How to Finance a Car
  • Buying Guides

How to Finance a Car

By Evan Walton | April 29, 2021

When looking to purchase a new vehicle, there are a few key things to know to ensure you are getting the best deal possible. And with the cost of new cars today, you want to make sure not to pay for any extra charges that could be avoided by fully understanding the financing process.

Here's a summary of the financing process:

  • Know your credit score and determine what will improve it
  • Get a preapproval from a financial institution
  • Secure lending
  • Choose a vehicle at a dealership and come to an agreed price
  • Use a loan to cover the entire amount needed
  • Sign a loan or lease agreement
  • Credit Score

Before going to a dealership or even searching for a new car online, understand your credit score. A lender or finance company will take your credit score as a contributing factor to your application and give access to competitive loan rates. Your credit score is not the only piece of information the finance company looks at when building a loan offer. To get an idea of your current credit score, utilize free online tools that generate a credit report for you to gain in-depth information on your credit.

Credit reports not only reveal an overall score, but they break down information on outstanding debts. Each of the big three credit bureaus, Experian, Equifax, and TransUnion, generates two types of consumer credit scores. These two consumer credit scores are the FICO Score and VantageScore. You can get a free credit report from Experian every thirty days, which helps you stay aware of your credit score at all times.

AnnualCreditReport.com allows you access to a full report, once a year free of charge, from all three credit bureaus that provide a detailed line item type of report of your credit. A full detailed report is important to ensure there are no fraudulent claims on your credit. If you do find issues with the credit report, contact the companies in question to have them remove the negative impact before moving forward with a new vehicle purchase.

If You Have Good Credit:

Having a good credit score helps in the car loan process, but it is not the only important factor. A good credit score is considered to be a score of at least 661.

A good credit score will assist in the loan process by showing good faith to the potential lender, leading to lower monthly payments, lower down payments, lower interest rates, and a better annual percentage rate (APR).

Good credit also allows you to arrive at the dealership with a preapproval letter from a bank or credit union showing the dealership you have buying power. Car buying is made simpler with a preapproval letter from a financial institution and a good credit score.

If You Have Bad Credit:

If your credit score is below 661, it may be more challenging to find a financial institution willing to provide you with a loan.

If you can secure a loan offer from a lending institution with a challenged credit score, expect to pay a higher interest rate and, in the long term, a higher total amount.

An option for someone with bad credit, or in some cases, not enough credit history, is using a co-signer to help you get approved by a bank, and in some instances may this may be required by the lending institution to approve the loan.

Financing Options:

There are three main ways to finance a vehicle purchase. You can gain financing through direct lending, dealership financing, or personal finance. Below is a breakdown of each financing option to help you understand which method of financing is best suited to your situation.

Direct Lending

If you borrow money from a bank, finance company, or credit union for an auto loan, this is considered to be direct lending. In an auto loan, you agree to pay an amount financed, plus a finance charge creating a total cost. This total cost is paid over time which varies based on the loan term. Once you are ready to purchase a new vehicle from a dealer, you use this auto loan to complete your purchase.

If you chose to use direct lending to finance your vehicle purchase, you should shop around and seek different auto financing institutions for the best rate. Sometimes the best financing options for borrowers can be found through online lenders. When shopping around for a lender, ask each potential lender about their credit terms before deciding on a lender.

As previously mentioned, seeking a preapproval before heading to the dealership to choose a vehicle will help secure lending terms in advance. You will know exactly how much buying power you have when entering the car dealership and know how much the APR, length of the term, and monthly payment might be before looking at cars.

Dealership Financing

Dealership financing is another option if you are not satisfied with the offers direct lenders gave you or if you have been denied through financial institutions. You can apply for financing through the dealership. You and a dealer enter into a contract where you buy a car and also agree to pay, over some time, the amount financed plus a finance charge. The dealer typically sells the contract to a bank, finance company, or credit union that services the account and collects your payments.

Dealership financing provides a greater level of convenience due to having extended hours, evenings, and weekends available to offer to finance while banks are closed. Car dealerships also have multiple financing options and connections with many banks and finance companies that may give you a loan based on the dealership's request. Having choices gives you more access to financial loan options. Car dealerships can also offer manufacturer-sponsored incentive programs and rebates. The manufacturer programs may be limited to certain cars or may have special requirements, like a larger down payment or shorter contract length (36 or 48 months). These programs might require a strong credit rating, but it is worth checking to see if you qualify.

Personal Loans

Personal loans differ in that they can be used for any purchase and are not vehicle-specific loans. Financial institutions follow the same process of approving or disapproving a personal loan as they do a car loan, but a personal loan could offer a better interest rate. Over time, this lower interest rate could save you hundreds if not thousands of dollars over what you would have spent with a car-specific loan.

Personal loans are an excellent idea for used car purchases as banks typically will not finance a used car if the used car is deemed not worth what a dealership or individual seller is asking. Personal loans are also ideal to buy a vehicle from a private party.

Down Payment:

Whether your credit is good or bad, a down payment on your new vehicle will lower the amount you need to finance and will therefore reduce your monthly car payment. A vehicle trade-in can also be used as a down payment as the dealership will apply an agreed-upon price for your trade-in toward the purchase price of your new vehicle. Having a paid-off car to trade in makes the car financing process easier but can complicate the process if there is still a lean on your trade-in.

Some lenders may require a larger down payment than what you originally anticipated. There are many factors to a lending institution's decision on a loan amount. In most cases, a down payment is utilized to bring the new loan's overall cost down to a more manageable monthly payment.

Monthly Payment:

Before signing a loan offer, make sure you have done the math on your own to ensure you can afford your new monthly payment. There are many online loan calculators accessible that will help dictate the loan payment based on the price of the car, the finance rate, and the number of months the loan offer includes. Also, ensure that the life of the loan is a term you can sustain if possible aim for a shorter term as longer loans will cost more over time.

Leasing A Car:

Leasing a new vehicle is an option that many car buyers opt for who want a short-term contract and lower monthly payments to make swapping into a new car every two or three years easier. Lease agreements also have mileage caps, typically between 10,000 and 12,000 miles per year and around 25 cents per mile for anything over that.

The leasing process is similar to the auto loan process in that the lessee has a credit check performed through the finance office and provides a down payment toward the lease agreement. The leased vehicle theoretically goes back to the dealership at the end of the contract, and therefore the customer cannot use it as a trade-in towards a new car.

Leases often end with the lessee returning the vehicle after the allotted time and milage and having no more financial obligation toward the car. However, there are penalties for excessive wear and tear, worn tires, crash damage, and mileage overages. Some lessees choose to purchase the vehicle after the original lease is up, and in this case, all of your monthly payments and down payments can be applied to the leased vehicle. The lessee is then going through an auto loan process to purchase the car at a lower price from the dealership.

All of these points have to be agreed upon in the lease contract. Not all leases are the same, so if leasing interests you, make sure you read over the lease's fine print and understand your options.

Another aspect of leasing is that the dealership is technically still the owner of the vehicle. Therefore, the warranty on your car is upheld by the dealership.

Refinancing:

If you have fallen victim to a bad car loan agreement, there are options available to help rectify the situation. Refinancing a vehicle is an option to get a better APR, lower interest rates, and lower monthly payments on your car. Refinancing does, however, require a good credit score but has no restrictions on your car's age or mileage.

Auto loan refinancing is similar to the auto loan process in that you want to check with different lenders to obtain the best rate. You can find auto loan refinancing quotes online or the traditional route of contacting your financial institution and asking for rates on an auto loan refinance.

Whichever lending institution you choose, make sure to ask about any fees for applying or initiating the loan and avoid lenders who want to lower the monthly payment by extending the term of the loan. The goal with an auto loan refinance is to get a lower interest rate and pay down the loan over the same amount of time or a shorter-term period.

After Signing:

Financing a vehicle is no easy task, but it is an accomplishment and a big step in continuing to improve your credit score. Be sure to keep a copy of the credit contract or lease agreement, with all signatures and terms filled in before you leave the dealership. If you chose to finance a new vehicle, understand that your lending institution has a lien on the car's title. The lending institution will keep a lien on the title until you have completely paid off the vehicle and met the terms of the loan agreement.

Late or missed payments on an auto loan are detrimental to a credit score. A favorable credit report ensures eligibility for loans in the future. Too many missed payments could lead to the repossession of the vehicle, which is even more detrimental to a credit score. It's vital that you carefully review the documentation presented by the dealership before signing. After all of the numbers are finalized on the contract, remember you still have an opportunity to change your mind before signing. You do not have to continue with financing if the terms of the agreement are unfavorable or it's too large of an expense for you.