A car is an expensive purchase and few people have enough cash sitting in the bank to buy outright. Auto financing makes it easy to buy a car that’s in good condition, but if you don’t understand the terms, you could end up spending a lot more than you expected. Before you start dreaming about the type of car you purchase, it’s important to think about how you’re going to pay for it.
Financing Basics
- Down Payment: Almost everyone needs a down payment in order to get an auto loan. This is a certain amount of money that you pay when you first buy the car. For example, if you want to buy a car that costs $15,000, you might put down $2,000, and the loan that you get will be for $13,000. If you have a trade-in, the money that the dealer gives you for that counts toward the down payment.
- Interest Rate and Term: Your auto loan will also have an interest rate and a term. The interest rate is the extra money that you pay to the lender. Higher interest rates mean higher monthly payments and spending more money over the lifetime of the loan. The term is how long it takes you to pay off the loan. Most auto loans are either 24- or 36-month loans, but you can sometimes find 48-month loans. Spreading the payment out longer decreases your monthly payment, but it will increase your overall payment. It’s better to pay the loan off as soon as possible.
Determining Affordability
Rather than looking at the car you want and trying to figure out ways to afford it, it’s smart to perform a reverse calculation to determine how much car you can afford to buy. Essentially, you should take a look at your budget and try to figure out how much money you can reasonably spend each month on a car. Enter this information into an auto financing calculator until you’re able to come up with a potential loan amount that matches your desired monthly payment. This should be your spending limit when you are looking at cars.
The Role of Your FICO Score
Your credit score will determine if lenders are willing to give you an auto loan and the interest rate you’ll pay on that loan. Those with bad credit pay higher rates, and will not be eligible for the rates that are typically advertised at the bank or dealership. The good news is that adding an auto loan to your credit profile is likely to improve your FICO score, particularly if you’re good about making your payments on time. After a year or two, you may be able to refinance the auto loan for a better rate. At the very least, you’ll be in a better position the next time you have to finance a vehicle purchase.
Shopping Around
Whether your credit is good or bad, it’s always smart to shop around for auto loan rates, as rates can vary widely between lenders. Start by applying for a loan through the bank you already use. Then check with local credit unions. Some dealers also offer financing, which can be a good way to get a deal. No matter which lender you choose for your auto loan, make sure you understand how to make the final purchase. Typically, the bank will give you a check that you can use to buy the car. If you show up at the dealership without this, you could be pressured into their financing options and not get the best deal.
Beware of Scams
You're in a better position to buy when you get approved for financing first. This gives you a good idea of how much a bank thinks you'll be able to afford. Try to avoid letting the salesperson know how much you are hoping to spend each month, as they can then trick you by lengthening the term of the loan and adding on a variety of extra expenses like warranties or extended care plans. You should also be wary of any deal that seems too good to be true. Dealers often try to lure customers in with promises of low rates and special dealer financing, but if you have anything less than stellar credit, you won’t qualify and will end up paying more.
Overall, the most important part about auto financing is going into the process with a clear idea of what you’re getting yourself into. When you understand the details of the loan and have a clear idea of what you want, it’s harder for lenders and dealers to take advantage of you.
