6 Hidden Costs of Getting an Auto Loan

1. Taxes

The sticker price of the vehicle you're buying doesn't include sales tax, which can vary depending on where you live. Only five states don't charge sales tax on auto transactions: Alaska, Delaware, Montana, New Hampshire and Oregon.

But even if you don't have to worry about sales tax, you may need to pay a registration fee to get the vehicle registered with your state's department of motor vehicles.

You can't avoid government taxes and registration fees, but you have options for how to pay them. For example, you can roll these costs into your auto loan, which increases your monthly payment and the total interest you'll pay. Alternatively, you can pay them upfront as part of your down payment to keep your loan balance lower.

2. Fees

Many dealerships charge a variety of fees, which can include things like:

• Title and registration fee
• Destination charge (covers the cost of shipping vehicles to the dealership)
• Document fee
• Advertising fee
• Fabric protection fee
• Paint protection fee
• Vehicle identification number (VIN) etching fee
• Rustproofing fee

While some fees are unavoidable, you can skip optional dealer add-ons like fabric or paint protection by declining these services before finalizing your purchase.

3. Gap Insurance

Gap insurance covers the difference between what you owe on your auto loan and your vehicle's actual value if it's totaled or stolen. Without this coverage, you'd be responsible for paying your lender that difference out of pocket.

However, gap insurance policies often include restrictions and limitations that can make claims difficult to approve in certain situations. Read the policy documents thoroughly before purchasing to understand what's covered and what isn't.

You could save money by purchasing gap insurance from your auto insurance company rather than through the dealership. Insurance companies typically charge less for gap coverage than dealers do.

Another option is to make a larger down payment when you buy the vehicle. A substantial down payment reduces the risk of owing more than your car is worth, which may eliminate your need for gap insurance entirely.

Learn more: What Is Negative Equity?

4. Credit Insurance

Dealers may offer to add credit insurance to your auto loan, but this coverage is entirely optional and rarely necessary.

Credit insurance typically covers your loan payments if you die, become disabled or lose your job involuntarily. While this might sound appealing, these policies are significantly more expensive than standard life insurance or disability insurance policies.

It's important to note that federal law prohibits lenders from requiring credit insurance as a condition of loan approval. If a dealer or lender tells you that you must purchase credit insurance to get financing, you can report this violation to your state's attorney general.

5. Prepayment Penalty

Prepayment penalties are federally prohibited on auto loans with terms of 61 months or longer, and some states have outlawed them altogether. However, if you have a shorter-term loan that includes one, you'll be charged a fee for paying off your loan early.

If you're planning to pay off your auto loan ahead of schedule, review your loan contract carefully before signing. Look for any mention of prepayment penalties in the Truth in Lending disclosures.

If your contract includes a prepayment penalty, you may be able to negotiate with the lender to have it removed or shop for a different loan that doesn't include this fee.

6. Opportunity Cost

Opportunity cost refers to the potential benefits you give up when you choose one financial option over another. With an auto loan, this means considering what else you could do with the money you'll spend on monthly payments.

This consideration is especially important if you currently have no car payment or if your new payment would be significantly higher than your current one. That extra money each month could go toward building an emergency fund, paying down high-interest debt, investing for retirement or other financial goals.

The opportunity cost increases with higher interest rates and larger loan amounts. Before committing to an auto loan, carefully evaluate how the monthly payment will affect your budget and progress toward your other financial goals. A payment that seems manageable in isolation may significantly limit your ability to save or invest for the future.

Learn more: Average Car Payment

Frequently Asked Questions

Build Your Credit to Minimize Costs

While interest on an auto loan is expected, you can control how much you spend by qualifying for a lower interest rate. One of the best ways to do this is by establishing a good credit score. You can use Experian's free credit monitoring service to pinpoint areas that need work, take action to address them and track your progress.

Other ways to qualify for a lower interest rate include shopping around and comparing multiple offers, putting down more money on the loan, applying for a shorter repayment term and seeking out promotions on new car sales.

Considering you'll likely be making payments on your auto loan over the course of several years, taking steps to reduce your interest rate could save you hundreds or even thousands of dollars by the time your loan is fully paid off.