When buying a vehicle, financing refers to how the buyer pays for that vehicle, and in many cases that involves loans or leases when the vehicle is too expensive for the buyer to pay cash. These forms of financing are very popular ways to buy a vehicle because few people can afford to pay the entire purchase price out of pocket.
There are quite a few factors that play a role in the type of auto financing offered, how much financing is offered, or if financing is offered at all. Here, we’ll attempt to untangle the web of dealership lingo and banking paperwork and explain the best way to finance a car, including what you need to get financing, how to get a loan for a used car, and the optimal loan terms. The key here is to do your research.
How To Get a Loan for a Used Car
What Does it Mean to Finance a Car?
What Do You Need to Finance a Car?
How Do You Finance a Used Car?
How Does Financing a Used Car on CarGurus Work?
Financing Online vs Financing In-Person
Loan vs Lease: Best Way to Finance a Car
The Bottom Line
What Does it Mean to Finance a Car?
When you decide to purchase a vehicle and apply for financing, you’re entering into a relatively complex financial transaction with both the vehicle’s seller and your financial institution. Luckily, this transaction can be broken down into a few simple parts.
First, there’s the principal, which is the purchase price of the vehicle plus any add-ons or fees that have to be paid. Then, there’s the interest rate, which is a percentage of the purchase price that gets broken down and paid along with the principal payments each month. This may also be described as the annual percentage rate, or APR, which is the annual rate charged for borrowing. Finally, the term is the length of the loan, which is usually a round number like 12, 24, 36, 48 months, though some loans on expensive newer cars can stretch out to eight years or more.
What Do You Need to Finance a Car?
Credit scores play a major role in qualifying for a car loan, so it’s important to check yours before proceeding. A high credit score can also save lots of money. Bad credit generally brings higher interest rates, while lower interest rates generally go to those with the best credit, which in turn can mean lower monthly payments. Note that, unlike a credit report, accessing your credit score isn’t always free.
It’s also important to set a budget and stick to it. That should include not only upfront costs like the down payment and any applicable taxes and fees, but also recurring ownership costs such as insurance, estimated maintenance costs, warranty coverage (less coverage means you’re potentially responsible for more repair costs) and fuel or charging costs. If you’ve got a trade-in factor that in as well. Figuring this out in advance will give you a better idea of how much car you can actually afford.
How Do You Finance a Used Car?
With lease options generally available only for new vehicles, a loan is the best way to pay for a used car for most people who can’t afford the entire purchase price up front. But to get a great deal on a used car, it’s important to consider all loan options, including the loan amount and how your credit history might affect it.
Get Pre-Qualified
Prequalification with lenders for an auto loan is relatively easy, likely won’t affect your credit score, and gives you a baseline of what to expect when shopping for financing. You can also take these loan offers to the dealership for use as leverage if the terms presented by the salesperson aren’t favorable.
Shop for Your Car
Before looking into financing, it’s best to have a specific car in mind to purchase or lease that you know is within your budget. If it’s a used car, check the vehicle history and, if possible, arrange an independent inspection to avoid surprises. If it’s a new vehicle, check the inventory at multiple dealerships to get the best car for your money.
Apply for Financing
A number of institutions offer auto loans, so the best way to finance a car really depends on your financial situation and creditworthiness. In any case, applying for financing ahead of time can limit the amount of time spent waiting around at the dealership.
Most car dealerships offer some degree of financing for the vehicles they sell, especially if it’s a branded franchise dealership like Robert’s Ford or Steve’s Chevrolet. But the in-house dealer financing is not your only option. In fact, the dealer’s financing may not even be your best option. In many cases, you’ll be able to find a better rate, a more favorable term, and less headache by applying for financing through an external financial institution, like a bank or credit union, before you head to the dealership. If you have a rough idea of the vehicle you want to buy, many lenders offer a pre-approval process that will give you an idea of how much you can borrow and what it will cost.
How Does Financing a Used Car on CarGurus Work?
CarGurus has also partnered with Capital One and Westlake Financial to offer financing to its customers. The partnership provides instant credit decisions based on soft-pull assessments (doesn’t affect your credit score), and rates are guaranteed to be honored by participating dealers for 30 days after you apply.
Financing Online vs Financing In-Person
Car buyers have traditionally arranged financing in-person or at the dealership, but a number of online lenders, including major banks like Chase, providing a more convenient option. Check with your lender for details.
Loan vs Lease: Best Way to Finance a Car
Your financing options may include either leasing or buying. Leases for new cars generally run for a shorter period of time, after which the vehicle is returned to the lessor (usually the manufacturer) or purchased outright. Leases can be more flexible than longer-term loans if you don’t plan on keeping a car for more than a few years, but also generally come with annual mileage caps—and added fees for going over them—and generally aren’t available for used cars.
Monthly Payments and the Money Factor
In some cases, you’ll be asked how much of a monthly payment you can afford. This may sound appealing at first because the salesperson appears to be working to meet your financial needs, but it’s a dangerous sales tactic that can lead you into a situation where you’re losing money.
Interest Rates and Loan Terms: How Many Years Can You Finance a Used Car?
In addition to the car payment and out-the-door costs, it’s important consider other factors that apply over the life of the loan, such as the loan term and the vehicle’s anticipated depreciation. Many lenders are willing to extend loan terms to several years, but if possible, you should focus on keeping your loan term to 60 months or less. Longer loan terms lead to situations where the vehicle has depreciated to a point where it’s worth much less than the amount that the borrower owes. This is known as being “upside-down” or “underwater”, and, as you can probably guess, it’s not a good situation to be in.
Another important factor to note is interest rates, which are generally higher for used-car loans than for new cars. Reasons for this include the higher resale value of new cars, that credit scores are generally higher for new-car buyers, and that people with poor credit history tend to default on loans more often. Dealerships are also generally more eager to sell new cars, and may offer more favorable terms, while automakers offer incentives on new car financing and leasing that aren’t available for used cars.
The Bottom Line
This all may sound like a cautionary tale, but the reality is that there are some financing offers that are better than great. Very low, or even 0% financing rates can be profitable for the borrower. If you have good credit and can get a loan with a low interest rate, you might actually be able to make money from the loan by moving money into an interest-bearing savings account at a credit union or bank.
No matter how you decide to finance your next vehicle purchase, it’s important to head into the process with open eyes and a good idea of what you’re getting into. Read the fine print, understand the total cost of the car, and don’t fall victim to the monthly payment trap.
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