Topics:Car Loans 101 Car Shopping Tips Co-Signing Downpayment GAP Pre-Approval Car Loans and Credit
For people with unscorable or subprime credit, it can be hard to get a car loan. One of the most common ways that Americans solve this problem is by getting a friend or family member to act as a co-signer on a car loan. Before you agree to help, know that there are risks! According to the Federal Trade Commission, a co-signer agrees to guarantee the debt if the borrower doesn’t pay. This may also include late fees or collections’ fees. Depending on the laws in your state, the lender can collect from you without first trying to collect from the borrower if payments are missed. Collections can mean that you could be sued for the debt or have your wages garnished. If the debt is overdue, it can be reported as part of your credit report. Despite all of this, 71 percent of consumers establishing first-time credit with an auto loan depend on a co-borrower to get approved. On top of that, for many Americans, money is the number one cause of stress. In an American Psychological Association study, 31 percent of adults with partners reported money as a huge source of relationship stress. With that in mind, we have compiled these suggestions to help navigate the car loan co-signing waters with someone you care about, while still staying on speaking terms. 1. Lay ground rules “I think ground rules from both parties should be laid out before signing the loan. Each party needs to know what each other expects from one another. If you’re the one signing, you need to make it very clear about the huge risk you’re taking and the equally huge favor you’re doing for them.” — Laura Gonzalez, Marketing Manager at Audi Bellevue 2. Set expectations and discuss specifics “Co-signing a loan is like you taking out the loan yourself except that you won't be making payments as long as the original borrower keeps up their end of the bargain. If they default on the loan, your credit takes the hit and you will be expected to pay the loan. It is important that they know they are expected to make every payment in full and on time. You are only co-signing to help them get a lower rate or help get them approved. It's very important to know the terms of the loan you are co-signing. If the borrower cannot make payments, the loan company will go after you to fork up the money. Here's what you should know: total amount borrowed, interest rates, time frame to pay it off, monthly payments, defaulted fees, late fees, early repayment penalties (if any), cosigner insurance, cosigner release benefits, and if the loan can be transferred. Knowing the terms of the loan can help you when speaking about the loan to your friend or family member. It also lets the borrower know that you know what's going on.” — Marissa Sanders, Personal Finance Expert, Simple Money Mom 3. Establish trust and open communication “Each party should have faith in and trust each other for this to go smoothly. If the trust is not there, it could end poorly for your relationship should things go wrong. Communication is another key aspect of making this work. If it looks like they may not be able to make a full payment on time, they should feel comfortable telling you and you should encourage them to do so. Otherwise, you both will take a hit to your credit.” — Gonzalez 4. Make your own personal contract “If you still decide to help a friend or family member, you should consider how they handle their money. Although the loan is a contract already, you may want to write a contract between the two individuals about what happens if things aren't paid so there will be no misunderstandings. Trust will be tested in this kind of situation, so beware of what you get yourself into. Talk about how things would impact your relationship. Remember most people don't talk about their money with others, but if you are going into something together you have a right to know. This discussion can save you some heartache in the future.” — Damisha Ricks, Author, How to Move Out and Not be Broke!: Young Money Sense 5. Keep lines of communication friendly and open “Make sure to keep lines of communication open regarding the loan. An occasional, "Hey, how's the loan repayment going?" can keep that line of communication open. If there is any hardship, you want to make sure this person can come clean to you so that you aren't stuck in the dark. Make sure to get duplicates of all loan transactions and/or login information so that you are up to date on the loan. This way, the borrower knows you are well aware of the status and cannot lie about it.” — Sanders 6. Consider the doomsday scenario “If someone requires a co-signer for a car loan, it's likely based on their poor credit from failing to fulfill previous financial obligations. You have to consider the very real possibility you'll end up on the hook for this. Before agreeing to co-sign, ask yourself if you're willing to make the payments or accept the damage done to your credit score. Consider how damaging it would be to the personal relationship if it comes to that.” — Morgan Taylor, CMO and Financial Advisor, LetMeBank 7. It’s okay to say no “It can be hard to say no sometimes, especially when it comes to family members or close friends. However, it’s okay to say no. You should be thinking carefully and logically about this decision. Ask yourself these questions: Do they have a history of defaulting on loans? Do they have a poor credit history? Do I trust them enough with my credit history? Saying no can prevent the relationship from going sour. They might be upset initially, but it will work out in the long run.” — Gonzalez
You have a lot to think about when looking for a new car, whether it's new or just new to you. On top of that, there are many strategies and opinions about how to take advantage of a down payment when shopping for a car. While they might not be the same, most experts agree that a down payment can be a secret weapon in your auto financing odyssey. We asked experts for advice about how to make the most out of your down payment. Here’s what they said you should know: 1. Down payments apply to principal “A down payment is a payment that is applied to the cost of the car before the loan is applied. In other words, it gets applied to the principal.” — Chane Steiner, CEO of Crediful “Ideally, the larger the down payment the better. Large down payments equate to shorter payment periods and lower interest rates — thus, saving you money.” — Laura Gonzalez, Marketing Manager at Audi Bellevue. 2. The 20/4/10 car financing rule “A useful rule of thumb when purchasing a car is 20/4/10 rule. This rule states that you should make a down payment of at least 20 percent, have a loan of no more than four years, and total transportation expenses should not exceed 10 percent of your income.” — R.J. Weiss, Certified Financial Planner and founder of the personal finance site The Ways to Wealth 3. Budget with down payment calculator first, monthly payment second “A down payment can be anything from 0 percent to 99 percent of the loan. I've used down payments to get my monthly payment within a certain range. A down payment amount should be an amount of money the consumer is willing to part with permanently.” — Kreigh Williams, personal finance blogger, eat.money. "Most 'how much car can I afford' calculators focus on monthly payment, because that’s what most car shoppers focus on. (Because it’s the first question dealers ask!) But if you flip it, and start with how much down payment you can afford, you’re more likely to get the right car payments. So first, figure out how much cash you’re willing to part with right now to buy your car. Then multiply it by five. If you stick to that as your maximum car purchase price, you’re likely to get the car that’s right for your budget. Keep in mind that positive equity in a trade-in can count toward your down payment, so make sure you’re getting the most you can for your old vehicle." — Sonia Steinway, CEO, Outside Financial 4. Buy a car with 20%–30% percent down for new, 10% for a used, if you can afford it “A down payment for a new car should be at least 20 percent of the cost of the vehicle and 10 percent for a used car. You really want to try to get ahead of the depreciation that happens when you take the car off of the lot.” — Steiner “Most auto finance experts recommend putting down at least 20 percent of the purchase price on a new car, and at least 10 percent down on a used car. That can amount to a lot of cash. At Outside Financial, we recommend putting down as much as you can afford. — Steinway “A good rule of thumb is that a down payment should be 20 percent of the car's purchase price. A 20 percent down payment helps keep you from owing more on a car loan than the car itself is worth.” — Jamie Page Deaton, executive editor, U.S. News Best Cars “It is widely considered customary to put 20–30 percent down on a financed vehicle purchase, but many buyers wish to finance the entire purchase amount or pay as little down as possible. Most people would choose to pay cash for a vehicle, but this is often not a feasible option. However, for several reasons, it is in the buyer's best interest to put as much down as is reasonably possible. The higher down payment, the less one finances; resulting in fewer finance charges, greater equity in the vehicle, and may result in better financing terms.” — Rob Drury, Executive Director, Association of Christian Financial Advisors “Any money put towards a down payment is a piece of the vehicle cost that you won’t have to pay interest on, so it makes long term financial sense to put up as much as you can spare. But, since that is not always possible, 10 percent of the total cost is a good rule of thumb for a minimum on a car down payment.” — Jake McKenzie, Content Manager, Auto Accessories Garage 5. There’s always a risk when buying a car “Edmunds has reported that the average car down payment was 10.40 percent of the car’s total price. My recommendation is to put down between $1,000 to $2,500 for a car lease. I remember years ago at my old dealership — we had a customer put down a substantial down payment on an exotic sports car. The next day he got into an accident totaling the car and losing his down payment.” — Roland Reznik, former high-end car dealership owner, auto transporter, now with Credit Repair Kings 6. Understand your loan-to-value ratio and more “Because lenders know that cars lose value quickly, they worry that you’ll end up underwater (i.e., you’ll owe more on the loan than the car is worth) if you use your loan to pay for the entire car purchase. The more you’re able to put down, the lower interest rate you can usually get, and the more likely you are to be approved for a loan. That’s because lenders take into account a few key metrics, including the loan to value (LTV) ratio of the vehicle (how much they lend you compared with the value of the vehicle) and payment to income (PTI) ratio (how much your car payment will be compared to your monthly income).” — Steinway “Loans are underwritten actuarially, based purely on a quantitative assessment of the risk to the lender. The greater the risk to the bank, the higher the interest rate. Based on factors such as one's credit history and the vehicle's residual values (anticipated resale and salvage values), the lender will determine an LTV percentage authorized for the loan. This is a ratio of how much of the vehicle's current market value the lender will lend; for example, if a LTV of 120 percent is authorized, the total amount approved will be 20 percent above the market value of the vehicle, to allow for such things as drive-off fees, negative trade equity, and warranties. If the authorized LTV results in an amount less than the total purchase figure, the difference will be required as a minimum down payment.” — Drury 7. Down payment = more equity = more refinancing “If you can swing a big down payment and get into an affordable car with lower monthly payments, it can be a great way to rehab your credit and get the transportation you need. As long as you keep the payments affordable and make them on time, you're helping yourself improve your credit rating. And, a larger down payment means more equity in your car. That equity can make it easier to refinance to a lower rate once your credit improves — saving you even more.” — Deaton 8. Big down payments can reduce interest or loan length “The bigger the down payment, the lower the financed amount. With a smaller financed amount, you can either take a lower interest rate and pay smaller monthly payments, or keep the monthly payments relatively the same and pay your car off in a shorter period of time.” — McKenzie 9. You can avoid GAP insurance via your down payment “A down payment should be as big as you can afford. You will pay interest on everything in a loan. Interest is money wasted. On top of that, with little to no down payment, you will find yourself upside-down on your loan. Vehicles depreciate quickly and if you buy a new car for $30,000 with no down payment, you will have a $30,000 loan and by the time you get home, your new car will have depreciated to $27,000. If it gets totaled by hail damage or an accident that night, you’ll be responsible to pay back the full $30,000 to the lender, but your insurance will only reimburse you according to the car’s value ($27,000). So, you’ll need to purchase GAP insurance when you buy your car to help you pay for that difference in what you owe and what the car is worth. You can avoid that extra insurance cost, though, if you pay enough down that you won’t be upside-down on your loan.” — Melanie Musson, insurance expert and writer, carinsurancecomparison.com 10. $1,000 down will affect your monthly car loan payments “Take a look at your budget and finances to see what amount of down payment you feel comfortable with. Consider that every $1,000 you put down, your monthly payment will drop by about $15 to $18.” — Reznik 11. Down payment = bargaining power = chances for better financing options “A significant down payment reduces the amount you owe on the car. When you owe less, it gives you more room to negotiate the price or interest rates down or crucial items together. Conversely, the more you owe, the less you have in bargaining power. It's a signal of your goodwill to the dealer, resulting in possibly much better terms — even if your credit rating isn't good.” — Gordon Polovin, finance expert and advisory board member, Wealthy Living Today. 12. A trade-in offer can affect down payments: Buying now and buying later “Try trading in your existing car as part of the down payment, so you are not paying cash-out-of-pocket.” — Polovin “And remember, the less you borrow, the less interest you have to pay over the life of the loan and the lower your monthly payment will be. That doesn’t just affect this loan, either; if you end up having to trade in your car with an outstanding balance on the loan, you may have to borrow more money for your next car purchase to cover the difference, at a higher rate.” — Steinway
"GAP stands for Guaranteed Asset Protection," says Sonia Steinway, CEO of Outside Financial. "It covers the difference between the value of your car and what you owe on your loan if your car is totaled or stolen. That 'gap' can be worth thousands of dollars because many people borrow more than the car is worth, even at the dealership, and cars depreciate as soon as they're driven off the lot." GAP coverage can be in the form of a GAP waiver or GAP insurance. These differ in several ways, but for the most part, offer the same type of protection to car shoppers. Read more: GAP Insurance vs. GAP Waiver: What's the Difference? To help you understand whether you need to consider this type of coverage, let's start with exploring how GAP applies to different types of car purchases. Car shopping and GAP insurance "Deciding how much to pay for a vehicle and whether to go new or used, own or lease is an important financial consideration," says Zhaneta Gechev, founder of One Stop Life Insurance. "Most people don't think about how their insurance will change with a different vehicle. They are thinking about the down payment, the monthly payments, the warranty (or no warranty). But knowing exactly how it will affect your insurance should always be a part of the equation. It affects your finances — and sometimes by a lot more than you'd expect." This includes the added cost of GAP. As Gechev mentioned, you have several options when you are in the market for a new set of wheels: buying a new car or a used car, or leasing a car, rather than buying it outright. How does GAP coverage apply in each of these situations? Buying new "New cars tend to depreciate the most quickly, so the likelihood of you needing GAP coverage is higher if you purchase new," says Melanie Musson, an insurance expert, researcher, and writer for carinsurancecomparison.com. Why? Gechev explains, "When you purchase a new vehicle, in particular, you can have a pretty wide gap between what your car is worth and what the insurance would cover if the car got totaled." Buying used When you buy a used car, you are probably less likely to need GAP coverage. Ryan Guina, founder and owner of The Military Wallet and CashMoneyLife explains, "large gaps between the amount owed and vehicle value is one strong reason to consider quality pre-owned vehicles [instead of new]. After over two years, a significant portion of that initial value loss has already occurred, so you nearly eliminate [the possibility of] owing more than the vehicle is worth." So buying a car more than two years old means that GAP coverage isn't a necessary cost, in most circumstances, unless you are underground on your loan due to other circumstances. Creditful CEO Chane Steiner warns, "Be sure to get gap insurance regardless of the age of the car! Any car could be totaled as soon as you get it off of the lot and then all of the money you spent would have been for nothing. You could even end up still owing money on a car you no longer have." Leasing Leasing a vehicle is a bit different. As risk advisor Charles R. Villafana explains, "When it comes to leases, the companies are a bit more rigid with their guidelines, requiring higher limits of liability and GAP insurance. Which in the end is a great thing, just because it takes care of the consumer as well as the companies' interest." "Sometimes the choice is made for you and you are required to purchase GAP insurance according to the terms of your lease," explains Joel Ohman, a Certified Financial Planner™ and the founder of Car Insurance Comparison. While your lease's terms are likely requiring you to get coverage, it can either be included in your financing deal, or not included. "As a general rule," explains Mike Scott, a Senior Mortgage Loan Originator at Independent Bank, "GAP is already included in the vast majority of leases done, so purchasing GAP waiver, or GAP insurance is not necessary in those transactions unless you are leasing through an off-brand company." Steinway advises that consumers be sure to check their lease if they aren't certain. With these three purchase options out of the way, let's examine just when GAP coverage would come into play. How does GAP insurance work? "In a nutshell, Guaranteed Asset Protection — better known as GAP insurance — covers the 'gap' between what you owe on your vehicle and what it's worth at the time of the loss," explains David W. Griffin Jr., Vice President at The Dowd Agencies. "If your car is totaled or stolen, your auto insurance policy only covers what your car is worth at the time of the claim, which may be far less than what you owe. GAP insurance can make up the difference so you can pay off the full balance of the loan." As Griffin mentioned, this would be a benefit to you in basically two circumstances: You get in a car crash and your car is totaled Your car gets stolen What are you risking without GAP insurance? Basically, all insurance is about risk avoidance. With GAP insurance or waiver protection, what is the risk that you are actually trying to avoid? Gechev has some insight to understand the heavy financial toll that neglecting this type of coverage can have: "Prior to launching [onestoplifeinsurance.com], I was an assistant manager at a major insurance company. I saw first hand the devastation that could come when people did not have GAP coverage." "Unfortunately," Gechev explains, "I've worked with many clients who did not have GAP insurance and for one reason or another, the car was a total loss. It might be an accident, it may be stolen. For an insurance company, it does not matter how much you owe on the car, just how much it costs to replace. There were many clients that were 'stuck' paying for a car that they no longer had. It is pretty upsetting when you have to do that." "In effect, GAP insurance saves you from having to continue making payments on a vehicle that you no longer own," explains Ohman. What type of problems can arise when you don't have GAP covered? No car to drive, but you still have to pay for it. — "GAP Insurance is an important protection," says Drew Scott from Scott Insurance. "Insurance carriers will pay the book value of a car if totaled or stolen. However, that amount may be less than the balance of the loan, leaving the insured with no car and money still owed." Two auto loans for one car — If you don't have GAP coverage and your car is totaled or stolen, insurance agent Brandon Tritten from JBLB Insurance Group explains, "you're going to buy a new vehicle and have a loan on your new auto — plus a vehicle you no longer own." That means paying two monthly payments to drive just one car, or wrapping your remaining balance into another loan. Either way, you pay a lot. What is the alternative to GAP? If you don't have GAP protection, you have to pay out of pocket for the difference. And who wants to do that? When weighing your options, it's pretty simple. Tony Matheson, CFP® is a Wealth Advisor and founder of Matheson Financial Partners LLC. He suggests looking at it this way: "With any insurance coverage, ask yourself 'Would I be able to cover the loss with my savings account?' If the answer is no, then you should consider purchasing insurance to protect yourself from a loss that could potentially devastate your finances. If you don't have the savings to cover a loss, GAP insurance is a good idea. We see this happen often when the value of the car is lower than the loan or lease obligation. This is often caused by a small down payment on a new car or when you have stretched the loan term out over five years." How does GAP insurance differ from car insurance? When you have a car, you are required to get car insurance. What's the difference between GAP protection and what you are already paying for your car insurance? "Standard auto insurance pays only what a car is worth at the time of a theft or accident," Car Leasing Concierge Paul Maloney explains. With car accidents, Guy S. DiMartino, DC, JD explains this general rule about car insurance: "Whether the claim is made through your own collision insurance or the other driver's property damage coverage, the insurer is only required to pay fair market value for the vehicle." And they don't just guess what the fair market value is. "Most insurance companies use the NADA program to calculate this actual cash value," says Kelly M. a paralegal at Hancock Injury Attorneys. "This amount is almost always less than what you owe on your lien." What does this mean for you? Because the car insurance payout is less than what you owe, Kristine Lee, a licensed insurance agent and content strategist at insurance comparison site, The Zebra, explains that the situation is likely "leaving you in a situation where you're not entirely 'made whole' by your insurer after an accident." How does GAP insurance help? "Gap insurance protects you financially if you happen to total your new car, as it fills in the gap between what your insurance company will reimburse you for and what you owe to your lender," advises Lee. Put another way, "GAP insurance comes to the rescue," says Maloney. "[It] supplements the payout you get from comprehensive or collision coverage if your car is totaled or stolen." Now that we understand that GAP insurance is mostly needed for newer cars, to cover your financial bases if you can't use your car anymore, let's examine the reasons why you might owe more money to your lender than your car is worth. Why would you owe more on your car loan than the car is worth? This can happen due to a couple of different circumstances: Taxes, fees, and ancillary costs — "Almost always you would owe more on a car than it is actually worth," says Gechev. "Just think of all of the expenses that are added on the back end: taxes, loan documents, warranties, trade-in balance, depreciation, etc." Trade-in wrapped into new loan — A consumer may "owe more on their vehicle than the trade-in value and the dealership wraps the deficiency [from the existing loan] into the new loan …" suggests DiMartino. Small down payment — "If you buy a new or newer car with little to no down payment," explains Musson, "there will be a period of time when your vehicle has depreciated and is worth less than what you have financed. So, you have to evaluate if you have the finances to pay that difference if your car is a total loss. If you can, then you can decide if you want to assume that risk. If you can't, then pretty clearly, you need GAP coverage." Long loan term — "Generally speaking, if you finance a vehicle over a term of 48 months or more, or you only put a small amount of money down then you should consider purchasing GAP insurance," advises Ohman. These last two, small down payments and long loan terms contribute to the biggest reason: Depreciation. What does depreciation have to do with GAP insurance? "GAP insurance is also important when a car is recently purchased, but no longer considered new," explains Drew Scott. "A vehicle's largest drop in value occurs the moment it is first sold and driven off the lot." This is critical. "It's critical to realize that new vehicles drop in value as much as 20 percent right after you drive off the lot," explains Gechev. "If you were to get into an accident or the vehicle is somehow damaged or stolen — you owe the difference between what the insurance will pay and what you owe on the loan. That can be a difference of thousands." Mike Scott from Independent Bank helps us understand how your car's value depreciates: "A vehicle depreciates the minute it is driven off the lot, and follows a normal depreciation curve, in which a large percentage of the depreciation happens within the first month to six months, and then it levels off as the vehicle depreciates slowly following that. Why? Well, let's look at new car sales. Right now (August of 2019), the 2019 double-cab Chevy trucks are being sold for 20 percent off of MSRP. That means that the vehicle you purchased three months ago is being sold for less than you may have paid and is also competing against the new vehicles. This is by no means exclusive to American vehicles. Nissan is currently offering $3,500 off of the Rogue in addition to any dealer discounts, BMW is offering discounts of $2,000–$3,500 on most of their models, and pretty much every manufacturer discounts the remaining vehicles at the end of the model year. What this means is that, unless you placed a very large down payment (30 percent or more) on your vehicle, you probably owe more on it than it is worth. When we combine that fact with longer-term financing, the curve at which a vehicle is paid off means that we often don't reach a break-even point (the point at which what is owed is equal to the value of the vehicle) until three years or more into a five-year loan. Even financing it at 0 percent interest, you still won't break even for at least 30 months without a large down payment. Can you afford to cover that difference between what your insurance company would pay and what you owe? If not, then getting GAP insurance may not just be a luxury, but a necessity." Where and how do you get GAP coverage? GAP coverage can be in the form of a GAP waiver or a GAP insurance policy. These can be acquired in a couple of different ways: through the car dealership's F&I department, through your loan provider, or with a car insurance company. At the dealership, through your loan "GAP policies are one of the ancillary products often sold by dealerships in the F&I office (usually at highly inflated prices)," explains Steinway. Insurance agent Brandon Tritten from JBLB Insurance Group warns, "A lot of dealerships will include GAP insurance in your loan. It is important to ask… Is the dealership or lender offering GAP insurance? What is the cost? Can you opt out of it?" While GAP costs can be rolled into your new financing agreement, Mike Scott warns, "Keep in mind, however, that the GAP coverage is one of those items which a dealer can mark up considerably. As such, you may have significant room to negotiate the cost." For example, he shares, "On a recent purchase of a $40,000 vehicle, GAP cost my wife and me about $600." Through your own outside lender If you are getting outside financing rather than going through the dealership, you can still try to roll GAP coverage into your financing agreement. "Many people don't know, but there are banks that offer GAP insurance built into their loans," says Gechev. "You don't have to pay extra for it. You get the best of both worlds — the coverage you need without paying extra for it. The catch here is that you could not be upside-down on the loan." From your car insurance company The third place that consumers can procure GAP coverage is with an insurance company. "A GAP insurance policy is typically sold separately from your traditional car insurance policy," explains Ohman, "though it can often be sold by your existing car insurance company to ride alongside your current policy." "Generally, most auto insurance companies offer a form of GAP insurance you can add to your policy," advises Tritten. Although, he warns consumers that "It is an endorsement you have to ask for. It doesn't come automatic. Nor is it free." While most insurance companies do offer some kind of GAP coverage, it isn't a given. Gechev adds, "It's important to note that not all insurance companies offer GAP insurance, so you may also find it necessary to change insurance companies." Additionally, when adding GAP insurance through your insurance company, there is a time window you should know about. Ohman explains, "Typically you have a 30-day window to purchase GAP insurance after you purchase your vehicle." However, he suggests that consumers can easily add GAP at the same time they buy the vehicle, because you have to notify your car insurance company that you are adding a car to your policy immediately. While you do have to secure your insurance within a timely manner, you don't have to keep it forever. Griffin adds, "Remember, though, that the 'gap' [between what you owe and what your car is worth] shrinks as you begin to pay down the loan and the vehicle decreases in value, so you don't need GAP insurance throughout the life of the loan." "Once you're comfortable with your equity position in the auto you can remove the endorsement from your auto policy," explains Tritten. When you contact your insurance company about the new car you are adding to your policy, make sure to ask questions. Guina from The Military Wallet, explains, "It's important to note that a lot of insurances now have 'full repayment cost' or 'new car replacement,' so you may not need actual GAP coverage. It's best to calculate carefully and talk to your insurance agent to make sure you're fully covered. Don't assume." So, which is best? Getting a GAP waiver from the dealership, your bank, or a GAP policy from your insurance company? "I would weigh the cost of adding the endorsement to your auto insurance policy versus buying it from the lender/dealership," advises Tritten. Knowing the difference in cost will help to make the decision. It's really just important that you are covered in the case of a total loss. "Wherever you buy GAP," suggests Steinway, "make sure you ask the salesperson the following questions: Does the policy include the deductible on your collision or theft insurance? Does it include any negative equity or rollover balance from a previous loan? Does it exclude cars that are uninsured or underinsured? Does it cover interest and fees that build up starting when your car is stolen or totaled until the insurance payment is made? Does it include any obligation you may have for window etching or other add on products?" Experts advise when it is worth it to buy GAP and when it's not "Both GAP insurance and GAP waivers serve a vital role in protecting consumers' investment in their vehicles," says Danielle M. Diodato, Esq., Associate General Counsel at DOWC® "When GAP should be considered just depends on an individual's circumstances." She adds, "There is no magic formula to determine who should consider GAP protection, but thankfully for consumers, there are options." Without a magic formula, we asked the experts to tell us when GAP coverage is worth it, and when it is not. Here's what they said: When it's worth it: "The advice we give to our motor vehicle accident clients is the following: In the majority of cases, Gap coverage is worth it. Gap insurance is VERY inexpensive. If your car is a total loss from an auto accident, the insurance company will only pay you for the actual cash value of your car. The gap insurance pays the difference. This protects the client from having to pay any out-of-pocket or have a rollover into another car." — Kelly M., Paralegal at Hancock Injury Attorneys "When leasing or buying a car, compare your total cost, including taxes and fees rolled into the loan, to the car's MSRP and ask yourself the following questions: Do I owe more than the vehicle is currently worth? If I do, could I pay the difference between what I owe and what the vehicle is worth? If the answer is no, then purchasing GAP insurance makes sense." — David W. Griffin Jr., Vice President at The Dowd Agencies "It's worth having gap insurance if a) you have a financed or leased car, b) you made a small down payment, c) you're financing long-term, or d) your car's value depreciates quickly while you still have a loan. In instances where you're potentially in a position to lose money because of the financial gap of what you owe versus the value of your car, it's prudent to have gap insurance to cushion the blow if the vehicle is totaled." — Kristine Lee, The Zebra "You should get GAP on any purchase in which you are not putting a significant (30% or more) down payment on the purchase of the vehicle, particularly if you are also financing the vehicle for an extended period of time." — Mike Scott, Senior Mortgage Loan Originator at Independent Bank "If the vehicle purchase is financed, it is ALWAYS appropriate to get GAP insurance. GAP insurance is priced very reasonably, and like any insurance product, it is priced actuarially, reflecting the quantitative risk to the insurer. If the negative equity resulting from a total loss results is minimal, the premium will be very low. If the resulting negative equity would be great, the premium will reflect that, and the buyer is relieved of the responsibility for that loss. There is simply no decision to be made. It is extremely disheartening to have no vehicle but continue to have a car payment." — Rob Drury, Executive Director, Association of Christian Financial Advisors "A car buyer that can only make a small down payment or needs longer financing terms — up to 84 months — is a prime candidate to consider GAP protection." — Danielle M.Diodato, Esq., Associate General Counsel, DOWC "The purpose of GAP is to cover the difference between what your car is worth and what you owe on your loan. So anything that increases that gap — either because you borrowed a lot more than the car was worth or because the car lost its value more quickly — will make GAP more valuable. If you can buy it at a reasonable price, we recommend purchasing GAP if... Your down payment was less than 20 percent of your total loan. You drive more than 15,000 miles/year. Your loan amount is greater than the value of your car because you financed your fees, taxes, negative equity or rollover balance from an older car loan, a vehicle service contract, or other items. You bought a vehicle that is likely to lose its value, or depreciate, more quickly than the average. Your loan term is 60 months or longer." — Sonia Steinway, CEO, Outside Financial "Gap Insurance, in my opinion, is a very important part of your insurance coverage, especially when auto dealers offer the zero to little money down and longer financing terms. Driving off the lot the car will not appreciate, but depreciate in value, essentially creating a loan-to-value gap. This the most important time to have the coverage in place." — Risk advisor Charles R. Villafana When it's not: "Insurance companies make money by providing insurance. If you can self-insure yourself with an emergency savings account, that is the best option." — Tony Matheson, CFP®, wealth advisor and founder, Matheson Financial Partners LLC. "If you make a large down payment or purchase an older car for a good deal, and you know you won't be upside down on your loan, then clearly, you can forego GAP." — Melanie Musson, insurance expert, carinsurancecomparison.com "The ONLY way you DON'T need GAP is if you had put in a big down payment or if you owe less than what your vehicle is worth." — Zhaneta Gechev, founder, One Stop Life Insurance
From time to time, you may see offers to get pre-qualified or pre-approved to buy a car, especially when you are actively researching cars to buy or loan providers. What do these words actually mean? Are they a guarantee that you can buy a certain car? To understand this auto finance industry jargon, we asked financial experts to explain these terms. You might be surprised at what we discovered. When you are done reading this article, you will know the difference between these terms and when to use each in the process of your car shopping journey. What is car loan pre-qualification? Tim Owens, a consumer vehicle lending executive at Bank of America answers this one for us, "Prequalified means you have an estimate of how much you can afford based on several factors, mainly income. This is typically used for prospective buyers who are looking to have a better understanding of what is possible when car shopping." Sonia Steinway, CEO of Outside Financial explains, "If you submit your information to a car loan site (like Outside Financial) and they run a soft pull of your credit history, you're considered pre-qualified." When you shop for a car loan, rates for people with less-than-perfect credit are hard to track down. Most lenders say "rates as low as" and credit unions and banks only say the starting interest rate (for people with prime and excellent credit scores), not what it will be for people who have a credit score that they aren't so proud of. So, if your credit score is 700 or better, you can mostly see the rates as advertised. While the national average FICO score is at an all-time high, not everyone has a score over 700. Generally, you provide some unsubstantiated information about your income and employment, a soft-pull is done on your credit, and helps potential borrowers know if they are in a place to get a good loan. It can help to estimate rates and terms, as well as the budget level for shoppers. "It's important to remember," says Owens, "that with prequalification, you're not actually approved for financing, but you are given an estimate of what you could be approved for." What is car loan pre-approval? "On the other hand," says Owens, "pre-approval is as close as you can get to confirming your creditworthiness without having a purchase contract in place. It means the lender has examined your income, credit, and other expenses to determine the loan amount you qualify for." Another way that people often see pre-approved auto loan offers may sound more familiar. Sometimes, you can see this type of offer from your bank or credit union in email or snail mail offers. Steinway explains "If instead the site bought a list of people with certain credit history from one of the credit bureaus and sent a marketing email or letter to each one, those potential borrowers would be considered pre-approved." While it is a baby step up from prequalification, it still isn't guaranteed approval. You generally don't have to have the car already picked out to get pre-approved, but you may have to include a budget-level in your application. Be warned: some financial institutions may do a hard pull of your credit report for a pre-approval. Be sure to look for keywords mentioning that applying for pre-approval will not affect your credit score. If a pre-approval is completed with a hard pull on your credit score, Chane Steiner, CEO of Crediful explains, "they will stay on your credit report for about 12 months." Honestly, it's not the end of the world. Steiner suggests that you "Complete all of your pre-approval applications in the span of 14 days, so it has the impact of just one pre-approval application." Pre-qualified vs pre-approved Sometimes these terms are used interchangeably, but both are generally entry-level steps to understanding your car loan options. However, "both are different than being approved," says Steinway. "Pre-qualifications aren't as strong as pre-approvals," explains Steiner, "as they are based off of less information and do not guarantee approval for the actual loan. While pre-approvals are stronger than pre-qualifications, they don't guarantee approval either, though, your chances are stronger, especially if nothing changes in the meantime. They also give you more bargaining power at the dealership because it shows you have the assets for the purchase." "Pre-approvals can be either a soft pull or a hard pull," explains Mike Todaro, Sales Manager at Matt Blatt Kia of Toms River. So, while pre-qualification generally comes with a soft credit pull, pre-approval may or may not. The end goal: loan approval Actual loan approval (without the pre), requires a hard pull on your credit against information about the specific car you are looking to finance to see if you can be approved to borrow money for it. Many lenders restrict their funding to specific model, mileage, and other restrictions, with clear lines that they won't cross when it comes to specific vehicles. While "pre-approval and pre-qualified terms are subject to change," reminds Steinway, "approval terms are not, at least during the time that the approval is active." Only once you have an official loan approval are you able to make a purchase. Prior to that, it is still possible that your pre-approval or pre-qualification may not pan out.
When it comes to GAP insurance, and a GAP waiver, many Americans are confused about the difference between these two products. Which one do they need, if they need one at all, and what is best for their purchase? Let’s start with what they have in common: GAP stands for Guaranteed Asset Protection. This type of policy basically helps car buyers to avoid having to keep making monthly car payments on their car, in the event that it is stolen or totaled. No one wants to be paying on a car that they don’t even have anymore. GAP coverage pays the difference between what your regular car insurance policy provides and your remaining loan balance. Although the terms are often used interchangeably in the auto industry, we got some help from auto finance experts to break down the difference between a GAP waiver and GAP insurance. Here’s what they said: GAP options: waiver or insurance "Most consumers don’t realize that there are options," says Danielle M. Diodato, Esq., Associate General Counsel at Dealer Owned Warranty Company (DOWC®) in Ringwood, NJ. "There is not a lot of functional difference between GAP insurance and GAP waivers, but there is a difference in how a car buyer can obtain each of them." GAP waiver basics "GAP waiver and GAP insurance aren’t actually the same thing, and most car buyers get GAP waiver," Sonia Steinway, CEO of Outside Financial. "A car buyer’s first line of defense, or first opportunity to secure any kind of Guaranteed Asset Protection (GAP), is actually during the purchase or lease of the vehicle, in the form of a GAP waiver," says Diodato. "Since a GAP waiver is negotiable directly with the dealership, it may be cheaper than obtaining GAP insurance. And the cost is rolled into the car payment over the life of the loan." "Waivers aren’t legally considered insurance," explains Steinway, "which means they don’t have to be regulated as insurance products. Other companies (like many auto lenders) can sell GAP waiver without having to get that license. The creditor agrees to waive any ‘gap’ between what you owe on your loan and the value of the vehicle if it's totaled or stolen." "Since GAP waivers are between the lien holder or creditor and the consumer — where the consumer obligation would be waived for the GAP amount by the creditor in the event of an accident — there is no insurance company involved, so GAP waivers are not subjected to insurance regulations," Diodato explains. GAP insurance basics "While a consumer can shop around for GAP insurance following the purchase of a vehicle," Diodato continues, "it is regulated by the state in which you are doing business, like any other form of insurance. And, consumers should expect that their insurance premium will increase following a GAP insurance claim." "In most states," says Steinway, "insurance companies have to comply with very strict regulations, including having rates pre-approved by the state insurance department, and get licensed as insurance providers. Only an insurance provider that has the appropriate license (and is regulated by the state's insurance department) can sell GAP insurance." "Also," warns Diodato, "GAP ‘insurance’ does not carry from one insurance company to another, and consumers can sometimes forget to add that coverage back in if they wind up switching insurance companies for one reason or another." On the other hand, she explains, "A GAP waiver stays with the loan until maturity," so this won’t be an issue." Questions to ask when you buy GAP coverage "Wherever you buy GAP," Steinway advises that you "make sure you ask the salesperson the following questions: Does the policy include the deductible on your collision or theft insurance? Does it include any negative equity or rollover balance from a previous loan? Does it exclude cars that are uninsured or underinsured? Does it cover interest and fees that build up starting when your car is stolen or totaled until the insurance payment is made? Does it include any obligation you may have for window etching or other add on products?" Asking these questions should help you ensure they know exactly what the insurance policy or waiver covers. You want to know exactly what it covers, and for what price, to make sure that you are getting the right coverage for your new car, whether you buy or lease. Special thanks to our experts: Danielle M. Diodato, Esq., is Associate General Counsel at DOWC in Ringwood, New Jersey. DOWC® is among the fastest growing service contract providers and administrators in the United States. DOWC® offers customizable F&I products, expertise in compliance, and a full suite of technology designed to optimize productivity and expedite claims adjustments, processing, and reporting. Sonia Steinway is Co-founder and CEO of Outside Financial, an online car lending platform that offers education to empower shoppers and the ability to prequalify for finance through a variety of lending companies, outside of a car dealership. Applicants are matched to lenders after filling out a quick application.
Many millennials find themselves without much credit to their name, even after graduating from college. Recently, the number of consumers younger than 25 with established credit has decreased. The 2017 report CFPB Data Point:Becoming Credit Visible states that 8.9 percent of people establish credit with an auto loan, though a high percentage of those needed a co-signer. Is this a good opportunity? Or a bad idea? It turns out that the answer isn’t so cut and dry. We asked finance experts for advice about how Millennials can use a car purchase to build credit, without messing it up. What are you building credit for? "First, we really need to understand what the reason behind building credit is in this case,” says Mike Scott, Senior Mortgage Loan Officer with Independent Bank. What are your motives? Scott says, “Are you looking to buy a home in the near future, or are you simply looking to build a long-term credit rating?” If you are purely looking at buying a car as a way to establish and build your credit, this might not be the best route. Instead, Scott advises: "To build credit, I strongly suggest starting with a secured credit card (assuming you have absolutely no credit) from a local credit union. The credit union cards will typically have a lower interest rate than those from other banking institutions. The first month that the card is active, use it to pay for everything that you would normally pay cash for, until the balance on the card is within $50 of the limit. When that happens, stop using the card and wait to receive the statement. When you receive the statement, pay the card off in full to avoid paying interest charges. From that point on, ensure that your card balance on the statement is no more than 10 percent of the available credit. Once the card has been in place for six months, the next step is to apply for two other credit cards that are not secured cards. Some factors that impact a credit score include proportion of the current balance reported to the available credit limit and how long accounts have been established. For the first year or two, you can expect that the new accounts will bring a credit score down some. For this reason, avoid closing credit card accounts, as closing the account can lower your credit score. Now, to an average person, $500 owed on credit card means that they owe $500. To a credit bureau, if they owe $500 on a $500 card, they are maxed out, a poor credit risk, and the score goes down. If they owe the same $500 on a card with a $5000 limit, they are a good credit risk and the score goes up. As a result, if someone tends to pay the card off every month, it would actually behoove them to pay the card twice a month: once when the statement billing cycle is about to end, and again after the bill comes out, making sure that the balance showing on the bill stays at under 10 percent of the available credit limit. Once credit has been established slightly, adding a car loan into the mix can be a good thing." Is a car loan a good way to boost your credit history? If you can afford to pay for a car in cash, then do it. Financing a car purchase is not a golden credit-building opportunity. ***“Saddling yourself with unnecessary high-interest debt is a bad way to build credit,” explains Credit Industry Analyst, Sean Messier with Credit Card Insider. While it's possible to finance a car with limited credit, Messier says it's not necessarily the right course of action: "If you’re dealing with limited credit and can avoid financing your new vehicle, you should absolutely do so, because any loan you’d be able to secure would likely have frustratingly high interest rates. If possible, pay for your vehicle with cash, and consider alternative credit-building methods, like secured credit cards and credit builder loans, which can cost you much less than a traditional loan while still bolstering your credit scores.” If you are in a position to pay cash for a car, but just wondering if a car loan is a good way to boost your credit history, it’s not. Can you finance a car with limited credit? Not every Millennial wondering about using a car loan to establish credit can pay in cash for a car. “The unfortunate reality,” says Messier, “is that you won’t always be able to cover the price of your vehicle with cash, so it might simply be necessary to use financing. The good news? There are ways to finance a car without descending into crippling debt.” In this case, he has three suggestions: “If you can find a co-signer that you trust, and who has better credit than you, you’ll likely have access to loans with much better interest rates.” “Make a large down payment, if possible, to keep the amount that you’re financing to a minimum.” “Shop for loans carefully, and examine all your options. More favorable terms are often available through credit unions and online lenders, rather than big-league banks. " How can a car loan help your credit? Edith Muthoni is Chief Editor of the investing education site Learnbonds.com. Prior to that, she worked in the banking and the Fintech industries for 16 years. She explains: “A car loan can help build your credit in several ways. First, the average price tags of most cars require financing, which can be done in installments of two to five+ year plans. By making payments on time, you can build your credit score which will, in turn, help build a positive credit history. Lenders look at your credit history when deciding whether to give you a loan or not. In fact, up to 35 percent of your FICO credit score is derived from your payment history. Besides helping to improve on your payment history, auto financing contributes to your credit mix and new credit which, when combined, constitute 20 percent of your credit score. So it is easy to see why buying a car with a loan and making increased monthly payments can impact over 50 percent of your FICO score.To begin with, you will be required to make a sizeable down payment and pay monthly financing charges. Overall, it is always a good idea to finance a car even if you have the cash. You can invest the amount in an interest-bearing account at a much higher rate than the amount you are paying for the car." However, the interest-bearing account will have to beat your loan rate to be worth it. Why would you get approved if you have bad credit? Jake McKenzie, Content Manager, at Auto Accessories Garage explains, “Buying a car is a great way to build credit, because often an auto-loan is the easiest type of loan to get. The reasoning behind this is, the bank or lending institution knows that in the worst case scenario, they could always repossess the car if you stop paying for it.” Is it good to make a big down payment? “Paying your loan on time will help build your credit,” says McKenzie, “but if that is the sole purpose of the loan, you don’t want to be throwing money away either. What you want is the lowest possible percent of interest. If a larger down payment can lower your interest rate, by all means go for it!” “Making a big down payment will give you less to pay over time and decrease your monthly payments,” says Jory McEachern, Director of Operations at ScoreShuttle. Scott says that this depends on your goals. “My advice is to make a down payment big enough to keep the actual car payment at less than 10 percent of your monthly income if you are financing the car for 4–5 years. That gives you flexibility to pay more on the car when you can, without forcing the larger payment.” What kind of rates and terms will you see? "The best case scenario is 0 percent APR,” says McEachern. “The worst is a high interest rate over a long period of time. Your credit score can affect your terms for paying a loan, for example: A borrower with excellent credit may qualify for a lower interest rate on an auto loan, excluding other unique specials each dealership may have to offer. Meanwhile, a consumer with poor credit may see a higher interest rate. When you add up the extra costs over the life of the loan, the borrower with a lower score would end up paying a lot more in interest for the exact same vehicle!" This is the scary part that you want to avoid. If you start your credit from scratch, as Scott suggested, “with a secured card, at the end of six months you should have a score in the mid-600s. As such, you should qualify for terms that are possibly not the best, but should be far better than the worst.” “If you have no score,” he says, “expect to pay 16–21 percent on the car loan, even with a nice down payment.” “Conversely,” he says, “with a score in the mid-600s (650 or so), you should be able to get a rate a few points above prime, and about half or less what you would pay without a score. In a best-case scenario, and with a nice down payment, you may get a rate of prime (currently around 5.25 percent).” McKenzie warns, “You don’t want to go over 60 months on your loan either. Even if you’re building credit, an extra-long loan will be doing more harm than good on your personal finances. Consider 36–48 months as your sweet spot.” Is it worth it to make bigger monthly payments? If credit building is your goal, McEachern says, “Paying increased monthly payments is not recommended.” Scott warns, “What many people make the mistake of doing ... is taking out the loan and paying it off in less than 12 months.” While that may sound awesome to be debt-free so quickly, he urges consumers to “Remember that one of the things that impacts a credit score is how long accounts have been open. The account should stay open at least 18, if not 24 months or longer, in order to positively impact a credit score. Accounts that are paid off in less than six months don't have the adequate time to raise the score and improve it." "Again, we are talking about long-term planning,” he says. “Before paying off a car faster, make sure that you have an emergency fund. Life happens. Also, make sure that you take at least 24 months to pay the car off, so that you are establishing the long-term willingness to repay that the credit bureaus are looking for.” If you are capable of paying in cash, but want to use financing to build credit, what kind of loan should you use? Scott says, “The process should be the same regardless of ability to pay cash.” “For one thing, never tell the dealership that you are paying cash. Financing the vehicles is actually a source of income for them, and they may not discount the car as much if they think you will pay cash.” McEachern suggests, “Speak with your bank or credit union, who may offer you better terms or interest rates on your loan.” Scott agrees that you should check on rates with your bank or credit union before you head out to the dealerships. “This way,” he explains, “you can at least know what your existing options are, rather than flying blind. The dealers can often beat the local bank's options, but you won't know and may end up paying a higher rate simply because you did not bother to check.” If this is your credit building strategy, what dealer add-ons, fees, and financing contract terms should we look out for? “Stay away from almost everything,” says Scott. “This is where the dealers make money.Car warranties are often marked up $1,000–$2,000 over dealer cost. Believe it or not, that is often more markup than there is on the actual vehicle. . . . I do recommend an extended warranty on the car, but not at a ridiculous price. Whatever they quote, expect to be able to get at least $1,000 off that price unless you run into one of the less snakey dealers.” “Car dealerships often try to add extra costs at the end of the sale,” adds McEachern. “Some may be beneficial to you, such as a security lock, which could lower your insurance rate. It is a case-by-case scenario. Be strategic, be careful about add-ons, be wary of customization.” That’s not to say that all add-ons are a bad idea. “Unless you are putting a large down payment on the vehicle (30 percent or more),” Scott advises to get the gap insurance, but beware of the dealer markup. He says, “When the dealer offered it to my wife and me, they initially quoted a cost of $1,100 for it. I was able to get it for less than half that by the time we were done. They try to quote it as a monthly payment difference, so $20 per month does not sound bad, but they were still marking it way up.” Should you just pay in cash and build credit elsewhere? McEachern points out, "Buying a car will build credit, as it is a large ticket purchase. It will help to diversify your credit profile. Using an installment loan will show a positive payment history." Scott says that this decision all comes down to your long-term goals. He says that if you are planning to purchase a home in the next 18 months, you may just want to pay in cash if you can. He says, “being debt-free may be better, and having a few credit cards may be enough credit to qualify for a home loan.” The bottom line Using a car loan to build credit is certainly an option; however its usefulness will depend on your current credit and your long term credit goals. If you are able to pay in cash and just looking to build credit, there are better ways that are less risky, unless you are ready to finance the car and simultaneously invest in a high-yield, interest-bearing account that makes you more money than you are paying on your interest. This isn’t likely if you don’t have the credit score to get a low rate. If you aren’t able to pay in cash and you do need to finance, try to start establishing credit with Scott’s advice, more than six months before you plan to purchase. Stay in the 36–48 months loan term sweet spot, and don’t pay it off sooner than 24 months. Get a co-signer if you can, and make a large down payment if possible. Lastly, if you plan to buy a house in the next 18 months, the usefulness of a car loan may not be the best idea. Paying in cash for a car may be the best option, considering your bigger financial purchase in the coming months. Check out other credit building opportunities to help get purchase-ready.