How to Finance a Car

Buying a car is easy, right? You just show up to the seller, hand them the money, and then drive off into the sunset in your new (or pre-owned) car. Well, no. First off, when you’re buying a car, you should always try to get in a test drive before you hand over the money. Secondly, just how easy it’ll be to pay for the car varies by who you’re buying from. If you’re buying from a dealer, most likely, there’ll be paperwork, monthly payments, and interest charged to those payments. If you’re buying from the car’s previous owner, they usually want all the money upfront in cash. This may not be a problem for you if you’re well-off to begin with or if you were able to set aside money for a specific amount of time until it was enough to go car shopping. But the reality is, most people just don’t have that luxury. What they do have are those other necessities that require them to put their hard-earned money towards, like rent, food, child care, health insurance—just to name a few. After those expenses, there’s little money for anything else, let alone a car.

That’s where car financing comes in. Car financing allows a person to borrow money from lenders with the expectation that they’ll pay back the money over time in the form of a loan. Most loans have a duration of 5 to 6 years and are paid back in monthly payments. These payments are comprised of the amount borrowed (principal), interest, and fees associated with taking out the loan.

In this article, financing your car with cash will also be mentioned, but because paying a lump-sum of cash isn’t a realistic option for many consumers, the majority of the focus will be on financing a car with loans.

So, how do you finance a car?

The process itself isn’t hard, but it’s not something you should take lightly either or else you could end up with a car you can’t afford. If that happens, not only does your credit takes hit when you start making late payments—or worse—no payments, your self-esteem takes a hit when you (and your neighbors) watch your car being repossessed. The process itself isn’t hard, but it’s not something you should take lightly either or else you could end up with a car you can’t afford. If that happens, not only does your credit takes hit when you start making late payments—or worse—no payments, your self-esteem takes a hit when you (and your neighbors) watch your car being repossessed. 

1. Research cars.

Even if you already have a car in mind, it doesn’t hurt to weigh your options. It might prove to be worthwhile if it turns out the car of your choice is out of your range. When considering which car to buy, take into account factors like mileage, how often certain cars need to be serviced on average, and how readily available replacement parts are. You want a car that’s easy on the eyes and on your wallet. 

2. Determine the amount of money you want to borrow.

Remember this a loan—you’ll have to pay it back. So, only ask for how much you’ll be able to afford. If you don’t already know how to calculate car financing payments, you can use one of the many free online calculators to get an estimate. 

3. Figure out how long of a loan you want.

At first glance, a longer loan term might be the most appealing option because of the lower amount you’d have to pay every month, but remember that each month, that payment is compounded by interest. That interest alone can cost you more in the long run. On the other hand, a short loan term may sound better because you can pay off your loan faster. However, the shorter the loan term is, the higher the monthly payments will be. If you opt for a shorter loan, zero-percent finance is usually offered, but usually people with excellent credit or people who can afford to put down a considerable down payment qualify for zero-percent financing. Zero-percent financing guarantees no interest in the loan, but to qualify for zero-percent financing, you might have to narrow down your selection to whatever’s currently on the lot, excluding any special offers.  

4. Stick with your price range.

It might be tempting to go for a car that’s slightly out of your price range, thinking it won’t hike up your monthly payments too much. Remember though, you have a price range for a reason. In addition to the car payments, you’ll have to pay for car insurance and emergency maintenance repairs—and that’s just the expenses related to the car. You still have your other financial obligations; make sure you don’t end up in a situation where you have to make costly sacrifices to be able to pay your car payments. 

5. Know your credit score.

How high or low your credit score determines how much interest you’ll be charged. The higher your score, the lower the interest. The lower your score, the higher the interest. This is because your credit score is how lenders predict the likelihood of you paying them back. A high score says that you’re responsible when it comes to your financial obligations, while a low score says the opposite. That’s not to say you’re a bad person if you have a low credit score, but lenders don’t want to take too much of a chance. For that reason, you should know your credit score before heading to the dealership, so you can research ahead of time what kind of interest rate you’re likely to get. Not arming yourself with this vital information leaves you vulnerable to getting stuck with an interest rate that costs you hundreds of dollars more over the duration of the loan.

6. Be prepared for additional expenses.

Car registration fees, title fees and license fees may not come a surprise to you, but what about floor plan fees and advertising fees? Some of the fees you’re bound to run into may be as ridiculous as they sound, but unfortunately for you, they’re also perfectly legal. 

7. Look around for the best deals.

Research both local dealerships and online to make sure you find best deals on both a car and interest rate. Some online lenders to check out are LendingTree, LightStream, LendingClub and E-LOAN—just to name a few. While it seems plausible to get financing directly from a dealership, the truth is, they stand to make more profit from financing than the actual sale of the car, meaning you may not get as good a loan as you would from an outside lender. Sure, consider the loan, but don’t settle before checking out what the bank or credit union offers. 

8. Apply to as many lenders as you can.

Don’t forget about the banks and credit unions. In fact, showing up at the dealership with a pre-approved loan is your best bet. A pre-approved loan is granted to the borrower by the lender before the car is purchased. If you have one of these when you go to the dealership, this tells the dealer you’ve already gone through the loan application process, had a credit check and provided documentation regarding your identity, income, assets, and other necessary information. This loan is usually good through 30 days after it’s issued, and can help you save money; because you’re already a dealer is more likely to lower his price to match the loan. Also, having a locked-in rate protects you should interest rates rise before you can close the deal. 
There’s the chance that the dealer can offer you a loan than the one you came in with, but if that’s not the case, you still have the choice to take pre-approved loan instead of accepting what the dealership gives you.

9. Compare rates.

If you get several offers back after sending out your applications, compare them to find the one with the best rate. Then reply to that lender to finalize the loan. 

What do I do if all my applications were rejected?

If your applications were rejected, don’t take it personally. Most likely, your applications were rejected because they determined the probability of your paying back the loan was too low to take the risk, or in other words, your credit score was too low. It could also be that you didn’t have enough income to qualify for the loan.

If your credit is the culprit, give yourself at least six months to repair your credit history. Some ways you can do this by reviewing your credit report in full and fix any errors and pay off any debts. If you have credit cards you don’t use anymore and don’t owe any debt on them, closing them could help raise your credit score. If your income was the was the culprit, the most obvious solution is to bring in more income.

Consider bringing on a co-signer with better credit than yours or having a down payment the next time around.

What are the requirements to finance a car?

Whether you apply for a loan with a bank, credit union or third-party lender, you should bring these things:

  • A state-issued ID is fine, but some states don’t allow you to buy a car unless you have a drivers’ license.
  • Social security number
  • Proof of car insurance. This is required by lenders because they want to ensure that in the event your car needs repairs or is totaled, you’ll have insurance to cover the costs. Lenders generally require you to have liability, collision and comprehensive insurance.
  • Proof of address. You’ll need to provide proof of address. A bill such as a utility or cable bill will suffice.
  • Source of income. To be on the safe side, bring three months’ worth of paystubs and your most recent W2 form. If you’re self-employed, provide income tax returns from the past two years.
  • Documentation about the car. If you’re borrowing from a bank, it may require you to provide information about the car you want to borrow. Bring the purchase agreement, which should state the year, make and model of the car. Some banks have a maximum mileage requirement and won’t give you a loan if the car’s odometer exceeds the limit, so your bank’s policy. Also, bring along the car’s current title and vehicle registration so the bank can verify that the seller owns the car and can legally sell it to you.

Can you finance a car with bad credit?

Is it even possible? Yes, it is. Just because you have bad credit, it doesn’t mean you won’t be eligible for a car loan. If you already have an account at a bank or credit union, apply for a loan there. You’re more likely to stand a chance with them since they already know you. When comparing loan offers, pay more attention to how long the loan term, not the monthly payment. A long-term will cost you more over time than a short-term loan because of the added interest. If you can only afford to take out a long-term loan, perhaps you should wait to buy a car until you can raise your credit score.

    Can you finance a car with no credit?

    Yes, you can, though have no credit almost puts you in the same category as having bad credit; with no credit history to review, lenders can’t gauge your ability to pay back the loan. You can remedy this with a reliable co-signer, who then becomes responsible to make the payments when you or unable to. It also helps to come with a down payment. This tells the lender that you’re serious about buying a car, and it may lower the cost of your loan.

    To find lenders, go to the same places you’d look if you had bad credit. RoadLoans works with people of all credit histories, including those with no credit history.

    How important is a down payment?

    Having a down payment tells the lender (and dealership) that you’re serious about buying a car, but it also saves you money. A substantial down payment lowers your monthly payment because if you already have a down payment in cash to make, you can take out less money in the form of a loan, which results in smaller monthly payments. When lenders see that you can provide a large down payment, that makes you worthier to receive lower interest rates. This is the way to go especially if you have bad credit.

    What red flags should you be out on the lookout for when buying a car?

    • Not-so-straightforward pricing. You’d balk at the sound of a $25,000 price tag, but maybe you wouldn’t if it were instead rephrased as $347 a-month payments. Still, it’s the same price, and that’s how much you’d pay if you took out a loan with 72-month duration. Dealers use this tactic to mislead buyers into buying cars they can’t afford.
    • Listen carefully to what a dealer says. While they might sound helpful when they suggest cars to buy, they could really be trying to persuade you to buy a car that’s out of your price range. As a result, you’ll end up paying more money no matter how much they’re able to stretch out the loan duration.
    • Discouragement of short-term loans. Dealers might try to sell out on a long-term loan with the idea of lower monthly payments. What they won’t tell you though, is that over time, the interest paid over time will cause you to pay more than if you accepted a short-term loan.
    • Loans with contingencies and penalties. Beware of loans that require you to also pay for extended warranties or after-market services. Also, find out if they come with prepayment penalties that still require you to pay the full amount of interest on the loan even if you pay off the principal (monthly payments) early.
    • Pre-computed loans are similar in nature to loans with prepayment penalties, mandating the borrower to pay both the principal and interest even if they pay off the loan early.
    • “Yo-yo” financing. Yo-yo financing happens when you leave with the car, under the impression that you’ve completed the deal. Weeks later, the dealer calls you to tell you that the transaction didn’t go through and then tries to get you to refinance on the loan or take a loan with a higher interest rate. You can—and should—refuse, but since you’ve had the car in your possession, the dealer can charge you for wear-and-tear, and may even threaten to report the car as stolen, or have the car repossessed, thereby damaging your credit.

    What are the advantages of financing a car with cash?

    This is the part where we address financing a car with cash. The most obvious advantage is that you don’t have to go through the process of taking out a loan and then pay it back. However, there are more advantages to consider. If you have the means to pay for a car with cash, but aren’t sure if it’s worth it to spend such a large amount on a car, here are some reasons to ponder.

    • No interest payments. Buying a car upfront with cash instead of a loan means no monthly payments or interest.
    • Fewer monthly expenses. Having no monthly payment leaves you more money to spend on other expenses. If you should happen to lose your job or your financial stability suddenly de-stabilizes, that’s one less obligation to worry about.
    • You own the car. As long as you’re making payments, the car really belongs to the lender. Should you fall on hard times and not be able to make your payments, “your” car gets repossessed. If you buy the car with cash, it yours, fair and square.

    How do you finance a car with a trade-in?

    Maybe you already have a car, but you want a new car. Should you sell your car or put it towards a payment for a new car as a trade-in? Between the two, you’d probably get more money if you sold is as a private dealer, but the time it would take to sell it could take much longer than if you took it to a dealership. On the other hand, if you used it as trade-in, you’d get less money because the dealer would factor in the cost of re-conditioning it to make it suitable for re-sale. Still, the money you’d get for your trade-in would go towards the purchase of your new car and decrease the amount of money you’d need to take out in a loan. Maybe you already have a car, but you want a new car. Should you sell your car or put it towards a payment for a new car as a trade-in? Between the two, you’d probably get more money if you sold is as a private dealer, but the time it would take to sell it could take much longer than if you took it to a dealership. On the other hand, if you used it as trade-in, you’d get less money because the dealer would factor in the cost of re-conditioning it to make it suitable for re-sale. Still, the money you’d get for your trade-in would go towards the purchase of your new car and decrease the amount of money you’d need to take out in a loan. 

    Let’s say after unsuccessfully trying to sell the car on your own, you decide to try the trade-in option. What do you do now? 

    1. Appraise your car.

    You won’t know if the dealership’s offering you a reasonable price unless you know how much your car’s worth. There are multiple car appraisal tools online available to get you started. Edmunds.com also has tips on how to appraise your car to get the most accurate appraisal, and don’t forget to check with Kelley Blue Book. 

    2. Get a quote from dealerships.

    After appraising the car yourself, call your local dealerships and set up an appointments to get your car appraised. Try to get an appointment on a weekday; if you show up on a Saturday, you could wait a long time until it’s your turn. If you have a CarMax nearby, go to them first. They’ll give your car a full-inspection and a written appraisal that’s valid for up to seven days. If you can schedule your appointments at the dealerships within that timeframe, you can compare the appraisal from the CarMax to the ones from the dealerships. 

    3. Close the deal or negotiate for a better deal.

    If either the dealerships or CarMax makes an offer you can’t refuse, take it. If not, it’s time to do some negotiation—with the dealerships, not CarMax; CarMax won’t do negotiations. Don’t be afraid to reference appraisals from the other dealerships. Of course, dealers will try to haggle the price with you, but ultimately, they know there’s competition and each one of them wants your business. 

    When’s the best time to take your car in for a trade-in?

    Go towards the end of the year when the new inventory is coming in. By then, dealers are looking to get the previous year’s inventory off the lot and may offer you a higher trade-in price if you buy one of the older models.