Is using a credit line to buy a car better than dealer financing?

Q: My truck is currently in the shop for repairs but they’ve told me it’s not worth fixing. I’ve got some money for a down payment on a used one but instead of going through the whole application process for dealer financing, I’m thinking I could just use my line of credit to pay for it. My brother hesitated when I asked him if that was a good idea or not. What do you think? ~Aaron

A: Purchasing a vehicle is usually the second-biggest spending decision most of us make; the biggest being our home. However, a good many people spend more time planning their next vacation than the purchase of a new set of wheels. When it comes to paying for a vehicle, new or used, it ultimately comes down to ensuring that how you pay for the car or truck is as comfortable and affordable as sitting in the driver’s seat. Here are some things to consider:

DON’T BUY UNDER STRESS OR DURESS

Even with your truck tied up in the shop, resist the urge to make an impulsive spending decision. To buy yourself time to shop around and check into financing options, inquire whether the shop has a loaner you could borrow, if they have any special arrangements with a car rental company, if your family can make do with a shared vehicle temporarily, if you could get by without a vehicle for a few days, if you could carpool, ride-share or take transit, or if a friend or family member has a vehicle you could borrow.

START WITH YOUR BUDGET

Financing options when it comes to acquiring a new or used vehicle are numerous. So before you step foot onto a car lot and risk falling in love with the “only” vehicle for you, it is essential that you take the time to consider what you can afford for payments, what your budget allows for all of the other costs that go with owning a car (e.g. maintenance, repairs, insurance, fuel, etc.), and what your bank or credit union can offer you in the way of financing to pay for the purchase.

The financing option you choose can change the price of a car

Be aware that there’s a chance the price of the vehicle you choose will change depending on the type of financing you select. Dealers receive incentives and/or bonuses when they provide the financing, and they have the ability to pass those on to the customer. If you’re dealing with an independent car lot, some have expensive in-house financing options. Arranging your own financing and paying cash for a car can mean less incentives, but you may still come out ahead; it all depends on the type of incentive and how it’s provided.

When negotiating the price of a car with a salesperson and you’ve got cash in hand, regardless of the source, you turn the tables and put yourself into the proverbial driver’s seat. On top of that, if you’re also prepared to walk away from any deal where the numbers don’t line up, you’re in a tremendous position of power to negotiate what you want and can afford.

PAYING FOR A CAR WITH YOUR CREDIT LINE

Having enough funds available to pay cash for a car can give you a serious advantage when negotiating the price you’re willing to pay. The cash can come from your credit line, savings, a personal loan, or some combination of these options. Cash on hand saves time buying the car because the dealer doesn’t need to take a full credit application from you and wait for their underwriter to adjudicate it. You don’t have the hassle of going back and forth between the car lot and your lender to finalize a car loan once you decide which exact vehicle you want to buy. Paying cash also doesn’t use the vehicle as security for a loan, which can make it easier down the line when it comes time to sell it or trade it in.

Car payments with a line of credit

If you have an existing credit line with sufficient available credit to pay for the vehicle you’ve chosen, keep in mind how your credit line assesses the minimum payment each month. It will be tied to the prime lending rate, which will go up or down depending on Bank of Canada announcements and economic factors beyond your control; it may be a percentage of what you owe (e.g., three per cent of your outstanding balance), or if your credit line is secured by your home it may only require interest only payments.

With a line of credit, your minimum monthly required payment will fluctuate, which can make it harder to budget, especially if you’re banking on only making minimum payments. If you save your credit line for emergencies, the cash you need for an emergency may no longer be available if you use most of your credit limit to buy a vehicle. If your credit score drops for some reason and your lender becomes concerned that you may not be able to repay your credit line, they can ask for full payment of the line of credit or lower your credit limit drastically at any time.

The biggest disadvantage?

The biggest drawback with using a line of credit to make a large purchase is that it’s a revolving form of credit; you can use it, make a relatively low payment, use it again, and keep this up on a revolving cycle like a credit card. There is a real danger that you may never pay the car off and end up deep in debt. You can, however, avoid this common trap if you pay down a set amount every month to ensure the line of credit is paid off before the vehicle gets too old.

WHAT TO CONSIDER WITH DEALER FINANCING

When it comes to dealer-sponsored financing, remember that there is no such thing as a free lunch. If they offer $1,500 cash back, read the fine print and disclosure statement to see what all the fees add up to — is it something close to the $1,500 rebate? A dealer will go above and beyond and do all they can to give you the financing you need. For instance, they will amortize your payments for up to eight years if your credit is great, thereby lowering your monthly payments. However, that can mean paying more interest in the long run. They can offer extremely low financing rates (e.g. zero per cent or 0.9 per cent) to the very best customers; others are not able to qualify for such terms and conditions. It’s convenient not to have to shop around yourself to obtain financing; they do it for you, but keep in mind that convenience always costs.

Key disadvantages with dealer financing

Applying for a car loan through a car dealer can mean that your loan application will be shopped around to various lenders to see who will approve you for the loan. There might be lenders in that pool you’d rather not do business with. A down payment is typically required when borrowing money through a dealer, and what many people don’t realize is that there could be an amount owing at the end of your term in order for you to keep the car.

The payout at the end is disclosed up front (look for it in the disclosure) and is one way dealers keep your payments within the range you can afford. Watch for this if you intend to get the most value from a new car by keeping it longer than the term of your loan.

The bottom line on financing a car with a dealer loan or line of credit

Be aware of the high-pressure sales tactics you’ll confront while car shopping, and take a friend along who can help you stick to your plan if you’re afraid that you’ll cave and commit to more than you can afford. If you’re tempted to use your line of credit, think about how you use credit cards. Do you pay them off each month or carry a revolving balance? Your creditline habits will likely be similar to your credit card habits, so proceed cautiously if you tend to keep yourself in debt. If you qualify for zero per cent interest through a dealer loan, that’s a tough offer to get anywhere else. Do your homework carefully and avoid using a line of credit to buy a car if you aren’t disciplined enough to make larger payments that actually pay off your car in a reasonable period of time.

Be aware of the high-pressure sales tactics you’ll confront while car shopping, and take a friend along who can help you stick to your plan...