How to Finance a Car: A Step-By-Step Guide
Most car buyers put all of their efforts into finding the perfect car. While that's critically important, figuring out how to pay for it and getting a car loan are also vital parts of the car-buying process. Figuring out your budget and financing can also help you gauge how much vehicle you can afford, helping you narrow your choices. Few buyers can afford to pay cash for the full price of new- or used-car purchases. Instead, you’ll need to get an auto loan to cover either the entire cost of the vehicle or a substantial part of it. Getting a bad car finance deal can mess with your wallet and wreck your credit history for years.
“Do your homework, and make sure it’s not just about ‘hey, I want to pay $300 a month,’” says Erin Klepaski, executive director of strategic alliances at Ally Financial. “Really make sure that vehicle meets your needs – that you can insure it, that the fuel economy makes sense for you, you can drive the number of miles you need, that it has the functionality that you need, so that you get that whole package and that total cost of ownership experience, as opposed to shopping the vehicle payment.”
It is common for car buyers to put off the thought of financing until they are in the dealership’s financing office. That's, unfortunately, a path to potential financial calamity. Smart car buyers know precisely how much vehicle they can afford and have a plan in place to finance their new ride before they even think about heading to a dealership. While you might end up with dealer financing, if the dealer doesn’t have an offer to beat, they’ll have no incentive to give you a deal.
Here's an outline of everything you need to know about car financing before visiting the dealer:
- Learn The Language of Lending - Know all the finance terms that are likely to be discussed during your visit.
- Your Credit Score, and Why it Matters - Understand what your credit score is and why it matters for financing your car.
- Finding a Good Financing Deal - Learn where and how to get car financing that you can afford.
- Applying for a Car Loan - Learn the steps to apply for a car loan.
- See What Financing the Dealership Offers - Compare your pre-approved auto loan to the offer from the dealership.
- Finalizing the Deal - Sign on the dotted line and close the deal.
- After You Have Signed the Loan Documents - Know what happens after you finalize the deal.
There are some essential terms that you’ll want to understand before you enter the financing world. Here are a few of the most important:
Car Loan (also auto loan, car financing): A car loan is simply a contract between you and a lender where they agree to provide you with the cash to buy a new or used car, and you agree to pay the money back over time. Unless you get a zero percent financing deal, you'll have to pay interest each month on the loan balance. Some lenders will also charge you a loan fee.
Until you completely pay off the loan, the lender will hold the title to the vehicle.
Interest (also Finance Charge): Interest is the cost of borrowing the money from the lender. It is expressed as an interest rate (often called the annual percentage rate or APR). The interest covers the lender’s costs, risks, and provides them with a profit margin.
For the last several years, auto loan rates have been near historic lows, though they are slowly climbing toward a more normal range. The annual percentage rate you'll pay is affected by a multitude of factors, including many you can control and some you can't. Your personal credit history, the length of the loan that you're seeking, and even the type of vehicle that you're buying can significantly affect the rate you'll be asked to pay. Different lenders are likely to charge significantly different interest rates for the same vehicle purchase.
Car Loan Term: The loan term is the length of the loan, and it’s typically expressed as a number of months. Loan terms of 36 to 48 months were once the most common lengths. As cars have gotten more expensive, however, loans with terms of 60 months or more are widely available. It helps to divide the loan term by 12 so that you understand the number of years that it will take to pay off the vehicle.
Longer loans mean more risk for lenders, so they typically come with higher interest rates. You generally want to get the shortest loan you can afford so that you can avoid the possibility that you’ll still be trying to pay off your car at the same time as the car’s age is leading to costly repairs. You don’t want to be faced with the choice of paying for repairs or having the money to make your monthly car payment.
Principal: The loan principal is the balance of the loan. When you first take out the financing, it will be the total loan amount. As you make monthly payments, the principal will decline. With each payment, a portion will go toward interest and the rest will pay down the principal.
Down Payment: A down payment is an amount of money that you’ll pay toward the purchase of the car when you initially buy it. It can come in the form of a cash payment, your trade-in, or both. The amount you’ll have to finance is the difference between the price of the car and the amount of the down payment. For example, if you buy a $40,000 minivan and pay a $10,000 down payment, you’ll have to finance $30,000.
Monthly Payment (or Car Payment): Each month, you’ll be required to make a payment toward the loan’s principal and interest. Monthly payments will be equal and have a specific due date.
Figuring out the monthly payments on a specific loan requires relatively sophisticated math, as you'll be paying a bit less interest each month as the loan balance declines. Fortunately, you can quickly find an answer by plugging a few numbers into our car payment calculator.
It's crucial that you look at the cost of the car plus the total cost of interest when comparing car loans. Focusing on the monthly payment, the number of months you'll be paying, or the interest rate alone won't give you a complete picture of the total cost of the vehicle.
APR Range: 1.99% - 27%
Loan Term: 24 - 84 months
Loan Range: $8,000 - $100,000
At least 18 years old, resident of the U.S. (except Alaska and Hawaii), with min. income of $1,800/month and min. credit score of 500
Max mileage of 125,000 miles, 10 years old or newer
myAutoloan presents up to four offers from a variety of participating lenders based on your specific loan requirements, offering a wide variety of choice and selections.
APR Range: 3.34% - 17.49% (AutoPay Discount of 0.50% also included)
Loan Term: 24 - 144 months
Loan Range: $5,000 - $100,000
Must have good to excellent credit*
LightStream caters heavily to applicants with very strong credit scores, offering a streamlined application process and a Rate Beat program that guarantees they'll beat any other qualifying offers an applicant receives.
APR Range: 3.99% - 10.08%
Loan Term: 36 - 72 months
Loan Range: $4,000+
$1,800/month minimum income requirements, resident of the U.S. (except Alaska or Hawaii)
Limited to vehicles available through the Capital One network of dealers
Capital One offers a pre-qualification, which allows you to take your offer to any participating dealer within 30 days.
APR Range: 4.29% - 24.99%
Loan Term: 48 - 72 months
Loan Range: $4,000+
At least 18 years old
Limited to vehicles available through the Chase network of dealers, no older than 2008
After your application is approved, Chase will send the information to the dealer you choose. The offer is good for 30 days.
|Bank of America|
APR Range: 3.49+%
Loan Term: 12 - 75 months
Loan Range: $7,500 - $100,000
At least 18 years old (19 in Alabama or Nebraska) U.S. resident
Max mileage of 125,000 miles, 10 years old or newer, valued at $6,000+, plus additional restrictions
Bank of America Preferred Rewards clients can receive an interest rate discount of 0.25-0.50% depending on their tier at the time of applying for an auto loan.
Disclaimer: All information provided here is based on Annual Percentage Rate estimates from the websites of the individual lenders on 12/18/2018. It is not a binding or guaranteed loan offer. Individual auto loan rates will vary.
Notes: In compiling this data, we used new-car purchase rates for Virginia.
*To meet LightStream's standard for good credit, you must have several years of credit history with a variety of account types, including credit cards, installment debt (vehicle loans), and mortgages. LightStream also prefers to see few, if any, delinquencies and a history of savings, evidenced by things like deposit accounts and manageable revolving credit card debt. You'll also want to provide proof of stable and sufficient income to repay current debt obligations as well as any new loan with LightStream.
You actually have several credit scores, as different credit reporting companies use different methods to determine scores. The main three credit bureaus are Experian, TransUnion, and Equifax. Sometimes your credit score will be referred to as your credit rating or FICO score. A FICO score is just one type of credit score available to lenders. While most models range from 300 to 850 points, some use other scales. Scores from one scoring model are not directly comparable to those from other models.
If you have a high credit score, getting a car loan with a low interest rate is easier than if you have a lower score. Consumers with lower scores will generally have a harder time getting a loan and can expect to pay a higher interest rate on their loan. Typically, if you have steady employment and a score of 720 or above on most scales, you should not have any problem getting financing.
So, what goes into a credit report? The two most important factors are your history of making on-time payments and whether or not you have been delinquent or defaulted on any obligations. The more often you have been late, the more points that will be deducted from your score. If a lender has had to write off a balance that you left unpaid, you’ll have a derogatory mark on your credit for several years.
Next is the amount you owe compared to the amount of credit that you have available. If you are utilizing 90 percent of the credit that you have available, for example, it will hurt your credit score more than if you’re just using just 30 percent of your available credit. If you are considering closing credit cards, you should wait until you get your auto loan. Closing cards reduces your availability of credit and raises the percentage of your credit that you are utilizing.
Less critical, but still significant, is the age of the accounts you have open and when the last activity on your accounts occurred. Lenders want to see stability, and if there are many recent account openings, your credit score will take a significant dip. The reports also reflect the mix of credit types, with revolving accounts such as credit cards weighing differently on the score than installment accounts like car payments.
Finally, the score will reflect recent attempts to secure credit. Each time a potential lender asks for a score at your request, it drops your score a bit. However, all inquiries during a short period for the same type of activity, such as a new auto loan, are treated as one request and won’t have a huge effect on your score.
How to Find and Fix Dings in Your Credit Report
The worst time to find out that there are problems with your credit is when you’re trying to make a purchase. Many buyers have no clue about their credit until they are sitting in the dealership’s finance office, which opens them up to falling into a lousy financing deal.
American consumers are entitled by law to one free copy of their credit report from Experian, TransUnion, and Equifax each year. The law does not mandate that they provide your credit score, though it is available for free from many credit card issuers and on some websites.
Well before you start your auto-buying odyssey, you’ll want to get copies of your report and go over them in detail to identify any errors and negative information. Pulling your own copies of the reports does not affect your score like an inquiry from a lender does.
Errors can take time to get corrected, and you might need several months of making on-time payments on all of your accounts to raise your score appreciably. If you’re thinking of major purchases that require credit, including cars or a house, you’ll want to stagger them so that they don’t slam your credit score too badly. Whatever you do, don't start randomly closing credit cards in an attempt to raise your credit score. Doing so can potentially increase your credit utilization percentage and lower your score instead of building it.
If you do have to accept an auto loan deal without the best terms, know that you can usually refinance your car loan at any time during its term. You'll want to watch out for prepayment penalties, but beyond that, you may be able to save a tremendous amount of money if your credit score has improved.
What Else Are Lenders Looking At?
There are several things on your credit report that are not reflected in your credit rating. Your age, income, marital status, address, or employment don’t figure into your score, though your lender may ask for that information on your loan application and use it to the extent that it is legally allowed.
“You’re looking at that whole picture of the customer,” says Klepaski.
Beyond the information from your credit report, the lender will be looking at your capacity to repay your loan: Do you have the cash flow to make your monthly payments? What is your monthly rent? They’ll want to know about your income, its sources, and how stable is your employment is.
“If you’ve had the same job for 10 years and you recently started another, that probably works,” says Klepaski. “If you’ve had 14 jobs this year that might be a red flag for somebody.”
From the information on your credit report and your auto loan application, the lender will compute your debt-to-income ratio. If you owe too much compared to your income, you’ll likely be asked to pay a higher interest rate, take a shorter loan, be required to make a more substantial down payment, or accept a smaller loan. If the numbers are way out of whack, the lender can turn you down altogether.
The lender will also be looking at the quantity and quality of your collateral. In the case of an auto loan, the secured collateral is the car that they are lending you the money for. They will hold the title to the collateral until you pay off the loan. Buyers asking for more than the cash value of a vehicle that they are buying may be asked to pay a higher interest rate or accept a shorter term than those making a substantial down payment.
Why would the amount of financing be higher than the purchase price at the beginning of the loan? The most common reason is when buyers still owe money on their current car when they decide they need a new one. By rolling the balance of the old loan into the new loan, you create a loan-to-value (LTV) ratio that’s higher than 100 percent. Though it’s done all the time, it’s a horribly dangerous way to buy a car. It’s a better idea to wait until the balance of your current car loan is paid off to look for a new ride, or you may want to consider leasing to get the latest technology and the ability to swap your vehicle every few years.
Different lenders charge auto loan interest rates depending on market demand, your creditworthiness, how much you’re borrowing compared to the vehicle’s value (the loan-to-value ratio), and their appetite for risk. With a bit of research, it's easy to find competitive rates and promotional offers with generous terms.
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Where Can You Get a Car Loan
Just like you should shop at several dealerships for a vehicle, you should shop with several lenders to find the best deal when you are financing a car. Never before have car buyers had the multitude of lending options and easy-to-access information about rates that they have today. Beyond getting loans from the financing arms of many carmakers, you can get auto financing from large national banks, small community banks, credit unions, finance companies, and online-only banks.
Large national banks are the financial institutions that we all know by name, including Bank of America, Wells Fargo, and Chase. They have thousands of branches in every corner of the country. They have sophisticated lending operations and comprehensive online lending resources, but they may not be the best choice if you need hand-holding through the loan process.
Community banks tend to have anywhere from one branch to a few dozen, located across smaller geographic areas. They may not have all of the branches and services of national banks, but you may find it easier to talk with a local representative if you need a bit of help in getting a loan.
Online-only banks don’t have physical branches, though many offer all of the services of large national banks. Ally Bank is an example of an online bank that works closely with auto dealers to make your car shopping and financing a one-stop experience.
Most automakers have financing arms, known as captive finance companies. While they provide traditional car loans, they’re also responsible for funding the carmaker’s special financing deals. You typically won’t find any other lender who will offer zero percent interest or other rates that are well below the market average.
Credit Unions differ from other lenders, as they are cooperatives owned by their members. Instead of providing profits to shareholders, nonprofit credit unions return their profits to members in the form of lower interest rates on loans and higher rates on savings. They range in size from tiny, one-person operations to massive institutions that rival the size of some national banks. Not every credit union is open to every consumer. You can find credit unions that you are eligible to join at MyCreditUnion.gov.
Financing companies provide financing for consumer purchases, including automobiles. While they loan money like other financial institutions, most don’t accept deposits. In many cases, finance companies offer specialized services to specific types of customers, such as those with subprime credit.
Car dealers generally don't lend money themselves; instead, they act as agents for third-party lenders. They’re compensated by the lenders for doing so, however. The financing that the dealer proposes may offer them the highest profit, rather than giving you the best deal.
When cars aren’t selling as quickly as automakers would like them to, they frequently offer incentives to pick up the sales pace. Some of the most common are low- or no-interest financing deals, which can’t be matched by banks and other lenders. Getting a zero percent auto loan means that you won’t pay a penny in interest over the life of the loan. You can see the best car financing offers on our new car deals and used car deals pages.
How to Compare Different Loan Offers
Choosing a loan is more complicated than just looking for an offer with a low monthly payment. Instead, you want to figure out the total cost of the vehicle, including the amount of interest you'll pay over the life of the loan.
First, you’ll want to plug the number of months in the loan term, your interest rate, and the amount that you are financing into our car loan calculator. It will figure out the interest that you have to pay and show you the monthly payment. Then take the monthly payment, multiply it by the number of months in the loan, and add your down payment to find the total cost of the vehicle (not including fees or taxes).
We’ll use the most popular vehicle sold in America as an example. Say you’re buying a midrange 2018 Ford F-150 with a price tag of $44,000 and paying $4,000 down, so you will be financing the remaining $40,000. The lender offers you a 72-month loan with an interest rate of 4.75 percent.
Plug those numbers into the auto loan calculator, and it shows a monthly payment of $640. Next, multiply the $640 monthly payment by the 72 months you'll be paying, then add the amount you paid up front, and you'll see that the total cost of your full-size pickup truck is $50,080.
Here’s where knowing the math comes in handy. Say the dealership also offers you a 60-month loan with an interest rate of 4.5 percent. Running the numbers through the car payment calculator shows a significant jump in your monthly payment to $746. However, the total cost of the loan is $48,760. By getting a loan that is one year shorter, you’ll save about $1,300.
Note that many car loan calculators have some rounding error, so the numbers they show may not be exactly what you’ll see on your loan documents – though they should be close.
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Choose the Shortest Term You Can Afford
In general, you want to get the shortest auto loan on your next car as you can. While a longer-term loan may come with a lower payment, it will also likely come with higher loan rates and a higher overall cost. The longer you borrow money, the more likely that the vehicle will depreciate more rapidly than the loan balance will decline.
When the loan amount is higher than the value of the vehicle, you have negative equity. This is also called being upside-down or underwater on the loan. If you’re a victim of auto theft or your vehicle is totaled while you’re upside-down, you will still be liable for paying the full balance of the loan, and any payments you receive from your car insurance frequently won't cover the total amount.
Another danger of long-term financing is that, as your vehicle ages, it is likely to require more frequent and costly repairs that may happened after the expiration of the manufacturer’s warranty. You don’t want to be caught in a situation where you have to pay an expensive repair bill while you’re still making monthly loan payments. A shorter-term loan allows you to be done with your payments closer to the time that the vehicle’s powertrain warranty ends.
The Importance of a Down Payment
You can likely get a better deal on your car loan if you make a down payment, and the benefits of putting money down will continue throughout the loan. First, by putting some money down or trading in a car toward the new one, you can get a smaller loan than if you financed the whole amount. That means you can shorten the loan term, reduce your monthly payment, or both. Since you’ll have a lower loan-to-value ratio, the lender may give you a better interest rate as well.
Another benefit of making a substantial down payment is you’ll be less likely to have negative equity (or be underwater) on the loan. That means that if your vehicle is stolen or totaled, your car insurance payment will probably cover the whole loan balance, and it may give you enough money for a down payment on a replacement ride.
You'll need to budget for more than just the down payment. In most states, you'll also have to pay taxes or fees when you buy a car. It's a good idea to pay them up front, as financing them increases the likelihood that you’ll be underwater on your loan.
The same goes for any add-ons the dealer might try to sell you. In most cases, the salesperson will tell you that buying each add-on will only cost you a few dollars per month. By asking to pay them up front, you'll see the real cost of the items, and you can compare them to similar products available outside of the dealership. Like taxes and fees, costly add-ons rarely add any value to the car but increase your loan-to-value ratio and the total cost of the vehicle.
Though it will take a bit of time and you'll have to provide your personal information to a number of lenders, it's a good idea to apply for financing from several sources. There’s nothing wrong with submitting multiple applications so long as you do so in a short period of time to avoid damaging your credit score. If you space your applications out over months, each application will knock your credit score down a few points. Do them over a short period, and the credit reporting agencies will see multiple applications as just one inquiry.
You'll want to do this a week or so ahead of visiting the dealer so that you can have a preapproved deal in your pocket before you actively start car shopping. It's critical that you have an offer in place before you visit the dealer, though you may not need to use it. If you don’t have a preapproved financing package, the dealer won’t have anything to try to beat, and you’ll be forced to settle for whatever car financing deal they offer. If you do have a preapproval in place, you'll won't feel pressured to accept a deal that's bad for your wallet.
When you fill out your loan applications, you will be asked for lots of information about your finances and employment history. It is imperative that your answers and information are accurate and complete to avoid problems down the road. Not only can providing incomplete or untruthful information cause your loan application to be declined, but it can also be grounds for the lender to immediately demand full payment for the loan at any time during its term.
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What Do I Do if I’m Declined for a Car Loan?
Loan rejections happen all the time, though it can be surprising and frustrating when it happens to you. In the long-run, getting turned down prevents you from getting in over your head on a bad loan. A denial means that a lending professional does not think that you are able to pay back the loan. Any lender that promises that they will approve anyone, regardless of your credit, is likely a lender who is willing to bury you in debt you can’t afford.
Loan rejections happen for many reasons, and the lender is legally required to tell you why you were denied. It may be your credit history, or you might be asking for more money than your loan application indicates that you can pay back. If you were rejected due to an error in your report, you can probably fix it in a reasonably short time.
Rather than just seeking out another lender with looser standards, it’s a good idea to look at the reason that they give you and reassess what you’re asking for. Avoid the temptation to purchase from a “buy here pay here” car dealership that can put you into a debt trap that you may never be able to escape from.
Buyers with bad credit can qualify for loans, though they may be required to pay higher interest rates, pay more money as a down payment, or accept a shorter loan. If you’re rejected by an online lender or a large national bank, consider talking to a smaller credit union or community bank. There, you’re more likely to be able to tell your financial story to a real person. While they may not be able to give you the loan you were seeking, they can help you devise a plan to move forward and provide counseling along the way. Some lenders offer second-chance programs to help buyers with issues in their past find financing options and improve their credit picture.
Some potential borrowers are declined because their credit history isn’t long enough for the lender to evaluate their creditworthiness. Getting a credit card and paying it off each month can help you build your credit history. You can also search for lenders who offer programs for first-time borrowers.
The Danger of Co-Signing an Auto Loan
For buyers with lousy credit, an easy solution is to find someone with great credit to co-sign the loan. A person with a great credit history essentially lends their reputation to someone with less-than-perfect credit to help them qualify for a loan. That’s rarely a good idea, however, as the co-signer is responsible for the entire loan balance. You’re doing more than letting them use your rep to get a loan, you’re promising to pay their debt if they fail to do so.
It will also reduce the co-signer's credit score. If they make a late payment, it goes down as a black mark on both signers’ credit reports. Getting the loan requires a credit inquiry, which lowers the score of each co-signer a few points, and the additional debt load will lower the scores even more. About the only time co-signing is acceptable is to help a young driver get low-cost used vehicles. There isn’t much financial risk to the co-signer, and the loan will help them build a credit history for future endeavors.
If you do co-sign on a car loan, you should talk to an attorney to find out whether or not it is a good idea in your state to have your name on the title. In most states, a co-signer and co-owner are not synonymous. Having your name on the title makes you responsible for paying any parking tickets or other fines, but it also might allow you to more easily take the car from the co-signer if they fail to pay the car payments. The only easy ways out of a co-signed car loan are to pay off the balance or refinance the balance in only one of your names.
Study the Fine Print
Auto loan documents are complex legal agreements, and you should not sign them without studying them. In the excitement that leads up to a new or used auto purchase, it's easy to skip this step, but you do so at your financial peril.
First, you want to make sure the documents accurately reflect the agreement that you discussed with the lender. Pay particular attention to the interest rate, the length of the loan, and the amount that you are financing. Check to make sure that no add-ins slipped into the amount financed and that there are no terms that would prevent you from using your car how you want to.
Some lenders and finance companies, for example, restrict buyers from using their cars for ride-hailing companies such as Uber or Lyft. Other lenders require such financing to be written as a business loan, with far tighter underwriting standards. If you are caught using your vehicle for a restricted purpose, the lender can potentially demand immediate and full payment of the loan.
Avoid deals that come with prepayment penalties written into the loan documents. Such loans charge you a fee if you want to pay them off early. Such a restriction makes it more expensive to upgrade to a new car before your current vehicle is paid off, or refinance your loan with a less expensive deal.
After you've researched what used or new car financing is available, and you have a preapproved deal in hand, it’s time to get to the fun part: car shopping. Knowing that you already have a financing plan that you can afford can help to take a lot of stress out of the process and allow you to focus on negotiating a great price for your new ride and a fair deal on your trade-in.
In general, car salespeople want to bundle the three components of auto buying – the price of the car, the value of your trade-in, and the financing – into one nice, neat package. You, on the other hand, want each of those components treated as individual transactions. You can do so in a couple of different ways.
While you don't want to ever be dishonest with a car dealer, you don't have to volunteer every piece of information they ask for. You can just say that you're unsure of how you are going to pay for the car and haven't decided if you are going to trade in your old model or not. The longer you can keep them focused on the price that you will pay for the car, the better. Just be polite – salespeople are less likely to fight for someone who is being a jerk.
Buying a car is simply a business transaction – nothing more, nothing less. You want the best price while they want the most profit. A fair deal is somewhere in the middle.
You can lock in the value of your trade-in by selling it yourself to a private party or another dealership. At the very least, you want to research its wholesale value online and have those values in writing when you visit the dealer. Ensure any price they give you on the trade-in is close to the market value. If they are giving you a lot more money for the car than your research tells you it is worth, they are making up the difference in some other part of the deal.
By getting preapproval for your financing, you’re giving the dealership something that they have to beat if they want to get the financing part of your business. Have our car payment calculator handy on your smartphone so you can compute the total cost of any other deal they try to negotiate with you. Dealers make a substantial part of their income from financing, and they will want to get that part of your business. They'll submit your application to many different lenders, hoping to find one that will give you a better deal than the one that you already have. Dealerships also have access to automaker incentive programs that outside lenders don't. Some of those programs are advertised, and you can find them on our new car deals page, while others are only known to dealers and their manufacturers.
Once you have negotiated a deal that is acceptable to both you and the seller, it’s time to sign the paperwork. It’s imperative that you read all of the documents to ensure they match the terms that you agreed to, and that they don’t include any costly add-ons or any spaces that were left blank. If there are errors or blank spaces, insist that they are corrected or completed before you sign the papers. If the finance officer says to go ahead and sign, and that they'll fix them later, you should politely decline and state that you will only sign them when they are correct.
A common practice at some dealers is called spot delivery or yo-yo financing. You think that you have done everything to buy your new ride, but several days later you get a call saying that there’s a problem with your financing and you need to return to the auto dealer to sign more papers. Many times, the financing deal on the new paperwork will be substantially more expensive than the contract that you initially agreed to.
What really happens in these deals is that the dealership delivered the car to you before they actually completed the loan paperwork with the lender. In some cases, the financing deal really does fall through. In others, the yo-yo delivery is a ploy to get you to fall in love with the vehicle before finding out that it will cost more. Some states have laws that explicitly regulate spot financing, though some are heavily weighted toward the dealership's interests than they are to yours.
You can avoid spot financing issues in a couple of ways. First, never leave the dealer until all of the paperwork, including the approval of your loan, is complete. Second, have an acceptable preapproved offer in place from an outside lender before you head to the dealer. That way, if the dealer financing falls through you can go back to the original lender’s offer.
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Now you have a new vehicle – or a new-to-you car – and a fresh auto loan. There are a couple of more steps that you’ll want to accomplish to stay in the good graces of your lender. First, you’ll need to buy car insurance to cover your new car in a way that satisfies your financial institution. They will expect that the insurance policy meets specific limits so that they are covered if something happens to the vehicle. If you fail to provide proof of sufficient insurance to your lender, they will buy costly insurance that covers their collateral – and charge you for it.
Note that the insurance that your lender requires will often exceed the limits required by state law. While the statutory insurance limits are designed to cover people you might injure or other people’s property you might damage, the insurance required by your lender is designed to protect your vehicle, which is the collateral on the loan. Lenders will generally require that you carry collision and comprehensive insurance with limits sufficient to cover the value of the car. They may or may not stipulate the deductible amount on these coverages. Before you buy insurance, it’s best to check with your lender to ensure that you have appropriate coverage.
It is also a great idea to set up an automatic payment plan that withdraws money from your bank account each month to make your car payment. Some lenders offer a discounted interest rate or waive the loan origination fee if you set up automatic payments.
A lender that provides the cash for you to buy a new car is putting a lot of trust in you. If you make your payments on time each month, they’ll reward you with positive marks on your credit report and a potentially higher credit rating. Fail to make your payments, however, and they can make your life miserable with aggressive loan collection tactics, negative information on your credit reports, and the possibility of repossessing your car. A car loan default will live on your credit report for years, affecting your chances of getting another loan and making any financing you get substantially more expensive.
Refinancing Your Car Loan
Like a mortgage, you can refinance a vehicle loan. There are a lot of great reasons to do so. One of the best reasons to at least consider refinancing is if you don’t think you got a great deal on your loan. You can compare your loan to other lenders to see if you can get a better offer. A recent TransUnion study shows that many consumers refinance their auto loans soon after getting the initial loan.
In many cases, consumers have to accept financing from the manufacturer to be able to take advantage of cash back deals. Refinance the deal as soon as the contract allows you to, and you can have the best of both worlds – an affordable interest rate, and the rebate.
“We found that some consumers, especially those interested in taking advantage of loyalty programs and bundled options, will refinance their loans a day or two after the original purchase,” said Brian Landau, senior vice president and automotive business leader at TransUnion. “Consumers who might be paying a somewhat higher interest rate on the loans they obtained through the dealership may find that refinancing can lower those interest rates or extend the loan term – in other words, help those same consumers manage their monthly cash flows.”
TransUnion's study indicated that the average auto loan refinance saves customers 2.4 percent, compared to their initial interest rate. That translates to an average of $52 per month in savings on an average new-car loan.
“Only 40% of consumers actually know that they can refinance,” says Landau.
Another reason to refinance is if your credit score has improved substantially since you initially took out the loan. After a year of making timely payments, your credit score will likely have increased, and you can show lenders a year's worth of proof that you are paying as agreed.
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What if I Can’t Make My Car Payment?
Sometimes life events happen that make it impossible to make your car payment. Whether its medical bills, losing a job, or another calamity that tightens your finances, there are several ways to avoid having your car repossessed and your credit wrecked.
If your vehicle is valued at more than the loan balance, you should consider selling it and paying off the loan before you miss any payments. You can then lease a car with low monthly payments or find a low-cost used car.
Contact your lender before you get too deep into trouble. If you have an excellent payment history up to that point, they may be able to refinance the car with a lower rate or longer term to lower your monthly payments. Many lenders have forbearance programs to help customers facing financial struggles. Getting a plan in place that is preapproved before you miss payments can save you from being reported to credit bureaus for late payments.
Banks and other lenders really don’t want to have to take your car back. It’s expensive, it destroys the relationship they have with you as a customer, and it takes a lot of time. Most financial institutions would rather work with you to find an amicable resolution.
Some lenders allow you to have someone else buy your loan (or lease). Before you consider this path, however, you’ll want to see paperwork that says it is allowed.
If you don’t have any options left and your car is going to be repossessed, it’s best to cooperate with the lender. Interest will continue to accrue on the loan until they get the car back and resell it, so the sooner they have it, the less interest that will accrue. By returning it to the lender, you can help them to avoid many of the repossession costs, which can be added to the loan balance that you are liable for. If the loan balance exceeds the value of the car, you’ll likely still be responsible for the outstanding balance, plus collection costs.
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