Car Financing Pitfalls and Solutions

When an auto loan deal goes wrong, it's often because of problems that occur when the contract is prepared in the finance and insurance office (the "F&I" room). It's here that a car buyer can see much of the potential savings regarding his or her auto loan go up in smoke.

To better inform car buyers, we contacted a finance expert and a former F&I officer to find out what typically goes wrong and how these problems can be avoided.

Brian Reed, director of Internet lending for Capital One Auto Finance (formerly PeopleFirst), said, "Most consumers have front and center the information about the cars that they want to buy. But then they go into the finance office and all the savings could go out the door."

Another auto loan expert contributing to this article worked as an F&I officer in dealerships for 15 years. He asked that his name be withheld because, as an auto wholesaler, he didn't want to alienate dealers. However, he said that most consumers "aren't aware of the importance of the F&I experience. They view it as paperwork that should be completed as quickly as possible so they can drive away in their new car."

First and foremost, the deal agreed upon by the salesman needs to be put in writing in the contract, our unnamed source advised. This often involves determining monthly auto loan payments based on an interest rate. Sometimes, the interest rate a customer qualifies for is inflated so the dealership can make extra profit.

This and other F&I headaches can easily be avoided by obtaining independent auto financing before going to the dealership, Reed advised. This means the consumer can proceed as a "cash buyer" and negotiate only the price of the car. Car salesmen prefer customers to be "monthly payment" buyers because, in this way, it is easier to obscure the total cost of the vehicle.

Independent car financing can be obtained from a bank, credit union or on-line lender. By checking Bankrate.com, shoppers can quickly review rates at a number of different lenders. But be aware that many of their lenders will run a credit check when you apply, which will reduce your FICO score by five or six points for about six months. Besides Capital One, auto loans are also available through Up2Drive.com.

If a person applies for an auto loan through Capital One (loans are also granted for motorcycles and to refinance existing auto loans), Reed said they will be contacted within 15 minutes by e-mail or telephone. If the application is approved, the borrower is given a credit limit at an established interest rate. A blank check is issued with no obligation to use it.

"For the majority of consumers, even if you know you have good credit, there is a little apprehension and tension around applying," Reed said. "So instead of going into a dealership and giving them your information and being sent to the coffee machine to wait for an answer, you can apply on-line, 24/7."

The former F&I officer confirmed that obtaining independent car financing is beneficial to most consumers. "My buddies in the F&I would die if they heard me say this," he commented. "But with a cash buyer, there isn't much you can do to them" to make extra profit.

Reed outlined the common pitfalls — and their solutions — to ensure that things go smoothly in the F&I room.

PITFALL 1: Many consumers don't know what their credit rating is when they apply for an auto loan. The strength of their credit score largely determines what kind of interest rate they will receive. Therefore, it's critical to make sure your credit report is in the best shape possible before shopping for a car.

SOLUTION: Order a copy of your credit report and look for items that may stand in the way of you getting a good rate. Correct any issues or errors promptly. Are all of your lines of credit in good standing? Are there any signs of identity theft? The credit bureaus will tell you how to correct errors when they send you the report. The following numbers and Web site addresses will assist you in checking your credit.

Equifax: 800-685-1111, www.equifax.com
Experian: 888-397-3742, www.experian.com
TransUnion: 800-916-8800, www.transunion.com

For more about credit scores, see "Understand Your Credit Report."

PITFALL 2: Many consumers are tempted to overspend once they get to the dealership.

SOLUTION: It's a good idea to set a sensible price range for the car you want to buy and stick with it. Experts suggest that monthly car payments and related expenses should not exceed about 20 percent of your monthly net income. You can even bring a printout of your budget to the dealership as a reminder. And we always recommend bringing printouts of True Market Value prices to use as a guide when negotiating.

PITFALL 3: Most consumers arrive at the dealership without having researched the current interest rates being offered in the marketplace, so they have no idea if they're being offered a competitive rate.

SOLUTION: Use the Internet as a research tool to compare rates. Check out Web sites like bankrate.com for national averages, and the Web site of your own financial institution.

PITFALL 4: Most consumers arrive at the dealership without approved auto financing in hand. This is either because they are not aware of all the financing options available, or they assume they will qualify for a low rate at the dealer. This approach deprives the consumer of bargaining power when it comes to negotiating the lowest possible interest rate.

SOLUTION: Become an "empowered buyer" by getting a no-obligation loan before visiting the dealership. Having your own loan could save you significant money. For example, a 60-month $26,000 loan at 4.49 percent can save the consumer about $1,500 over the life of the loan, compared to a loan at 6.56 percent.

PITFALL 5: Many dealers offer a choice between discounted (or zero-percent) financing or a rebate — but not both. Consumers may erroneously assume that the zero-percent loan will deliver the most savings.

SOLUTION: Sometimes it's better to take the cash rebate and apply it against the purchase price of the vehicle — and then use your own preapproved car loan to finance the vehicle. The savings chart below shows how a low-interest rate and a rebate can "beat" a zero-percent deal.

PITFALL 6: The F&I officer may try to confuse you by "intertwining" different elements of your deal. For example, they may say "we'll give you an extra-low price on the vehicle, but this interest rate is the best we can do."

SOLUTION: Consumers should "unbundle the deal" and treat the car-buying process as three separate negotiations — vehicle price, financing and trade-in value. Avoid discussions that can take you off of this track, such as "how much can you afford to spend per month?" With financing, focus on the APR, not the monthly payment.

PITFALL 7: By the time they get to the finance department, many consumers are mentally worn out and don't review the contract thoroughly before signing. As a result, they may agree to buy things they didn't plan on (such as an extended warranty, rust-proofing, etc.).

SOLUTION: Before you sign any papers or hand over any money, check the figures in the contract and understand all the charges. The sudden appearance of extra fees should be questioned. Sometimes, dealers add extra fees — so-called "junk fees" — to retake profit they have lost by selling cars at invoice.

PITFALL 8: The consumer feels rushed, pressured and confused by the dealership's staff. In some cases these buyers have second thoughts about completing the deal — but sign the documents anyway.

SOLUTION: Consumers who feel out of their comfort zone should walk away. The buyer — not the seller — should be the one in control of the process. Remember, the federal "cooling off" law does not apply to cars.

If you do your homework ahead of time, and know what to expect before entering the F&I room, the paperwork process can go quickly and easily. But more importantly, you will receive a deal on your auto loan that you can feel good about for the life of the car.