What’s the best way to pay?

It’s a whole different game when you’re buying used. Here’s how to have the edge if you need a car loan

The financing options available to new-car shoppers are well advertised but what’s out there for shoppers of pre-owned vehicles?

Unlike new-car dealerships, whose low, low financing rates are subsidized by the manufacturers to keep their assembly lines humming, used-vehicle dealers remain at the mercy of the lending market.

And despite the fact interest rates are at historic lows, used-car lots are borrowing at 5.99 per cent right now – a good rate, but not a great one. Yet consumers won’t be seeing that number on their loan agreement.

The dirty secret of the finance world is that your chartered bank would rather loan the money to dealers than to their own customers. In fact, auto dealers earn a cash incentive from the banks to loan that money out at the highest possible interest rate.

“Banks pay a flat commission for a base rate loan, and incentives if the borrower has good credit and can be bumped to a higher interest rate,” explains George Iny, president of the Automobile Protection Association (apa.ca).

“For a $10,000 loan, the best rate from the small dealer I contacted is 7.25 per cent; the dealer can get a commission of about $150 (from the bank). By bumping the rate by 1.5 percentage (points), the dealer will collect $400.”

“It incentivizes the dealer not to give you the best rate,” says Iny.

As a general rule, car loans valued at less than $10,000 are levied a higher interest rate, while larger sums are cheaper to borrow.

Car loans are almost always negotiable. When pressed, most dealers can shave a half-per cent off the quoted rate to win your business, but to really get their attention, utter the two most hated words in the car business: credit union.

“A credit union can offer car loans at 6 to 6.25 per cent to their best customers,” Iny says. “Dealers hate that. It’s like showing a crucifix to a vampire.”

The best bank rate for a larger loan on a more recent model can be as low as 6.5 per cent. But to qualify for their lowest rates, banks want to see substantial money down: about 15 to 20 per cent of the vehicle’s transaction price.

The banks’ dealer plans are available for vehicles as old as 2005, with a surcharge on the interest rate for 2004 models. For older vehicles and weaker borrowers, expect to pay between 12 and up to 28 per cent with sub-prime lenders such as Wells Fargo. Buyers in this class – typically new Canadians and poor credit risks – are often desperate and will pay,

The “get-me-done” auto loan is a specialty of used-car lots that advertise wheels for clients who are credit risks, often the same people who use cash-advance payday services. They typically need a car right away to get to work.

Customers with a fixed address and two paycheques can qualify – as long as they can put one-third down, agree to expensive add-ons like administration fees and warranties, and are shopping the $3,500 to $5,000 auto market.

“The cost to the dealer of the cheap car is recouped up front through the down payment and various fees, so the loan repayment is pure profit,” explains Kevin Bavelaar, president of used-car retailer Auto Showplace.

“Sub-prime lenders take the `deals with the hair on it,’ as it’s called,” he says. “But miss the payment by one day and you’ll find your car hooked on a tow truck.”

Bavelaar advises against giving into the punishing interest rates and excessive fees: “Take the bus for a couple of years and save your money.”

He points out most of his showroom customers tap their personal line of credit, with an interest rate ranging from 2.5 to 3.5 per cent. The only problem with that, he says, is that the principal often remains untouched as consumers fall into the trap of paying only the minimum monthly charge.

“At least with a bank loan, there’s a start and an end date to it,” Bavelaar says. Car loans are also open, which means they can be paid off anytime with no penalties.

Auto broker Mark Derry of Carsense.to says it’s not uncommon for buyers to bring in a co-signer, often a relative, who can guarantee repayment of the loan – making it less risky and hence more affordable – although he cautions it’s a commitment not to be taken lightly.

“If the client defaults, the co-signer risks her own credit rating if things go awry.” Alternatively, the new breed of online financial institutions is very consumer friendly. Derry says PC Financial is currently offering an “all-purpose” loan with very competitive rates starting at 5.2 per cent, depending upon the repayment schedule (the shorter the term, the lower the rate).

In addition, Derry says, some manufacturers are moving into factory financing of their dealers’ used inventory as another way to build brand loyalty. The rates are usually very competitive – 2.9 or 3.9 per cent on selected models – but often specify shorter terms, such as 24 or 36 months.

Bob Pierce, director of member services for the Used Car Dealers Association of Ontario, says many smaller, independent used-car dealers find it difficult to arrange favourable financing. Especially those selling older, high-mileage models.

He’d like to see the banks evaluate the car and the borrower, rather than write off the whole segment and leave it to the sub-prime lenders.

“With the new disclosure rules coming in January, the focus should be on the vehicle and whether it is worth the value of the loan,” says Pierce.

In the meantime, dealers are discovering new financing portals online that appear to be more competitive than the traditional lenders.

Pierce advises used-car shoppers to take the time to scrutinize their loan agreement. There’s a new tick box for clients to initial, indicating they understand their payment obligations.

“Slow down and read the stuff.”

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Dec 17, 2009

MARK TOLJAGIC

The Toronto Star