Why it's a great time to buy a car

This is when your credit record matters. You have great scores? Car loans are cheap, and carmakers are eager to deal. Bad scores? You'll pay and pay.

By Liz Pulliam Weston - MSN Money

If you plan to get a car loan this year, you'll find a tale of two markets:

Folks with untarnished credit will find good rates, eager lenders and some amazing deals as increasingly desperate car manufacturers try to revive sagging sales.

Folks with troubled credit will find higher rates, increased scrutiny and warier lenders, but they won't face anything like the trouble they'd experience if they were shopping for a mortgage.

As the credit crunch has spread through lending markets, some pundits have proposed that auto loans could be the scene of the next subprime implosion. The idea is that loose lending standards combined with increasingly strapped borrowers could lead to a spike in defaults and a crackdown by lenders, making it tougher for consumers -- especially those with troubled credit -- to get new loans.

That's certainly what's happened among mortgage and home equity lenders, as I wrote in "A homebuyer's market? Hardly" and "Lenders cut off the home-equity tap."

And you don't have to look far for ominous signs in auto lending. Until now, auto lenders moved vehicles off the dealer lots by:

- Stretching out loan terms. As I wrote in "The real reason you're broke," more than 80% of car loans are for terms longer than four years. The average loan term has grown from just under 55 months in 1990 to more than 64 months today. Longer loans allow consumers to buy more-expensive cars but virtually ensure that they pay more interest and stay "underwater" on the loan (owing more than the vehicle is worth) for years.

- Approving bigger loans. The average amount financed in December was $29,062, up 20% from the 2005 average of $24,133. Median household incomes barely grew at all during the same period.

- Encouraging "upside down" owners to roll negative equity into new loans. Haven't finished paying off your last car? No problem. Dealerships are so eager to sell you another one, they encourage you to roll your debt into a new loan, putting you further upside down. Roughly one out of four -- 26.3% -- cars that are financed include debt rolled over from a previous vehicle, according to vehicle research site Edmunds.com. In February, Edmunds said, the average amount of negative equity in these deals was $4,369. These loans cost consumers more because interest rates are higher to reflect the fact that a good chunk of the loan is unsecured. They also put lenders at risk because whatever they cleared from a repossession wouldn't repay the loan.

- Reaching out to borrowers with more-troubled credit. To make more loans, auto lending experts say, mainstream lenders began approving loans for people with increasingly blotched credit reports. Interest rates for these folks were often 10 percentage points higher, or more, than for those with good credit to reflect the extra risks of default.

It's bad but not that bad

In an economic slowdown, you'd expect all these factors to contribute to a higher default rate. And they have.

Standard & Poor's reported in January that delinquencies on auto loans sold to investors were climbing across the board, including on loans made to people with the best credit. (Loans made to folks with so-called prime credit, defined in the auto industry as FICO scores of 680 and above, represent about 70% of all auto loans.)

The number of prime loans that were more than 30 days overdue was up 18%, Standard & Poor's analysts said, and had exceeded the previous high reached in 2001, during a recession.
The numbers could get worse, the analysts warned, because of the housing mess. Prime borrowers were more likely than subprime ones to be homeowners and thus affected by mortgages with resetting payments.

Scary, right? Except the higher delinquency rate the analysts are warning about is 2.06%, compared with 1.75% on earlier loans.

Delinquency rates for loans made to folks with "nonprime" credit (FICO scores of 620 to 680) are still under 5%, while 30-day delinquencies for subprime credit (FICOs under 620) are under 8%, S&P figures show. Higher than in the past, yes, but still below 2001 rates.

Although some industry experts are predicting more defaults and repossessions this year, "it's still peanuts," said Ralph Ebersole, the director of automotive consulting for Cars.com. "It's not like things were in the last real recession, in '91 and '92."

Aim is not just to finance but to sell

Even if defaults do skyrocket, it's hard to imagine the auto lending market seizing up the way the mortgage market has. Auto lending differs from mortgage lending in many ways: The amounts at risk are much lower, for one thing, and the bulk of loans are made by lenders that have a vested interest in encouraging sales.

These lenders, called captive finance companies, are arms of the car manufacturers: GMAC, Ford Motor Credit, American Honda Finance, Toyota Motor Credit, etc.

"If they're not flexible enough to lend to people," said Jesse Toprak, the director of pricing and market analysis at Edmunds.com, "they're not fulfilling their function, which is to help the dealerships sell cars."

As delinquencies have increased, lenders -- captive and otherwise -- have focused more attention on snaring good-credit customers with low rates. They're still making loans to people with less-than-perfect credit, Toprak said, but their rates tend to be higher than in the past, and they may require more money down.

What lenders offer, though, can vary from moment to moment, with the captive lenders being the most erratic, Toprak said.

"One month, as long as you qualify for any financing, you'll get the 0% rate," Toprak said. "The next month, only (the best) credit gets the 0% rate. Everybody else has to pay the regular rate."

So how can you make sure you get the best possible deal? Here's your game plan:

- Polish your credit scores. The better your scores, the better the deals. The fastest way to boost your FICOs is to pay down credit card balances, pay bills on time and dispute any serious errors to get them off your credit reports. You're entitled to one free copy of each of your three credit reports from Annualcreditreport.com; scores derived from those reports aren't free, but you can purchase FICO scores for all three bureaus from MyFico.com.

- Do your homework. Research cars and current incentives, such as low-rate financing, cash back or leasing deals, using sites such as MSN Autos, Edmunds.com, Cars.com and Consumer Reports. (Consumer Reports offers unlimited new-car reports, which include detailed pricing information and reviews, for $39.) And here's my take: Although manufacturers are offering some eye-popping deals on leases right now, keep in mind that buying and keeping your car for 10 years or more makes the most financial sense. Only people who are saving enough for retirement and for their kids' college educations, who have fat emergency funds and who still have money to burn should consider leasing as an alternative to buying a new car every three or four years.

-Figure out what you can really afford. No car is a bargain if it upends your financial life. My take: Don't finance a car for longer than four years, try to put 20% down to make sure you always have some equity in the vehicle, and be wary of payments that eat up more than 10% of your gross income.

- Get approved elsewhere for the loan. Credit unions, banks and online sites such as E-Loan typically offer the best rates. (You can compare rates nationwide here.) Applying for a loan doesn't mean you have to take the money, Toprak said, but it does lock in a rate that you can then take to a dealership. "You're getting an idea of your market value," he said.

- Ask the dealership to beat the rate. You'll want to first negotiate all other aspects of the deal, including the price of the car and the value of your trade-in. Only then do you bring out your lender's rate and ask the dealership to do better. The dealership often has access to "a slightly better wholesale rate" that could knock a quarter of a percentage point off your rate. If so, you can take the dealer financing; if not, go to the lender that has already approved you and get a cashier's check to buy the car.

Liz Pulliam Weston's new book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.
Published March 6, 2008