Avoiding Credit Hassles at the Dealership

You fill out a credit application at a car dealership. You're led in to see the finance manager who happily announces, "Great news! I can finance you at 9.9 percent."

You're tempted to say, "Sounds good. Let's do it." But then doubt sets in. Isn't the prime rate 6.5 percent now? How do I know this is the best rate I can get?

So instead of readily agreeing, you say, "That rate sounds a bit high."

"We base our interest rates on your credit score," he tells you.

Naturally, you ask, "So what was my credit score?"

Now the tap-dancing begins. The finance manager tells you your credit is good — but not that good. There are a few little things on it ... But at the end of this shuffle he might say, "You know what? I just remembered there is this other bank where I think we can get you 9.1."

Well, you've just saved yourself some money. But the rate still might not be as low as you can get. After all, if you don't know what your credit score is, you can't aggressively demand the best terms.

The interest rate you pay on financing your new car is like so many other things at the dealership — open to negotiation. So how do you go about getting the best deal? And is it worth haggling over a few percentage points?

First things first: Yes, it is definitely worth trying to get the best interest rate possible. While one percentage point might not seem like much, applied to a five-year loan it can be significant. For example, on a $20,000 auto loan at 9 percent for five years, according to the Edmunds.com loan calculator you would pay $415.17 a month. But if you financed the $20,000 at 7 percent, you would only pay $396.02 a month — a savings of $1,149 over the five-year period. And because of the way car lease payments are calculated, they have a greater impact when leasing than when buying.

Clearly, a low interest rate is important. To accomplish this, make sure your credit report is up-to-date and all black marks have been removed. Those things that can negatively affect your credit include the following:

• Late payments
• Non-payment of bills
• Bankruptcies
• Liens
• Repossessions

Any financial blemishes will lower your score with the most commonly used credit ratings agencies: Experian, Trans Union and Equifax. These companies generate a rating which, for most people, falls somewhere between 330 and 850, and are called "FICO scores" named after Fair, Isaac & Co. Over 800 is considered perfect. Below 800 may put you on a lower credit tier. In the 600s you find yourself in the "sub-prime" area and will pay inflated interest rates. Higher interest rates are justified by lenders who say there is a risk the person will default on the loan. (Visit the FICO Web site for a more complete description of how credit scores are interpreted.)

Auto dealers rely heavily on FICO scores in setting your interest rate when you buy a new or used vehicle. Therefore, it's in your best interest to know your credit score before you visit a dealership. Otherwise, it may come as an unpleasant surprise in the finance and insurance room when you set up your loan.

Two extreme cases are referred to as spot deliveries and bogus insurance sales.

A spot delivery occurs when a dealer looks at a customer's credit and sees that they will probably qualify for a car, but they don't have all the information to set up the loan. They allow the customer to take the car while they continue trying to get them qualified. In some cases, the customer is told to return to the dealership and a new contract is generated — at a higher interest rate.

In other cases, a customer is told that their credit is weak and they can't buy the car unless they pop for an expensive extended warranty or additional insurance policy. This is a false requirement intended for dealer profit.

Consumers should also know about a practice used in the auto business called "dealer markup." Here's how it works. You go car shopping and agree to buy a vehicle for a certain price. You then tell the salesperson that you are either going to finance the car or lease it through the dealership. Before you go into the finance and insurance room to review the final documents, the finance manager begins shopping for a car loan on your behalf. She may find that you qualify for a 7 percent loan over five years.

Now things get sticky. The finance manager calls you in and says, "Great news! I can give you this loan at 11 percent." Obviously, she has marked up the interest rate 4 percentage points. The difference between what the bank charges the dealer and what the dealer charges you is their profit.

Is this illegal? Absolutely not. Is it unfair? Well, it depends how you look at it. They've done you a service by arranging the loan. For their work, they are making a profit.

It's a good idea to check your credit scores periodically. In some cases, people who have common names might find someone else's misdeeds on their record. Besides that, if your credit is sub-prime, you will be subject to a number of expensive — and unpleasant — practices.

However, you want to save as much money as possible. The easiest way to do this is to arrange your financing before you go to the dealership. Check with your credit union or bank (keep in mind that interest rates are slightly higher for used-car loans than new car loans). Auto loans will usually be one or two points above the prime rate, which fluctuates throughout the year.

Once you have been approved for a car loan, it's easy to go to a dealership and negotiate only for the purchase price of your new car. You will be asked several times throughout the process how you plan to pay for the car. Give them a relieved smile and say, "I'm paying cash for the car." This doesn't mean you are going to give them $20,000 in cash. It means that the dealership will receive one lump-sum payment for the car.

There are times, however, when financing through a dealership makes sense. Sometimes, the manufacturer offers to loan money at exceptionally low interest rates such as 2.9 or even 0.9 percent. If you can qualify for these special programs, you should take advantage of them, though they often mean reduced payment periods such as 24 or 36 months.

Bottom line: Don't be held hostage by the dealer. Do yourself and your family a big favor — clean up your credit report before you begin the car shopping process. Next, nail down a low-interest loan from an independent lender such as your credit union or bank. Then, and only then, hit the car lot and start shopping.

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