Car Financing 101

Buying a car is an exciting milestone—whether it’s your first or an upgrade, or if you’re adding another vehicle to your garage. BUT, it can get pretty stressful, financially. 

That’s why over 80% of car buyers in the US use some car financing option when getting a new vehicle.

For most people, financing makes it possible to get the car they want without having to pay the full cost upfront. Simply put, car financing—or auto financing—is the process of borrowing money to buy a car and then repaying that amount, plus interest, in monthly installments.

If it’s your first time financing a car, you may have some difficulty steering towards the right lane. There are so many questions that even financed car owners often struggle to answer. In this guide, we’ll walk you through the essentials—from the basics of auto loans to tips on securing the best deal for your situation. Whether you’re buying from a dealership, working with a bank, or exploring online options, this guide has you covered.

Car financing lets you buy a vehicle by borrowing money from a lender, and repaying it in installments over time. This makes the buying process easier on your bank account, spreading the cost out over months, or even years. Typically, a car loan involves an agreed-upon interest rate and repayment term, giving you the flexibility to use the car while paying it off gradually.

When you take out a loan to buy a car, the vehicle itself becomes collateral. This gives the lender the right to repossess the car if payments aren’t made. However, once you’ve paid off the loan in full, you own it, i.e. the car becomes completely yours. Financing can be a smart choice for those looking to upgrade to a dependable vehicle without spending years saving up.

Car financing options can vary, but most buyers choose between these three main routes:

Bank Loans

Banks commonly offer car loans with fixed interest rates and repayment terms. They tend to have stricter credit requirements, so a strong credit score is usually needed to secure favorable rates. Some banks also offer personalized offers or loyalty discounts. So if you are an active customer at a bank you trust, be sure to ask about such programs.

Credit Union Loans

Credit unions often offer lower interest rates and more flexible terms to their members. You typically need membership to secure any form of auto financing from such unions, but it’s worth exploring local unions to see whether you qualify. If you have a decent credit score and qualify for membership at any such union, this avenue of auto financing is worth a shot.

Dealer Financing

Many car dealerships work with lenders to provide financing options right on site, making it easier to handle everything in one visit. Sometimes, these ‘in-house financing car lots’ offer incentives that could get you a better overall deal. This can be super convenient and save you time, but it’s worth noting that dealer financing may have higher interest rates. Many of our partner dealerships offer car financing options. You can use our free tool to find authorized dealers near you and have them reach out with information on auto financing options for the vehicles you’re interested in. 

Online Auto Loans

Online lenders are a modern, streamlined alternative to traditional financing. They often have competitive rates, quick application processes, and let you compare multiple offers in one place. This option is ideal for those who want the convenience of searching for the best loan terms without having to visit a physical bank/union or dealership. Many credible sites have listings of top car financing vendors, letting you filter by location, loan amount, and even credit score.

You can also check each listed lender's Better Business Bureau rating before applying, just as a precaution. 

Read Also: Where to Shop for a Car Loan

To qualify for car financing and auto loans, you typically need to meet certain requirements in these areas:

Credit Score

A higher credit score (usually 661 and above) increases your chances of securing a loan with a low interest rate. If your score isn’t ideal, you may still qualify, but expect higher costs.

Income and Employment Stability

Lenders want assurance that you can handle monthly payments. A steady income and low debt improve your chances of approval.

Down Payment

A larger down payment reduces the amount you need to borrow, making you a less risky candidate in the eyes of lenders.

Getting a car loan doesn’t have to mean paying more than you need to. With the right strategy, you can save money on interest and reduce your overall loan cost. Here are some tips we recommend to make your car financing more affordable:

Improve Your Credit Score

BEFORE applying for a loan, check your credit score and work to improve it. Paying down debt, making on-time payments, and reducing your credit use can help you get better loan offers.

Shop Around for Rates

Don’t simply go with the first car loan you’re offered. Compare rates from banks, credit unions, online lenders, and dealerships to find the best deal for you.

Consider a Shorter Loan Term

While longer terms usually result in lower monthly payments, they often mean paying more in interest over time. Opting for a shorter repayment period could save you money in the long run.

Make a Larger Down Payment

The more money you put down upfront, the less you need to borrow. This not only lowers your monthly payments but can also help you get a lower interest rate.

Negotiate Loan Terms

What most car buyers don’t realize, is that you can often negotiate the terms of your car financing to get a better deal. You can start by asking about rate reductions, promotional deals, or other discounts that could make your loan more affordable.

By planning carefully and following these tips, you can reduce your car loan costs and drive away with confidence knowing you got a great deal.

Before getting a car loan, here are some mistakes many make that YOU should aim to avoid:

Skipping Pre-Approval

Pre-approval helps you understand your budget and gives you an edge during negotiations. Skipping it could leave you vulnerable to unfavorable terms.

Ignoring Additional Costs

Monthly payments aren’t the only expense. Don’t overlook taxes, insurance, maintenance, and registration fees when planning your budget. Look at stats on your desired car such as the mpg, cost-to-drive, and similar figures. These will help you get a more accurate sense of how much you will need to pay in the long run (long drive, rather).

Focusing Solely on Monthly Payments

Low monthly payments may stretch your loan term, increasing the total interest paid. Look for the balance between affordability and overall cost.

If you’re uncertain about how to finance a car and are looking for an alternative solution to car financing, here are a few options you could consider:

Leasing

Leasing allows you to drive a new car with lower monthly payments. However, you won’t own the car unless you opt to buy it at the lease’s end.

Personal Loans

Some buyers use unsecured personal loans, which may have higher interest rates but don’t require the vehicle as collateral.

Paying Cash

If you’ve saved enough, paying upfront could prove better if you can afford it, since you won’t have to take on any debt.

Buying a car is a big decision, and financing, i.e. taking out an auto loan, can help make it more affordable. However, it’s important to plan carefully and really do your homework before making any hard decisions. Take time to explore your financing options, know your real budget, and steer clear (no pun intended) of common mistakes that many first-time car buyers make. Whether you’re buying your first car or upgrading to something you’ve always wanted, a well-thought-out financing plan can make the process smoother and help you drive away with confidence.

What credit score is needed to finance a car?

While requirements vary, a score of 661 or above often qualifies for competitive rates. Lower scores can still qualify but with higher interest costs.

Can I pay off my car loan early?

Yes, but check for prepayment penalties in your loan agreement. Paying early can save on interest over time.

Is leasing cheaper than financing?

Leasing typically has lower monthly payments, but you won’t own the vehicle unless you buy it after the lease ends. Financing results in eventual ownership.

Can I trade in a financed car?

Yes, it is possible to trade in a car you’re still paying for. Here’s how it works:

- If the car you are still payin for is worth more than what you owe, the extra value (equity) can go toward your new car.

- If you owe more than the car’s value, the remaining debt (negative equity) is added to the loan for your new car.

Example:

Let’s say you owe $10,000 on your car loan, but the car is worth $12,000. You have $2,000 in positive equity, which can reduce the cost of your new car.

However, if you owe $12,000 and the car is only worth $10,000, you have $2,000 in negative equity. This amount would be rolled into your new loan, increasing what you owe.

The dealership usually handles paying off your old loan as part of the trade-in process.

Before trading in a car you’re still paying for, make sure to get all the details and trade-in terms in writing. Review everything carefully to ensure there’s no room for error before making any payments.