With prices averaging more than $20,000 for a new vehicle and $9,500 for a four-year-old vehicle, most consumers need financing or leasing to acquire a vehicle. In some cases, buyers use “direct lending:” they obtain a loan directly from a finance company, bank or credit union. In direct lending, a buyer agrees to pay the amount financed, plus an agreed-upon finance charge, over a period of time. Once a buyer and a vehicle dealership enter into a contract and the buyer agrees to a vehicle price, the buyer uses the loan proceeds from the direct lender to pay the dealership for the vehicle. Consumers also may arrange for a vehicle loan over the Internet.

The most common type of vehicle financing, however, is “dealership financing.” In this arrangement, a buyer and a dealership enter into a contract where the buyer agrees to pay the amount financed, plus an agreed-upon finance charge, over a period of time. The dealership may retain the contract, but usually sells it to an assignee (such as a bank, finance company or credit union), which services the account and collects the payments.

For the vehicle buyer, dealership financing offers:

1. Convenience – Dealers offer buyers vehicles and financing in one place.

2. Multiple financing relationships – The dealership’s relationships with a variety of banks and finance companies mean they can offer buyers a range of financing options.

3. Special programs – From time to time, dealerships may offer manufacturer-sponsored, low-rate programs to buyers.

This booklet explains dealership financing and can serve as a guide as you evaluate your own financial situation before you finance a new or used vehicle. It will also help you understand vehicle leasing.

BEFORE YOU ARRIVE AT A DEALERSHIP

Do some research:

• Determine how much you can afford to finance and spend on a monthly payment by using the “Monthly Spending Plan” worksheet in this booklet.
• Get a copy of your credit report so you are aware of what creditors will see. Errors or accurate negative information can impact your ability to get credit and/or your finance rate.
• Identify your transportation needs.
• Check auto buying guides, the Internet and other sources to find out the price range and other information for the vehicle you want to buy.
• Compare current finance rates being offered by contacting various banks, credit unions or other lenders. Compare bank quotes and dealer quotes; there may be restrictions on the most attractive rates or terms from any credit source.

WHAT HAPPENS WHEN YOU APPLY FOR FINANCING

Most dealerships have a Finance and Insurance (F&I) Department, which provides one-stop shopping for financing. The F&I Department manager will ask you to complete a credit application. Information on this application may include: your name; Social Security number; date of birth; current and previous addresses and length of stay; current and previous employers and length of employment; occupation; sources of income; total gross monthly income; and financial information on existing credit accounts.

The dealership will obtain a copy of your credit report, which contains information about current and past credit obligations, your payment record and data from public records (for example, a bankruptcy filing obtained from court documents). For each account, the credit report shows your account number, the type and terms of the account, the credit limit, the most recent balance and the most recent payment. The comments section describes the current status of your account, including the creditor’s summary of past due information and any legal steps that may have been taken to collect.

Dealers typically sell your contract to an assignee, such as a bank, finance company or credit union. The dealership submits your credit application to one or more of these potential assignees to determine their willingness to purchase your contract from the dealer.

These finance companies or other potential assignees will usually evaluate your credit application using automated techniques such as credit scoring, where a variety of factors, like your credit history, length of employment, income and expenses may be weighted and scored.

Since the bank, finance company or credit union does not deal directly with the prospective vehicle purchaser, it bases its evaluation upon what appears on the individual’s credit report and score, the completed credit application, and the terms of the sale, such as the amount of the down payment. Each finance company or other potential assignee decides whether it is willing to buy the contract, notifies the dealership of its decision and, if applicable, offers the dealership a wholesale rate at which the assignee will buy the contract, often called the “buy rate.”

Your dealer may be able to offer manufacturer incentives, such as reduced finance rates or cash back on certain models. You may see these specials advertised in your area. Make sure you ask your dealer if the model you are interested in has any special financing offers or rebates. Generally, these discounted rates are not negotiable, may be limited by a consumer’s credit history, and are available only for certain models, makes or model-year vehicles.

When there are no special financing offers available, you can negotiate the annual percentage rate (APR) and the terms for payment with the dealership, just as you negotiate the price of the vehicle. The APR that you negotiate with the dealer is usually higher than the wholesale rate described earlier. This negotiation can occur before or after the dealership accepts and processes your credit application.

WHAT INFLUENCES YOUR APR

Your credit history, current finance rates, competition, market conditions and special offers are among the factors that influence your APR.

WHAT ABOUT A CO-SIGNER?

You may be allowed by the creditor to have a co-signer sign the finance contract with you in order to make up for any deficiencies in your credit history. A co-signer assumes equal responsibility for the contract, and the account history will be reflected on the co-signer’s credit history as well. For this reason, you should exercise caution if asked to co-sign for someone else. Since many co-signers are eventually asked to repay the obligation, be sure you can afford to do so before agreeing to be someone’s co-signer.

SHOULD I LEASE A VEHICLE?

If you are considering leasing, there are several things to keep in mind. The monthly payments on a lease are usually lower than monthly finance payments on the same vehicle because you are paying for the vehicle’s expected depreciation during the lease term, plus a rent charge, taxes, and fees. But at the end of a lease, you must return the vehicle unless the lease lets you buy it and you agree to the purchase costs and terms. To be sure the lease terms fit your situation: Consider the beginning, middle and end of lease costs. Compare different lease offers and terms, including mileage limits, and also consider how long you may want to keep the vehicle.

When you lease a vehicle, you have the right to use it for an agreed number of months and miles. At lease end, you may return the vehicle, pay any end-of-lease fees and charges, and “walk away.” You may buy the vehicle for the additional agreed-upon price if you have a purchase option, which is a typical provision in retail lease contracts. Keep in mind that in most cases, you will be responsible for an early termination charge if you end the lease early. That charge could be substantial.

Another important consideration is the mileage limit – most standard leases are calculated based on a specified number of miles you can drive, typically 15,000 or fewer per year. You can negotiate a higher mileage limit, but you will normally have an increased monthly payment since the vehicle’s depreciation will be greater during your lease term. If you exceed the mileage limit set in the lease agreement, you’ll probably have to pay additional charges when you return the vehicle.

When you lease, you are also responsible for excess wear and damage, and missing equipment. You must also service the vehicle in accordance with the manufacturer’s recommendations.

Finally, you will have to maintain insurance that meets the leasing company’s standards. Be sure to find out the cost of this insurance. “Keys to Vehicle Leasing,” a publication of the Federal Reserve Board, contains more information about leasing. You can request a copy from:

Publications Services
Board of Governors of the Federal Reserve System
Mail Stop 127 Washington, DC 20551

This brochure is also available on the Web at: www.federalreserve.gov/pubs/leasing

DETERMINING HOW MUCH YOU CAN AFFORD

Before financing or leasing a vehicle, make sure you have enough income to cover your current monthly living expenses. Then, finance new purchases only when you can afford to take on a new monthly payment. The “Monthly Spending Plan” is a tool to help determine an affordable payment for you.

The only time to consider taking on additional debt is when you’re spending less each month than you take home. The additional debt load should not cut into the amount you’ve committed to saving for emergencies and other top priorities or life goals. Saving money for a down payment or trading in a vehicle can reduce the amount you need to finance. In some cases, your trade-in vehicle will take care of the down payment on your vehicle.

Buying a new car is second only to a home as the most expensive purchase many consumers make. According to the National Automobile Dealers Association, the average price of a new car sold in the United States as of June 1998 was $23,480. That’s why it’s important to know how to make a smart deal.

Buying Your New Car
Think about what car model and options you want and how much you’re willing to spend. Do some research. You’ll be less likely to feel pressured into making a hasty or expensive decision at the showroom and more likely to get a better deal.

Consider these suggestions:

• Check publications at a library or bookstore, or on the Internet, that discuss new car features and prices. These may provide information on the dealer’s costs for specific models and options.
• Shop around to get the best possible price by comparing models and prices in ads and at dealer showrooms. You also may want to contact car-buying services and broker-buying services to make comparisons.
• Plan to negotiate on price. Dealers may be willing to bargain on their profit margin, often between 10 and 20 percent. Usually, this is the difference between the manufacturer’s suggested retail price (MSRP) and the invoice price.

Because the price is a factor in the dealer’s calculations regardless of whether you pay cash or finance your car — and also affects your monthly payments — negotiating the price can save you money.

• Consider ordering your new car if you don’t see what you want on the dealer’s lot. This may involve a delay, but cars on the lot may have options you don’t want — and that can raise the price. However, dealers often want to sell their current inventory quickly, so you may be able to negotiate a good deal if an in-stock car meets your needs.

Learning the Terms
Negotiations often have a vocabulary of their own. Here are some terms you may hear when you’re talking price.

• Invoice Price is the manufacturer’s initial charge to the dealer. This usually is higher than the dealer’s final cost because dealers receive rebates, allowances, discounts, and incentive awards. Generally, the invoice price should include freight (also known as destination and delivery). If you’re buying a car based on the invoice price (for example, “at invoice,” “$100 below invoice,” “two percent above invoice”), and if freight is already included, make sure freight isn’t added again to the sales contract.
• Base Price is the cost of the car without options, but includes standard equipment and factory warranty. This price is printed on the Monroney sticker.
• Monroney Sticker Price (MSRP) shows the base price, the manufacturer’s installed options with the manufacturer’s suggested retail price, the manufacturer’s transportation charge, and the fuel economy (mileage). Affixed to the car window, this label is required by federal law, and may be removed only by the purchaser.
• Dealer Sticker Price, usually on a supplemental sticker, is the Monroney sticker price plus the suggested retail price of dealer-installed options, such as additional dealer markup (ADM) or additional dealer profit (ADP), dealer preparation, and undercoating.

Financing Your New Car
If you decide to finance your car, be aware that the financing obtained by the dealer, even if the dealer contacts lenders on your behalf, may not be the best deal you can get. Contact lenders directly. Compare the financing they offer you with the financing the dealer offers you. Because offers vary, shop around for the best deal, comparing the annual percentage rate (APR) and the length of the loan. When negotiating to finance a car, be wary of focusing only on the monthly payment. The total amount you will pay depends on the price of the car you negotiate, the APR, and the length of the loan.

Sometimes, dealers offer very low financing rates for specific cars or models, but may not be willing to negotiate on the price of these cars. To qualify for the special rates, you may be required to make a large down payment. With these conditions, you may find that it’s sometimes more affordable to pay higher financing charges on a car that is lower in price or to buy a car that requires a smaller down payment.

Before you sign a contract to purchase or finance the car, consider the terms of the financing and evaluate whether it is affordable. Before you drive off the lot, be sure to have a copy of the contract that both you and the dealer have signed and be sure that all blanks are filled in.

Some dealers and lenders may ask you to buy credit insurance to pay off your loan if you should die or become disabled. Before you buy credit insurance, consider the cost, and whether it’s worthwhile. Check your existing policies to avoid duplicating benefits. Credit insurance is not required by federal law. If your dealer requires you to buy credit insurance for car financing, it must be included in the cost of credit. That is, it must be reflected in the APR. Your state Attorney General also may have requirements about credit insurance. Check with your state Insurance Commissioner or state consumer protection agency.

Trading in Your Old Car
Discuss the possibility of a trade-in only after you’ve negotiated the best possible price for your new car and after you’ve researched the value of your old car. Check the library for reference books or magazines that can tell you how much it is worth. This information may help you get a better price from the dealer. Though it may take longer to sell your car yourself, you generally will get more money than if you trade it in.

Considering a Service Contract
Service contracts that you may buy with a new car provide for the repair of certain parts or problems. These contracts are offered by manufacturers, dealers, or independent companies and may or may not provide coverage beyond the manufacturer’s warranty. Remember that a warranty is included in the price of the car while a service contract costs extra.

Before deciding to purchase a service contract, read it carefully and consider these questions:

• What’s the difference between the coverage under the warranty and the coverage under the service contract?
• What repairs are covered?
• Is routine maintenance covered?
• Who pays for the labor? The parts?
• Who performs the repairs? Can repairs be made elsewhere?
• How long does the service contract last?
• What are the cancellation and refund policies?