan.
Daria Uhlig contributed to the reporting for this article.
