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Why You Should Borrow Before You Buy a Car

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

On Sunday, the New York Times reported about borrowers paying sky-high interest rates for used cars. They correctly identified that many elements of the sub-prime mortgage crisis can be seen in the auto lending market today.

We agree with the NY Times and we will give you:

  1. Tips to avoid the sub-prime auto trap if you are looking to buy a car
  2. Tips to get out of the sub-prime auto trap if you are stuck there today, and
  3. Our view of why the system is such a mess

Know before you go

If you are buying a car, you need to do most of your work before you go to the dealership. When you first step foot on the lot, you should already know:

  1. Your credit score
  2. How much you can afford to pay each month
  3. The interest rate and loan amount that you have been approved for

If you don’t know this information, then you will be depending upon the auto dealership to guide you. And that would be a mistake.

1. Your credit score is your ticket to financing. Some credit card companies provide your FICO score free of charge on your statement. There are other sites that can provide a free credit score (not FICO, but a good approximation), like CreditKarma. A score above 700 makes you prime, and will give you access to the best deals. Below 700 means you need to do a little more homework. Remember: you do not need to be rich to have a good credit score, you just need to pay on time and not max out your cards.  Learn how to get a 700 score here.

2. You need to create a budget and understand how much you can afford to pay (comfortably) each month. Keep in mind that people always underestimate their expenses when making a budget. The auto dealer will do his best to talk you into a more expensive car. When a dealer lies about your income on an application, he is only helping himself – not you.

3. Once you know your score and how much you can afford, you should get pre-approved.

      • If you have a score higher than 700, then there is probably no better deal than a credit union like PenFed (who offers a 5 year used car loan at 3.74% APR). Anyone can join PenFed, but your local credit union will also probably offer a great rate. In addition to your credit score, PenFed generally wants a debt burden (monthly expense as a percent of monthly income) to be less than 50%. And so should you.

If your score is below 700, then you should still speak with your credit union. If they do not approve you, then go directly to CapitalOne, who has a Blank Check program and is one of the largest lenders in this space. In 10 minutes, they will tell you how much you can borrow, and at what interest rate. They will then give you a “blank check” that you can take to one of the 12,000 dealers who partner with them. Borrowing with the Blank Check program will be cheaper than borrowing at the dealership.

Once you know your score, how much you can afford to pay each month, and your pre-approved interest rate, you can walk onto the dealers lot with confidence.

Once on the lot, remember:

  • Avoid “rolling over” debt. You do not want your loan to be more than 100% of the value of the car. If you have no other choice, then you really need to consider a cheaper car, to keep the total amount financed below 100%.
  • Beware the warranties and add-ons sold at the end of the deal. They wait until the very end, and try to sell expensive warranties – and then add them to the loan.
  • The dealer may be able to beat the financing you bring to the lot. If you are buying a new car, there may be a 0% offer, for example. But make sure you compare the full cost of the loan he tries to sell you to your pre-approved offer (including any fees or points).
  • Don’t let the dealer talk to you only about monthly payments. They can give you a low monthly payment – but charge you a lot more – if the interest rate is high and the loan term is very long.

Already Stuck in a Bad Loan?

So, you wish you would have done all of these things, but, you didn’t and now you have a loan at an outrageous interest rate.

There are ways to get out of the mess. The most important first step is building a plan to get your score above 700. That means paying your bills on time every month, not maxing out new credit cards, and keeping open credit available. Once your score is above 700, you can find a lot of options to refinance your car loan, up to 100% loan-to-value. (If your car is worth $100 and your loan is $100, then you have 100% loan-to-value. If your car is worth $100 and you have a $50 loan, than it is 50%.)

Again, one of the best refinance programs out there is PenFed. You need a score above 700 and a debt burden of 50% or lower. Once you get there, you can slash the interest rate on your car, below 3%. The best way to get out of a subprime loan is to make yourself prime, and then refinance.

If you can not get approved at PenFed, you may want to speak with your local credit union.

If your score is lower, you may want to consider re-financing at CapitalOne, who also has a refi program.

If your loan is above 100% LTV, then your goal is to get it below 100%. One way is to consider a low interest rate loan from a credit union to cover the portion above 100%. For example, PenFed offers 9.99%. You could also consider a loan from LendingClub* or Prosper.

Unfortunately there is no magic solution. But, once your balance is below 100% and your score is above 700, you can dramatically cut the cost of debt. So, your goal should be to improve the score (payments over time) and reduce the LTV (including a personal loan) to reach that point.

Why it will never be good at a dealership

Dealerships make money in two big ways: selling cars and financing cars.

Selling cars is straight-forward: they want to sell you a bigger car with more features. Beware.

Less clear is the money they make on financing. The dealer discount is a payment that the lender makes to the dealer. Those fees are not always transparent. And the dealer will want to put you in the loan that pays him the most, not in the loan that gives you the best deal.

That is why you should always walk onto the lot knowing how much you can afford and already having a great interest rate. If the dealer can beat it – great. But you will have control.

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Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Personal Loans

Removing the Middleman: When a P2P Loan Makes Sense

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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Banks long held the monopoly on giving loans to those in need of money. When the banks rejected them, people turned to predatory lending like title loans. Fortunately for the consumer, a new type of loan has entered the financial marketplace.

Peer-to-peer lending, commonly referred to as P2P, is a relatively new way for borrowers to gain access to loans and for investors to diversify their portfolios.

For a borrower, the goal is to find a loan at the lowest possible interest rate. P2P loans open another option for finding lower interest rates. However, if your debt is on a credit card and you have a 700+ credit score, we recommend pursuing a balance transfer.

What is a P2P loan?

You borrow a fixed amount of money at a fixed interest rate, fixed monthly payment and you know when you’ll have completely paid off the loan.

What makes this different from a bank loan is how you borrow the money. Instead of being given a loan by a bank, borrowers go through an intermediary such as Prosper or LendingClub to receive a loan from an investor (or investors). These are sometimes regular people like you who are looking to diversify their investment portfolio. Other times they may be institutions including hedge funds, endowments and pension funds.

A personal loan is suited for you if you need access to cash or want to refinance existing debt at a lower rate and a balance transfer isn’t an option.

Peer-to-peer lending is interesting because they were developed specifically for the digital environment. This makes them accessible with a few clicks on a computer and a relatively simple application process. There is no need to visit a bank branch. The aim of P2P lending is to give a borrower lower interest rates while giving investors higher returns.

How is this possible? P2P lenders remove the middleman (aka the bank branch).

How does a consumer get one?

You can complete an application online.

Once you complete the application, it will be reviewed without a hard inquiry on your credit report, so your score will not drop. You will also know your proposed interest rate before accepting the loan.

If approved, your loan will then be presented to investors who will review available loans and decide which ones match their criteria.

The borrower will then have set monthly payments at a fixed rate that is often significantly lower than the bank would offer.

At MagnifyMoney, we’ve reviewed Prosper and LendingClub. You can read our reviews to see if one of these is right for you.

Ensure you’re shopping around before committing to a loan. Check to see if a credit union offers you a better interest rate or if your credit card debt can be taken care of with balance transfers.

How is this better than a bank loan?

P2P lenders tend to approve people with lower credit scores than a bank would, which makes them more accessible. They also offer lower interest rates making it easier and more cost-effective to pay back the loan.

LendingClub* states: LendingClub uses technology to operate a credit marketplace at a lower cost than traditional bank loan programs, passing the savings on to borrowers in the form of lower rates and to investors in the form of solid returns.”

Prosper says, “We cut out the middleman to connect people who need money with those who have money to invest…so everyone prospers!”

The downside is you may have to wait a bit while your loan is funded, which can take up to 14 days, and you might also be asked to send in some documents to verify your income.

If you have a credit score of 700 or above, we typically recommend a balance transfer instead of a bank loan or personal loan. You can use this tool to see how long it would take to pay off a balance transfer vs. a personal loan.

Why would a lender take the risk?

To answer that question, it makes sense to think about what happens when you put your money in a savings account.

When you put money into a savings account, banks borrow the money from you to loan it to someone else, it doesn’t just sit in a vault. The bank then offers a pitiful interest rate for your loan. Traditional banks often give .01% while some Internet-only banks do a much better job at closer to 1.0%.

Either way, it isn’t a great ROI.

P2P Lenders typically see much better returns on their investments – not that you should dump all your savings in P2P loans! It simply offers investors an opportunity to diversify their portfolio.

We’re fans of P2P Lending and Personal Loans

At MagnifyMoney, we’re fans of personal loans and peer-to-peer lending and how they’re offering alternatives to what the banks offer.

Read this article to find out how to find the best personal loan rates online.

Be sure to email us ([email protected]) if you have any questions about whether a personal loan is right for you or how to complete the process.

Decided to take out a personal loan? Be sure to check out the four traps of a personal loan.

*We receive a referral fee if you click on offers with this symbol. This does not impact our rankings or recommendations. You can learn more about how our site is financed here.  

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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