You’re probably paying more for your car loan or mortgage than you should
The Federal Reserve makes headlines from New York to Hong Kong every time it raises its benchmark interest rate. Rightly so, because every increase tends to increase borrowing costs on everything from credit cards to auto loans and mortgages.
There is one more important factor that determines how much you’ll pay when you borrow money to buy a car or a house, and it’s entirely in your hands: the lender you choose. This is because the amount that a lender can charge you for a loan can vary widely from lender to lender. That is why it is worth shopping around.
My auto loan research shows that most consumers don’t, which can cost them hundreds or even thousands of dollars over the life of a loan or cause them to buy a lower quality car than originally expected. Fortunately, it is quite easy to avoid this.
Most of us shop until we come across deals on clothes, computers, or pretty much anything else. With the Internet, finding the best deal among products and businesses is easier than ever.
A recent poll found that 92% of shoppers always look for the best deal when shopping, while 80% said they would go out of their way to find a good deal.
So one would think that this logic would apply to the most important purchases in life. For most Americans, automobiles are the tallest or second household member they own. And most cars are purchased using an auto loan.
And yet, while people often work hard to find the best possible deal on the price of a car, surprisingly, most don’t look for the best deals on interest rates at all. Research shows that this behavior isn’t limited to auto loans – most people don’t shop when they take out a loan. mortgage or one Personal loan.
Even though the costs of financing a typical loan can be a significant portion of the total cost of buying a car. For example, suppose you buy a car for US $ 25,000 and finance the entire purchase. A loan of $ 25,000 at 4% interest would cost you $ 2,600 in interest over its life, which adds over 10% to the actual price of the car.
What is a rate
Let me explain how a lender comes up with a particular interest rate.
The lender usually starts with a benchmark rate, such as the preferential rate or even a US Treasury bond, both of which tend to fluctuate based on the Fed’s target rate.
Other variables that go into the rate you ultimately pay include borrower-specific risks, such as credit scores or your debt-to-income ratio and the lender’s profit margin, which can be influenced by various factors. For secured loans, such as mortgages and auto loans, the amount of down payment and the value of the asset will make a difference.
Not all lenders will set the same price for the same borrower in the same way. In fact, just over half of borrowers overpay on their auto loans.
This is the surprising conclusion of a recent study I led with Brigham Young finance professors Bronson Argyle and Taylor nadauld. We came to our conclusions, after reviewing the anonymized data provided by the software services company Visible equity on more than 2 million car loans granted by 326 different financial institutions.
The data allowed us to compare the interest rates on auto loans from the same metropolitan area and the same time period for similar amounts on similarly priced cars and on borrowers with similar credit characteristics.
We found that almost one in five consumers take out a loan more than 2 percentage points higher than the best rate available to people with similar credit scores.
For example, Mark from Nashville with a credit rating out of 711 agreed to pay a rate of 5.85% to purchase a used 2012 Toyota Camry for $ 18,033, which is the average loan size in our study. However, another bank in the area offered Jamie a 4.2% rate on roughly the same loan, even though she had the same credit. In other words, Marc will end up overpaying about $ 1,000 over the life of the loan, or about $ 17 per month.
Compare that with the likely consequence of the Fed’s rate hike by a quarter point this month, which would have a lot less impact on your cost of getting a loan. If a car loan increased by 0.25 percentage points, the monthly payments on this typical car loan would increase by just $ 2 per month, or $ 120 over five years.
Additionally, we have found that many car buyers who end up paying too much manage to buy older, cheaper cars rather than looking for a better interest rate. If the borrower had looked for a better rate, they could have spent most of that $ 1,000 on additional financing for a better quality car.
The same lessons apply to other loans as well. A government investigation found that not looking for the best mortgage rate could easily cost you $ 3,500 over the first five years of the loan and thousands more on a typical mortgage.
Why people don’t shop for loans
What explains this seemingly nonchalant attitude towards interest rate buying?
Applying for credit often involves paperwork, which can be tedious or stressful. This might require a trip to a separate lender’s office when car buying takes enough time. Borrowers may not even know there are better deals to be had.
In fact, we’ve found that a consumer only needs to research three deals to get something pretty close to the best available rate.
Other wrong assumptions may also be at play, including the idea that you need to finance your car through the dealership (you don’t), that your own bank will give you the best deal (often not, according to our data), that the dealer’s rate will be the best (not always), or that your credit score will be affected if you apply to multiple locations (it will not be).
Part of the problem also seems to be that consumers doesn’t appreciate the power of compound interest and the extent to which small differences in monthly payments add up.
Granted, it’s not as exciting to shop for a loan as it is to try out a car, but most of these factors can be overcome or shouldn’t be a concern in the first place. While it takes a little more work to research other financing options, modern tools make it easier than you might think. Much of the same financial documents can be used by multiple lenders and websites like The bank rate, Credit Karma and Nerdwallet allow you to compare multiple interest rate offers.
The bottom line: Car buyers are literally paying more for less by not doing their due diligence to find the best financing deals. When it comes to credit, it’s worth shopping around.