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You should not finance a car through the dealership if it is at all possible to avoid it.

The reason to avoid dealership financing is simple…dealerships are legally allowed to add percentage points to the loan as compensation for arranging the loan. What happens is that the finance manager at a dealership will find out what interest rate a ”preferred” lender would offer a person with your credit score. With that figure in hand, and knowing that the dealership gets a commission if you agree to a higher interest rate, the finance guy will tell you that the lender approved your loan. On the loan agreement, the interest rate will be one or two percentage points more than the lender offered. So, if the lender wants 5 percent, the dealership may tell you that you must pay 7 percent. This is often known as “rate-padding” or “dealer reserves,” and the Center for Responsible Lending (CRL) estimates that American consumers paying $25.8 billion in such kickbacks.

Shopping Your Loan to Local Lenders

You can avoid paying this bogus interest rate. You should start your car buying process by doing some research. Start by narrowing down the type of vehicle you want. Have a year, make, model, and approximate mileage in mind. With that information, you can find out about how much the vehicle should cost. Armed with that information, start shopping your loan around to local lenders. Do not neglect credit unions during this first round of applications. If the first round fails, look for online lending resources.

The only downside to shopping your loan around is a small hit to your credit score from applying for new credit. Normally, each application requires a lender to pull your credit report. Each pull lowers your score a few points, but, if you group applications, the hit to your score is lessened because the reporting agencies see that you are shopping a single loan for the best terms. That only holds true if you group the applications into a 30-day period.

Estimating The Rate You Deserve

If you do decide to opt for dealer financing due to the convenience factor, make sure you know what rate you deserve. This is the only way to tell if the dealer tries is trying to jack up your rate. First, you will need to know your credit score. Second, use this calculator on FICO’s official site to check average local auto finance rates in your state, for your type of loan, given your credit score. Bring this information to the dealership, so you can negotiate for the best rate.



About the author: Jerry Coffey


Jerry Coffey is the financial expert here at A recovered "debtaholic," he now preaches frugal-living and sound money management here and at, where he is the chief contributor. He works for a major automaker.


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