How to Finance a Car and Get a Car Loan

In today’s automotive market, financing a new or used vehicle makes sense for many drivers. Prices have risen over the past two years more quickly than in previous years. An auto loan may be the only way to drive the car we need or want.

What Does it Mean to Finance a Car

Financing simply means taking out a loan to get the money to buy a car. The loan can come from any lender available to you. These include your credit union, your local bank, a national bank, or a lender that you find through your dealer or vehicle retailer. Many new car dealerships offer financing through the parent company of the brand they sell. For example, Toyota Motor Credit Corporation (TMCC). Financing is very profitable for automakers and is a very important stream of revenue for corporations.

For clarity, we won’t cover leasing in this story, but you can find more on the topic of leasing here at Car Talk. And click here to learn more about how to lease a car.

Checking Your Credit

Before you begin the process of applying for a loan, start by checking your credit. And not just the score. Read over your credit report closely to see if there are any errors, duplications, or if any of your family members’ credit history is accidentally included with your own. This can happen if you share the same name and address with, say a father or a son of the same name.

You can find your credit report for free in numerous ways. If you have a bank account or a credit card it is likely that you are offered your credit report frequently. You can simply follow the instructions from your bank or credit card company to see your credit report. You can also check your credit score using the government-mandated website called, “Annual Credit Report.com”. It is a free service.

If you find any errors in need of correction, you can submit a request to have the credit data corrected. There are three main credit reporting agencies in America. You can access their online landing sites and go directly to their dispute resolution pages using our links below. Follow the instructions on the sites to correct any errors by filing a dispute.

Bad Credit Does Not Mean No Financing

“Bad” credit is not a disqualifier for auto loans in most cases. The past three years have been very difficult for many families and individuals. With a pandemic, shutdowns, and a war in Europe causing shortages of goods globally, many of us have had setbacks. Some of these may have resulted in reductions in our credit scores. If this has happened to you, don’t quit yet. You can still apply for an auto loan.

Those of us with lower credit will likely have a few realities to deal with. First, lower credit usually means you pay a higher interest rate compared to what a person with very strong credit would pay. Second, your limit for borrowing may be lower than a person with higher credit. Last, your list of available special incentives may be reduced or eliminated. Automakers often advertise financing deals for “well-qualified buyers.” If you are not well-qualified, it doesn’t mean you can’t buy a car. It just means you are not eligible for the special financing package some borrowers with stronger credit histories may enjoy.

Learn more about Getting an Auto Loan Without Hurting Your Credit here.

What Exactly is a “Good” and “Bad” Credit Rating?

Terms like 'good' and 'bad' are scary. They seem to indicate there are just two options, but with credit that is not the case at all. Your score is a number. The number changes upward as you build a credit history and also establish a long-term record of paying your bills on time. If you fail to pay on time, your score goes down.

Poor or 'subprime' credit scores are around 600 or lower. If you are an individual with such a score, you may want to step back and consider holding off on more borrowing. If you can spend some time, say a year, paying your debt down, paying on time, and speaking to any lender to whom you have overdue billing, you can move the needle upward. Let's be real for a moment; If you are not willing to do those things, a new car loan at a high interest rate may harm you more than it might help you.

Credit scores between 600 and 700 are good enough to obtain a loan from many lenders. This is the range between what is called 'bad' and what is considered 'good' credit.

A credit score over 700 is considered “good.' A score above 750 is very good and a score over 800 is the gold standard. If you have a credit score over 700 you need not worry that lenders will offer you fair rates. Above 750 you should be picky and expect the best rates and highest possible incentives to apply to you. Knowledge is power. Know where you stand and why.

Learn more about Average Auto Loan Rates here.

Get Prequalified First, Pre-Approved Has a Different Meaning

If you are shopping for financing packages, be aware that the words pre-qualified and pre-approved are different things with different meanings and consequences. Shopping for a car when you know you will rely on financing can be stressful. To minimize your stress, seek to have the best information available. Know if you are able to obtain the loan you need before shopping, not after you have picked out a gleaming three-row Acme Thruster with the Everything Package.

The way you find out how much you are able to borrow is by prequalifying. Ask lenders to provide you with a loan pre-qualification by working with them online. Your local bank may also be able to help you by phone. Do this before you visit a dealer to see what interest rates and what borrowing limits the lenders offer you. You can always opt to take a further step and get pre-approved before accepting financing arranged by the dealer.

Prequalification will not harm your credit in any way. The lenders do a “soft” credit pull or credit check by looking at your credit score, and that does not change your credit score. By contrast, a pre-approval is a later step and it may change your credit score a bit (downward).

Pre-approval is a term that applies once you have finalized your search and are ready to buy. A lender will review your entire credit report before providing you with a pre-approval. If you are pre-approved for a loan you become a shopper with a loan you can apply at the time of purchase as if it were cash. If you wish to get pre-approved from more than one lender, complete the pre-approval process in one short span of time and keep the total number of pre-approvals low (two or three at most). If you get pre-approved more than once over a period of months it can lower your credit score.

Learn more about the Best Auto Loans available here.

As you can see from the table below, the loan type with the most benefit to the borrower is to make a large down payment up and have the shortest loan duration possible. By choosing this type of loan struction, you will save on the total cost of the loan over time.

Setting Your Budget

Dealers want you to shop based on “your monthly payment.” If you follow their lead they may stick you with a long-term loan with little money down. The result of this is you pay a LOT more in interest over the life of the loan. Another downside to long-term loans (let’s say longer than sixty months for a new car, or 36 months for a used car) is that you may not have positive equity in the vehicle. You may end up owing more than the car is worth while you “own” it.

Make your car payment an important part of your total family or personal budget. Understand that cars almost always depreciate. That means their value goes down over time. If possible, use your savings to make a strong down payment and keep the loan duration as short as you can safely manage. Try to build equity and become a person who owns a car with no car loan before the car is used up and has no meaningful value.

If you are a good budgeter, you may be ready to take the added step of always budgeting for a vehicle even if your loan is paid off. Your vehicle continues to depreciate, so begin saving for the next vehicle even while you are still happy with the one you are driving. If you try to plan on huge $30K hits to your finances every five to ten years, you will always feel like a car purchase “blows up your budget.”

Deciding on the Car You Want

The folks at Car Talk are among the most experienced vehicle testers in the industry. Here are a few things we can tell you about vehicles:

• There is good in all cars.
• No car is perfect.
• Many vehicles in the same segment are so similar they are nearly identical.
• Reliability matters a LOT in ownership satisfaction. Nobody loves a broken car.
• 0-60 MPH times are a lie meant to persuade you into thinking fractional seconds matter.
• Energy costs will be your highest cost of ownership - not the new car price tag.

Yes, style and comfort matter. Yes, we understand that you want a fun-to-drive car, but if we can offer just one piece of advice it is to be flexible. If you want that Acme Thruster and the financing deals and discounts are not kind to you, consider another similar model. Always look at the reliability of any model you consider at Consumer Reports, and always look closely at the annual fuel costs at www.FuelEconomy.gov.

When you choose your next vehicle, try to let your brain be your final guide, not your heart. We’d all love an Alfa Romeo 4C Spider. However, a practical car may be a better choice if you are financing.

Don’t Finance Snake Oil

When you are shopping for your new car, the dealer will first emphasize what a durable and reliable car you are considering. Once you decide to buy, the dealer will immediately tell you the complete opposite. The dealer will explain that the paint needs to be protected and that unless you add a paint protection film and ceramic coating, the paint will literally wash off the first time it rains. Your rims will be damaged by potholes because the dumb manufacturer used ultra low profile performance tires ill-suited for normal duty. The engine and transmission could fail at any moment after the warranty runs out, and the infotainment system is very likely to go blank the day you make your last payment.

Ahh, but they can help, of course! They have a basket of insurance packages they can provide to take away all your worries. Say no to all of it. If you must buy anything of that sort, shop for it after you buy and do not finance it. You will be paying interest for years on something you didn’t need in the first place.

Arranging Your Own Financing? Dealers May Not Be Thrilled To See You

One oddity in car shopping is this: If you arrive at a dealership with cash or a pre-approved loan, the dealers are not going to be thrilled to see you. That is because they earn money by arranging financing for you. They “sell” your financing to the manufacturer’s financial arm or a bank they work with to profit from your borrowing.

Prior to the current inventory shortages, it was common for special deals and discounts to be offered only to shoppers if they obtained financing from the manufacturer through an authorized new car dealer. Be aware that if you obtain your financing from a lender that is not set up by a dealer, certain incentives may not apply to you. Today, incentives have all but evaporated. However, they may return as the economy shifts.

Applying for Financing

Applying for financing is very intrusive. You are going to be asked for all of your secret information such as your social security number, date of birth, income, savings balance, and shoe size. Be honest, and be entirely transparent. Don’t assume the question asked does not apply to you. Complete the form in full and as neatly as you can. At this point, you are still requesting something from the bank.

Be certain that you understand the terms and conditions. Ask questions if you see fees you don’t think should be included. Look for any language related to penalties for early payoff. You should not have any. When your financing is approved, look over the information carefully. Be certain you understand what you have applied for. Need help? Now is the time to get it.

A Polite Warning About Used Car Financing

If you have a credit score below 600 and are shopping used, be aware that you may be targeted by some unscrupulous used car dealers and lenders. These are sometimes called Buy Here, Pay Here dealerships. There exists in America a separate finance world for those with poor credit coupled with a poor payment history. If you are shopping for a low-cost used car and the dealer has offered you financing at a rate over 10%, seek the advice of a friend or family member with more financial experience.

Read more on How to Finance a Used Car here.

Read more on the Best Time to Buy a Car here.