Understanding your true returns is the key to making investment decisions that win.
Before we get started there are a few words of caution that need mentioning. Specifically, if you can afford to buy a car with cash, that's your best option. Any time you use your credit cards you run the risk of getting further into debt. But I would be doing you a disservice if I didn't let you know about yet another way you can save money!
I'm going to discuss five reasons why you need to consider your credit cards when financing a car.
First, when you use a credit card, the loan is unsecured. That means that if for some reason you have financial problems in the future, your car is not in jeopardy of being repossessed. You own it outright. The bank can't visit you in the middle of the night and drive it away.
Second, you always have the option of paying less per month. When financing a car people tend to want to pay off the loan within three to four years. Of course, the shorter the loan, the greater the monthly payment. If financing is obtained from a bank, the monthly payments are fixed for the loan term. But what happens if after couple months you a have difficult time coming up with the full monthly payment? If you're late or don't pay in full you could potentially damage your credit history. Now if you use a credit card to finance the car, you can make payments that retire the loan in three years but if you have any problems in any given month, you have the option to make the minimum payment, which would be considerably less.
Third, you don't have to wait for a loan approval. You can just use your credit line like cash anytime you're ready to buy. No need to go into the back room with the car salesman to start talking about loan rates and loan applications.
Fourth, because you're using a credit line, preferably a check, you have more bargaining power when you're making the car purchase. From the car dealer standpoint, you're buying the car with your own money. That means you don't have to deal with the secondary transaction of getting the loan. You can essentially say, "See this check, give me the deal I want, and I'll fill in the numbers right now."
Fifth and most importantly, you can save big money! When you finance anything-car, house, last night's dinner-you are really making two purchases. The first is the actual object you want to acquire-the car. The second is the money you are using to make the first purchase.
Each of these transactions needs to be carefully considered if you want to ensure that you receive the best deal. Assuming that you did the best possible job at negotiating a reasonable price for the car, we're going to move on to the purchase of the money, or the financing.
When you considered the value of the car, you had to compare it to other vehicles and their various features-power brakes, air bags, etc. Each car is different and you must weigh those differences carefully when deciding how much you are willing to pay for the car. But when it comes to the purchase of the money (the loan), every banks' cash is the same.
Here's a description of the product you get from the bank…green paper called money. It's all the same no matter which bank you borrow it from. It doesn't matter if the money comes from dealer financing, a bank loan, credit card, a second mortgage, or your neighbor. The only consideration when comparing each loan is its cost. How much will you end up paying for the use of that money today.
Let's say you're buying a used car and still need to finance $9,500. Used car loan interest rates range from 6.95% to 16.63% with the average being 9.95%. After visiting many banks, you may discover that your best rate, for whatever reason, is 10%. But you also have an offer from one of your credit cards for 4.9% for six months, and you have more than $9,500 in available credit. Is it worth using the card? You bet! At least for six months.
The bank loan at 10% APR, $9500 for three years gives you a monthly payment of $306.54. After paying the loan for six months, you'll still owe $8107.02. Now, the correct question to ask yourself is how much would you owe in six months if you use the credit-card offer and make payments of $306.54? The answer is $7877.02. That means you saved $230 by using the credit card for six months.
Some people may say, "So what, 230 bucks, big deal." Fine then, go straight to the nearest bank and make a donation of $230 to the bank manager…doesn't feel too good does it? What happened to "a penny saved is a penny earned"? If you could have gotten another $230 off the price of the car from the dealer, you'd be very happy with yourself. My point is that you can find better things to do with the $230 saved…like pay back other debts.
At the end of the six-month credit-card offer, the rate will probably go up, so you'll need to re-examine your financing at that time. You can always go to the first bank that offered you 10% and ask for a secured loan at that time to pay off the credit-card balance. But the bottom line is that you are locking in the $230 savings.
Don't finance your car blindly. Consider all your options carefully and you'll get the best deals and save a lot of money.
Scott Bilker is the founder of DebtSmart and author of the best-selling books, Talk Your Way Out of Credit Card Debt, Credit Card and Debt Management, and How to be more Credit Card and Debt Smart.