7 hidden costs of taking out an auto loan
By Sarita Harbour/GOBankingRates
Unless you recently won the lottery or you've been budgeting diligently for years, chances are you'll need an auto loan before driving away in your new car. And though know your new car's price, your down payment amount, and what your monthly loan payments should be when you're considering taking out a loan, the less obvious expenses that accompany a car loan might surprise you.
Understanding hidden fees when you take out an auto loan for your next car will help you identify them, and either avoid or minimize these costs when comparing car loans.
Here are seven less obvious costs to watch out for when taking out an auto loan.
This article was originally published by GOBankingRates.
Increased auto loan interest rate
One of the less obvious costs when buying a new car is the higher interest rates that often go along with car dealer financing. According to the Consumer Financial Protection Bureau, car dealers sometimes add their own fee on top of auto loans through a higher interest rate, bumping up the annual percentage rate. Instead of getting hit with this higher-cost loan with a great APR from a car dealership, and depending on your credit worthiness, you might be able to get a pre-approval for an auto loan from a credit union before going car shopping.
Credit unions usually charge 0.5 to 1 percent less than auto dealers on financing as long as you're an acceptable credit risk. If you think you might want to go with dealer financing, strengthen your negotiation position by getting a car loan pre-approval from a credit union or other financial institution before you start to bargain with the dealer.
Prepayment penalty
Though you might need a car loan to buy a new vehicle, there's always the chance that you'll want to pay your loan off early either with cash or by refinancing into a low-interest loan. In this case, watch for a hidden cost known as a prepayment penalty, which is a fee for paying a loan off before the term is up. Not all auto loans have prepayment penalties -- ask your lender to point it out. You might even be able to reduce this penalty as part of your auto loan negotiations.
GAP insurance
Guaranteed Auto Protection insurance is another cost you might not be aware of when you're looking at financing a car. GAP insurance is an optional insurance that pays the difference between what your car insurance provider will pay and how much is left on your auto loan if your car gets damaged, totaled or stolen.
GAP insurance can be purchased from the car dealer, but also from a third-party finance company or a general or GAP-exclusive auto insurance company. It's smart to shop around before purchasing insurance, because when it's bundled in with the auto loan, GAP insurance adds to interest payments.
Opportunity cost
When it comes to economics and money, opportunity cost refers to the financial opportunities you give up by choosing to spend your money one way over others. So for an auto loan, the opportunity cost is whatever you won't be able to spend your money on because you're making monthly payments on a car loan. Depending on your financial situation, this could mean that you won't be able to grow your long-term savings as quickly, pay down your other debt as fast, or make other purchases.
This hidden cost adds up fast, both for your household and for the country. Outstanding auto loan credit in the U.S. reached over $1 trillion for the first time ever in the second quarter of 2015, according to the Wall Street Journal. That's $1 trillion that isn't being used by Americans towards retirement savings or investing in other sectors.
Extended vehicle warranty
Extended vehicle warranties or service contracts cover the costs of expensive electrical or mechanical vehicle issues that aren't covered by a manufacturer warranty. Car dealers that offer financing also typically offer extended vehicle warranties, which might add to the cost of your car loan and monthly payment. However, these warranties are not required, so think carefully before agreeing to one. If you do decide to take an extended vehicle warranty, try to negotiate the price or pay for the warranty with cash. Or if you're getting financing from a credit union, ask if they offer these warranties because the cost might be lower through a credit union.
Negative equity financing
If you already have a car loan and a vehicle, and you owe more on your auto loan than your vehicle is worth, then you have what's known as negative equity. And if you're shopping for a new car with new financing, you might run into what's known as negative equity financing, which means when you trade in your car, the amount you currently owe on this vehicle gets added to your new loan for your new vehicle.
So you're not only paying interest on the loan for your new vehicle, but you're also still paying interest on what you owe on the vehicle you're trading in. This adds to the cost of taking out an auto loan, yet approximately one-third of car owners who traded in their cars this year have negative equity as of 2016, according to J.D. Power and Associates.
Credit insurance protection
You might not have heard of credit insurance protection, but this optional insurance, which covers your car payments in certain situations, might also add to your auto loan expenses.
Typical situations that credit insurance protection might cover include:
- Credit life coverage to pay off all of part of your loan should you die
- Disability or accident and health insurance to cover car loan payments if you have a qualified injury or illness and can't work while you have your loan
- Involuntary loss of income or unemployment insurance, which makes your monthly payment for a specified number of months should you lose your job through no fault of your own
Credit insurance protection can be quite expensive. Shop around and get quotes from a few different sources before committing to it. And don't forget to check your existing insurance policies as they might already include coverage for these situations.
Final thought
These hidden fees and charges are costs that everyone financing a car deals with, but few people actually talk about them or factor them into the true cost of borrowing to buy a car. Although these costs might be hidden in an auto loan payment, by knowing what to watch for and what questions to ask, you'll reduce your chances of being surprised by some unintended fees when shopping for your next car loan.