Lots of people love buying new cars, relishing the freshness, the style, the newest options, the prestige, even the smell. Others hate the whole process, feeling out of their element when they haggle and dreading the cost.
Like it or not, every car owner has to run the car-buying gauntlet eventually. One of the biggest issues: how to pay for the new vehicle.
Although everyone keeps talking about today’s “low interest-rate environment,” car loans are nothing to brag about. Average rates range from about 6.5 to more than 7 percent, depending on the length of the loan term, according to the manybanking.com survey.
You might beat the averages by looking around with the shopping tool. Bank of America (Stock Quote: BAC), for instance, has a 36-month new-car loan for 4.54 percent, covering 90 percent of the purchase price, while National City Bank (Stock Quote: PNC) has one at 4.83 percent, for 100 percent of the price. Many credit unions are offering four-year deals at less than 5 percent. (Use the Auto Loan Calculator to figure payments.)
Before taking out a new-car loan, consider three other approaches:
Liquidating assets. Basically, that means tapping savings or selling investments, like stocks, bonds or mutual funds. That way, you can avoid interest costs altogether. Avoiding a 7 percent car loan is like earning 7 percent on an investment. But there’s a price to pay, nonetheless, in the form of lost earnings on the investment or savings.
The choice comes down to comparing the interest rate on the best auto loan you can find with the expected return on the investment or savings. If you have a stock fund you expect to pay 10 percent a year, keep your money there even if it means taking out a car loan at 7 percent.
Keep in mind, though, that any investment that might return more than 7 percent a year will carry some risk of loss. By comparison, the savings you realize by forgoing a car loan is like a guaranteed return equal to the loan rate.
Home equity. If you own a home that is worth more than you owe on it, you could use a home equity loan to pay for your new vehicle. For most people, interest paid on a home equity loan is tax deductible.
The manybanking.com survey shows home equity installment loan rates of between 7.2 and 8 percent. That’s no better than a car loan, though the tax deduction would cut the effective rate on an 8 percent loan to 6 percent, assuming a 25 percent tax bracket. Compare home equity and auto loans with the Auto Loan vs. Home Equity Loan calculator.
However, if you use the home equity search tool and click the “Home Equity Line of Credit” box, you’ll find many “HELOC” loans at 3 to 3.5 percent. The tax deduction can take one of those even lower.
Note, however, that, unlike home equity installment loans, which have fixed rates, HELOCs carry floating rates that can change as often as once a month. A borrower with good credit can find a HELOC at the prime rate, currently 3.25 percent, plus two percentage points. That comes to 5.25 percent, or just under 4 percent with the 25 percent tax deduction.
Because of the risk the rate will rise if the prime rate goes up, the HELOC is best if you could tap savings or investments to pay the loan off if the rate jumps.
Buy used. If a new car and the payments involved give you sticker shock, think about buying a used car, like one that has just come off of a two- or three-year lease. Many lease cars have regular dealer servicing, and when sold often come with warranties. Getting a car that is several years old could cut the price by a third, perhaps even half.
Interest rates usually are higher on used-car loans, though the payments could be lower if you borrow less. As an alternative, the car might be cheap enough for you to pay cash.
Or take out a home equity line of credit. You’ll get the same HELOC rate regardless of whether you use the loan for a new or used car.
—For more ways to save, spend, invest and borrow, visit MainStreet.com.