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Before you take out an auto loan, it's important to fully understand what you're getting yourself into. Depending on where you live and the situation, there may be some hidden costs to watch out for.
Take a moment to learn about these costs you may incur and take steps to minimize them or avoid them altogether.
The sticker price of the vehicle you're buying doesn't include sales tax, which can vary depending on where you live. Only five states don't charge sales tax on auto transactions: Alaska, Delaware, Montana, New Hampshire and Oregon.
But even if you don't have to worry about sales tax, you may need to pay a registration tax to get the vehicle registered with your state's department of motor vehicles.
Unfortunately, there's not much you can do to reduce your tax burden. You can choose to include it in your auto loan, which increases your monthly payment, or you can put enough money down to cover the tax expense.
Many dealerships charge a variety of fees, which can include things like:
- Title and registration fee
- Destination charge (covers the cost of shipping vehicles to the dealership)
- Conveyance or document fee
- Advertising fee
- Fabric protection fee
- Paint protection fee
- Vehicle identification number (VIN) etching fee
- Rustproofing fee
While some of these fees are unavoidable, fees for services the dealer provides—such as fabric or paint protection—can be avoided by asking the dealer to forgo the service.
3. Gap Insurance
Gap insurance is a type of coverage that protects you in the event your vehicle is totaled or stolen and you end up owing more than it's worth. Instead of having to pay your lender the difference, gap insurance can pay it for you.
But gap insurance can come with several restrictions and limitations, making it difficult to get a claim approved in some situations. As a result, you'll want to read the policy documents carefully before you agree to the terms. You may also consider adding gap insurance after you buy the car from an insurance company instead of through the dealer. This could potentially save you some money.
A large down payment can also help protect you from encountering a negative equity situation, and do away with the need for gap coverage.
4. Credit Insurance
Some dealers may try to add a credit insurance policy to your loan, but it's purely optional and generally not necessary.
The most common forms of credit insurance are designed to cover your payments if you die, become disabled or lose your job through no fault of your own. However, these policies can be expensive compared with standard life insurance or disability insurance policies, and may not be worth the additional expense unless you're concerned about a layoff.
Note that lenders are not allowed to require you to obtain credit insurance to get approved for a loan. If one tries, you can report them to your state's attorney general.
5. Prepayment Penalty
Prepayment penalties aren't common among auto loans, but if yours has one, you'll be penalized if you decide to pay off your loan in full before your scheduled payoff date.
If you're getting an auto loan and thinking about paying it off early, make sure the contract doesn't include a prepayment penalty.
6. Opportunity Cost
Opportunity cost describes the gains from other financial opportunities you'd be missing out on if you make a certain decision. For example, if you're thinking about taking out an auto loan, you'll want to consider what else you could do with the money you'd use to make your monthly loan payment.
This is particularly true if you don't have a monthly payment on your existing car at all, or if the new monthly payment is higher than your current one.
The opportunity cost is higher for auto loans with higher interest rates or larger loan amounts, so it's crucial that you take the time to consider how the payment will impact your budget and other financial goals.
Build Your Credit to Minimize Your Costs
While interest on an auto loan is expected, you can control how much you spend by qualifying for a lower interest rate. One of the best ways to do this is by establishing a good credit score. You can use Experian's free credit monitoring service to pinpoint areas that need work, take action to address them and track your progress.
Other ways to qualify for a lower interest rate include shopping around and comparing multiple offers, putting down more money on the loan, applying for a shorter repayment term and seeking out 0% APR promotions on new car sales.
Considering you'll likely be making payments on your auto loan over the course of several years, taking steps to reduce your interest rate could save you hundreds or even thousands of dollars by the time your loan is fully paid off.