5 Mistakes to Avoid When Getting an Auto Loan

The wrong choice could cost you thousands.

Whether you're getting an auto loan or using a personal loan to pay for your car, the process of choosing the best financing can be confusing at best. If you're not careful, you could end up spending way more than you should on your next auto loan.

Before you take out a loan to pay for your next car, here are some common financing mistakes to avoid.

1. Having overpriced or unnecessary warranties rolled into your loan

If you're buying a used car, chances are it's no longer under warranty. This means that if you have any problems with your car that need to be repaired, you'll probably end up paying for them out of pocket. Because of this, most car dealers will try to sell you a dealership warranty or extended warranty that will cover the cost of some repairs and often routine maintenance as well.

These aren't necessarily a bad deal, but in most cases, a dealer will try to sell you a warranty that's marked up hundreds -- if not thousands -- of dollars. They might even try selling you a warranty that only covers a limited list of issues you're unlikely to encounter. If you're taking out a loan, they'll often offer to roll the cost of the warranty into your loan, and this can add thousands of dollars to your overall loan.

In many cases, extended warranties on used cars don't end up being worth it. That being said, you might like the peace of mind that comes with knowing that if you encounter any serious and expensive issues, they'll be covered by your warranty. Do some math beforehand to figure out how much you expect to spend on repairs and maintenance and compare that with the price of any dealer warranty you're offered, and make sure you know exactly what's covered by that warranty. You can usually negotiate down the cost of a warranty quite a bit, but don't get pressured into buying one unless you're sure it's what you want.

2. Being upside down on your auto loan

Being upside down on a car loan means you owe more on your loan than your car is worth. Cars lose value quickly, to the tune of hundreds of dollars each month. If you pay for all or almost all of the car with a loan, rather than making a down payment, you can end up owing $18,000 when your car is only worth $15,000.

This isn't necessarily a problem apart from the fact that you'll be paying off that loan for a while. However, if you were to get into an accident and total your car, your auto insurance would only cover the current value of the car. If your car is worth $15,000 and you still owe $18,000 on your loan, you're going to end up paying $3,000 out of pocket for a car you can no longer drive.

To avoid this mistake, make a larger down payment. Shortening your loan term can also help -- while it makes your monthly payments larger, that also means you're paying off your loan quickly.

Make sure to check out this guide on types of car insurance coverage to help you decide how much auto insurance is right for you.

3. Accepting dealership financing without getting pre-approved elsewhere

Getting the best low-interest loan for your car can save you hundreds of dollars per year on interest. To do this, you'll want to shop around and compare rates from a variety of lenders.

While taking the dealership financing is convenient, you'll get a better deal by applying for pre-approval through a variety of banks and credit unions before you start car shopping. This will also give you a better idea of how much you can borrow and what rates you qualify for, which will help you set a budget. Plus, these institutions might offer you a better deal than a car dealer would.

4. Taking your bank or credit union's rate without asking if your dealer can beat it

Once you have received pre-approval from a few different institutions, you can print out your pre-approval letters and bring them to the dealership with you. Asking the dealer if they can beat the rates you were already offered can also result in big savings.

Some people prefer to go with their bank or credit union over dealership financing. You might think this is easier or safer than going with what your car dealer offers. However, in most cases, it's best to go with whoever can offer you the best loan. Securing the lowest interest rate possible should be your main priority, but make sure you can get a loan term that's comfortable for you as well. And avoid loans that charge prepayment fees if you pay off the loan early.

5. Choosing the wrong loan term

Car loans typically come in loan terms that range from 24 months to 72 months. You might be tempted to get the longest loan term because that makes your monthly payments lower. However, stretching out your loan over a long period of time means paying more in interest. It can also mean finding yourself upside down on your loan if you're paying it off more slowly than your car's value is depreciating.

On the other hand, selecting a short loan term means larger monthly payments. If you find them hard to afford, you could end up missing a monthly payment, which can land you in further debt and hurt your credit. A slightly longer loan term with smaller monthly payments will give your budget a little more wiggle room.

You can always pay off your loan early. It's smart to keep your loan term as short as possible, but you can opt for a term that leaves you with smaller monthly payments than what you can actually afford in order to give yourself some flexibility.