Auto Loans

Financing a Car: A Guide to Getting Your Wheels

Due to the rising costs of both new and used vehicles, most people borrow money to pay for their car or truck. Of course, you could pay cash, which would eliminate interest charges and other fees, but also take a big chunk out of your savings. That leaves financing a car, either through a loan or a lease. Getting your best deal possible on that financing could save hundreds of dollars off the cost of your next vehicle.

How to finance a car: the basics

The first lesson in how car financing works is this: it almost always adds to the total cost of the vehicle. (There are a few zero percent loans out there for people with excellent credit.) Most people will also finance the sales tax, title and license/registration fees (TT&L), which add to the amount you have to pay back to the lender, as much as 10% of the total price. In other words, even if you budgeted for the sticker price of your new car, you may not have accounted for these additional costs.

Financing a car with a loan

The majority of new car purchases are financed with a loan. That means the bank, credit union or online lender pays the seller of the vehicle, and you make payments to the lender for the term of the loan. Your payment includes the interest and principal of the loan. When the loan is paid off, you own the car.

You can finance new and used cars with a loan. New car dealers will usually offer financing through their manufacturer’s financing arm such as Toyota Financial Services or Ford Credit or national and regional banks. For a used car, the dealer can apply for your loan through other lenders such as banks and credit unions. But you won’t know you’re getting your best deal unless you can compare those offers to those you applied for on your own. It’s always a smart idea to go to the dealer with a preapproved auto loan.

Auto loans vs. personal loans. Most car loans from banks, credit unions and manufacturer’s finance companies are secured loans. Your car serves as collateral, and if you default on the loan, the lender can repossess your vehicle. Some lenders offer personal or unsecured loans and approval depends on your credit history.

Financing a car with a lease

Leasing is a different type of financing. Instead of owning the vehicle, you pay for the use of the car over the mileage and length of the lease term. You pay for a portion of the car, not the entire car. That means the monthly payment on a lease is usually lower than a loan for the same car. Unlike a loan, it’s uncommon to arrange your own lease — in most cases, the dealer will arrange it through the manufacturer and sometimes through a bank, credit union or financing company.

At the end of the lease, you will have two options: turn it in or buy it. If you turn it in, you can lease or buy another car. If you like the car and want to keep it, you can pay for the rest of the value of the vehicle, using a lease buyout loan or cash. Some people buy their leased car if they go over the mileage limit and would have to pay a lot to cover the excess mileage fees at the end of the lease.

Before financing a car, take these steps

As you’re trying to decide between a lease or a loan, it’s first important to understand some of the common technical terms you might hear at the dealership.

Understand the terminology

APR — Annual percentage rate is the cost of credit, including interest and fees, expressed as a percentage. Auto loan borrowers on the LendingTree platform pay an average 8.06% APR, but your APR could be higher or lower, depending on your creditworthiness.

Capitalized cost — In a lease, the capitalized cost is essentially the selling price of the vehicle. The lease amount is based on the difference between the capitalized cost and the expected value of the car when the lease is up. That’s the amount financed in a lease, divvied up into monthly payments based on the terms of the lease.

F&I — The Finance and Insurance (F&I) department is  where your deal will be finalized at the dealership. The F&I manager will discuss financing options and also try to sell you a service contract and other accessories. These items will add to the total cost of the vehicle (see below).

MSRP — Manufacturer’s Suggested Retail Price is the price that the auto manufacturer suggests that the dealer place on the car. Dealers are free to negotiate the final selling price.

TT&L — Taxes, Title and License fees, as we mentioned earlier, are part of the out-the-door price for the car. We’ll break down each part:

  • Taxes are sales tax you pay for the car. They will be added to the final selling price of the car.
  • Title refers to the fee covering the cost of transferring the title from the previous owner into your name.
  • License refers to the fee covering the cost of registering the vehicle with your state’s Department of Motor Vehicles and having the license plate transferred to your name. A dealer will collect this as part of the total vehicle price, but in a private sale you’ll pay these fees at the DMV.

Total cost — This is the total amount you will pay for the vehicle, including the principal and interest on the loan, as well as dealer and TT&L fees. The Consumer Protection Financial Bureau recommends making your buying decision based on this number rather than monthly payments.

Check your credit score

Your credit score will affect the APR and loan amount that you will qualify for on your loan or lease. Higher credit scores mean lower interest rates, which means you’ll pay less for your car overall. Those with the best credit may be eligible for incentive financing from the manufacturer’s financing company. Those with poor credit may pay substantially higher interest rates, and the lender may require a larger down payment. (More on down payments in a minute.)

FICO Auto Score. For auto loans, lenders use the FICO Auto Score, which looks at your history of paying back vehicle loans. You can check your basic credit score for free, but accessing your FICO Auto Score requires paying a fee at MyFico.com.

Set a car-buying budget

Now that you have an idea for your loan amount and APR, it’s time  to set your car-buying budget. Calculate what monthly payment could fit into your budget and how much down payment you could make. To keep things simple, this example doesn’t include a trade-in.

Here’s a look at a new car-buying budget for a person with fair-to-good credit.

Credit Score 601-660
Average new car price $38,948
Title & registration fees $50*
Sales tax @ 8.6% $3,350.00*
Total financed $42,351.83
Down payment @10% $4,235.18
Loan amount $38,112
APR 8.76%
Loan term 72 months
Monthly payment $682.46
Total interest $11,025
Total cost $49,137

*Taxes, title and license fees vary widely by city and state.

Best places to finance a car

Today, there are many ways to finance your car, from the credit union in your neighborhood to online lenders. Here’s a closer look at each of the options.

Dealership

A franchised new car dealership will offer loans from its manufacturer’s financing company as well as local and national banks. To get the lowest incentive rates, you’ll have to use the manufacturer’s financing company. If you don’t qualify for those rates, another lender may offer a better rate. Some dealers will offer lower prices if you use their financing. As we mentioned earlier, most leases are financed through the manufacturer’s finance company.

Pros Cons
Availability of manufacturer incentive rates Dealer may get incentives to steer you to a particular lender.
Convenience — the dealer sends your application to lenders so you don’t have to. You may be able to get lower rates on your own.

 

Banks

Some national and regional banks work closely with dealers to offer financing through the F&I office. The F&I manager will take your application and send it to several lenders. You can choose the lender you want to use.

A better way is to apply to those national or regional banks yourself, perhaps starting with your own bank. Yes, it’s more legwork for you, but it’s the best way to know you’re getting the APR you deserve, not one that the dealer negotiated. Dealers can and often do raise customers’ auto loan interest rates for their own profit. Check out some of our recent lender reviews here.

Pros Cons
Offer a wide selection of auto loans, including new, used, lease buyouts. Regional banks may focus on those with good or better credit.
Fast application and approval through the dealer and perhaps on your own. May have to live near a regional bank branch.

 

Credit unions

Credit unions are nonprofit organizations formed to serve their members, which may be people who live in a specific area or work at a company or are part of some other group. Navy Federal Credit Union for example, serves active duty military, retirees and family members and Department of Defense employees and their families. State Employees' Credit Union (NC) serves employees of the state of North Carolina and their family members.

There’s likely a credit union near you that could qualify to join. Credit unions are owned by their members, so they tend to offer loans with lower interest rates. Some credit unions require you to be a member to apply for a loan, while others allow you to apply for a loan and then become a member to finalize the loan process.

Credit unions may offer loans based on measures other than your credit score, so you may be able to get approved more easily than you could at other lenders, or secure a lower interest rate than at a bank.

Pros Cons
Personalized local service Membership required
Credit scores are not sole the determining factor for approval or rates You may have to get the loan yourself, not at the dealer
Lower rates and fees Limited branch locations or online offerings

 

Online lenders

Some online lenders may be tied to banks, such as LightStream, which is a division of Truist Bank. Then there are independent online lenders for new and used cars and refinancing existing loans. You can take care of everything online, possibly even from a mobile app. Some online lenders like New Road Auto specialize in working with buyers with bad credit.

Pros Cons
Fast approval May not offer loans for business vehicles
Low overhead may result in lower fees, rates Better rates may be possible where you currently bank
Offer unsecured personal loans that you can use for a classic car that other lenders won’t finance No personal customer service

How to apply for car financing

With your car budget in hand and an idea of where you’d like to finance your new set of wheels, it’s time to get to work.

1. Apply for preapproval

If you’re buying, apply for a loan with the bank, credit union or online lender of your choice. You will be approved to borrow up to a certain amount. The lender may provide a check or coupon for the preapproved amount to take to the dealer. Or you will work with the F&I manager to finalize the loan with the lender. With a preapproval, you have a comparison to the financing the dealer will offer.

2. Negotiate the price

Use sites such as Edmunds or Kelley Blue Book to research the market value of the car you’re interested in buying. Negotiate the price before talking about down payments or trade-ins.

3. Discuss the down payment

Have a plan for when the dealer asks how much you plan on paying upfront. The more you pay now, the lower the amount you will finance. For a new car, a down payment around 10% is standard now, although the conventional rule of thumb called for 20%. It’s about 20% for a used car. It makes sense to at least pay for taxes, title and license fees upfront so you don’t finance those costs, which adds to your payment and the total cost of the car. (See below.)

4. Ask the dealer to beat your preapproved offer

Share the amount, APR and loan term with your dealer and let them know they have to match or beat it to use their financing. Dealers may receive incentives from financing companies so they may be willing to negotiate on other costs.

5. Consider add-ons carefully

When you’re sitting in the F&I office finalizing the deal, the manager will present you with a list of options and add-ons, such as paint protection packages, service contracts, nitrogen inflated tires or a tire-and-wheel warranty. Consider these very carefully, as you can probably find these items cheaper somewhere else if you really want them.

6. Pay for any add-ons, taxes, fees with cash

As we mentioned earlier, if possible, pay the taxes, title and license fees with cash so you don’t finance those amounts. Otherwise, you might wipe out any savings that came from making a down payment. No down payment plus financing TT&L fees means your loan payoff amount may be higher than the value of the car, which puts you upside down on your car loan. This could create a problem if you decide to trade in or sell the car.

7. Set up automatic payments

Many lenders offer a lower APR if you set up automatic payments from your bank account. It could save a few hundred dollars over the life of the loan.

 

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