A gentleman came into the Bank to get an objective opinion on a car loan he was considering.
“The people at the dealership asked me what I was looking to pay a month,” he told me. “And that’s the amount the payment is. I can see that. But it looks like this car loan goes out to 2024. Can that be right?”
He was being offered a 7-year car loan. That was correct. Absolutely accurate. But when the man heard his suspicions confirmed, he certainly didn’t think it was “right.” He had no desire to be paying off a car for the next seven years with seven years’ of interest. “How can they do that?” he asked.
The dealership didn’t do anything wrong. Nothing illegal or unethical. At all. They asked him how much he wanted his monthly payment to be and then found a way to come back and say, “Yup, we can make that happen.” The dealership made his number work. They made him an offer he was free to consider and counter-offer. Or walk away from.
When it comes to some of life’s major purchases – cars and houses especially – sometimes people get fixated on getting a low monthly payment without taking into account how much the whole deal will actually be costing them.
But with cars, pricing usually isn’t completely transparent. And – making things even more tricky – car financing is often tied in with purchase and trade-in negotiations.
Every car financing package includes three key elements: The bottom-line price of the car (after any trade-in), the rate of interest and the length of the loan.
To use an extreme example: If someone could get a 100-year car loan, the monthly payments would be very reasonable. But the interest paid over the life of that loan would be astronomical.
Which makes financing a car much more like one of those 3-dimenional chess games from the original Star Trek than just “What’s your monthly number?”
To get the best price on the whole deal, you don’t want just any “low monthly payment.” You want: 1) The best price you can negotiate on the car and your trade-in, 2) At the lowest interest rate available, 3) With a loan term that gives you the specific monthly payment that lets you comfortably pay it off in the shortest reasonable amount of time.
The gentleman I spoke to ultimately decided to buy somewhat less car with a loan he could pay off in 4 years. The monthly payment was only a little higher than his original “low monthly number” and he saved a lot in interest.
Financing a house works pretty much the same way. With one major difference.
In almost 100% of the cases, the bank is not selling you the new house. Or taking a trade-in on your old house. And lending guidelines require a lender to obtain an appraisal to make sure a house’s price is comparable to similar houses. Which protects the lender from lending more than a property is reasonably worth. Ultimately that protects home buyers too.
With both cars and houses, it’s important to bear in mind that excise and property taxes, auto and home insurance, gas, utilities and maintenance have to be included in the monthly “cost of ownership” number too. It’s not just about the monthly loan payment, no matter how low that loan payment might be.
Also your goal with any loan should be to pay it off as quickly as you can. Because it’s better to own things outright. It’s good to be free of monthly payments.
Nick Maffeo is the President & CEO of Canton Co-operative Bank in Canton. “Smart About Money” is a regular column he writes for the Canton Citizen. Have a financial question you’d like to ask? Email to firstname.lastname@example.org.