How Do I Finance a Used Car?
In the excitement of shopping for a used car, many shoppers think about financing last. Instead, you should get preapproved for an auto loan first. According to the credit bureau Experian, about 55% of used car buyers take out a car loan to pay for their cars.
While the price of purchasing a used car can save you thousands of dollars compared to buying a new car, financing a used car can be more expensive. With preparation, persistence, and a bit of patience, however, you can get a great deal on an auto loan for your new-to-you vehicle.
We’ve put together a list of the steps you should take when getting a used car loan. They are similar to the steps new car buyers take, though there are some key differences. The most important tool you'll have in getting a great deal on financing is knowledge: Knowing about your credit history, where to find financing, and how to apply for a car loan will put you ahead of the game before you approach a dealer or private party.
How to Finance a Used Car
Know Your Credit Score Before You Apply - Getting your credit score and knowing what’s in your credit score gives you an idea of the interest rate and loan term you can expect.
Research Lenders - Learn the difference between national banks, credit unions, community banks, and more for getting a used car loan.
Apply For a Used Car Loan - Follow these strategies to apply for a used car loan the right way.
Compare Different Used Car Financing Offers - Compare offers to arrive at the best financing option for you.
Shop at Used Car Dealers with Confidence - See what to expect when you go into the dealer to buy your used car.
Watch Out For Red Flags - Know which words and phrases are dangerous in the used car finance world.
Know How to Buy From Private Parties - Understand the difference when buying from a private party vs. a dealership.
Follow These Final Steps - Know what you need to do after you've gotten your financing and used car.
Learn What to Do if You Can’t Make Your Loan Payment - Protect your car and credit if financial troubles strike.
Understand Why Used Car Financing Costs More - Understand why there is more risk associated with used car financing.
Lenders will look at your credit history before they decide whether or not to give you a car loan. Most will use your credit score, which is a snapshot of your credit history. A credit score is a number between 300 and 850 that's generated from the information in your credit reports. It’s sometimes called a FICO score, though that’s just one of a number of scoring models that are used. In fact, most consumers have multiple credit scores, which are based on information from the three major credit reporting bureaus – Equifax, TransUnion, and Experian. The scores derived from the different models are usually pretty close to one another.
With your credit score in hand, a potential lender will classify you in categories ranging from deep subprime at the low end to superprime at the top. Borrowers at the lowest end of the spectrum will have a hard time getting an auto loan, while those at the top will have lenders falling over each other trying to loan money.
If you pay, you can receive your credit score from one or more of the credit bureaus. You’ll have to enter several pieces of personal information, including your social security number, in order to see your credit score. Before you pay, though, check with your bank and credit card companies. Many credit card issuers now offer a glimpse of your credit score as a benefit of having the card. Some financial websites will also show you your score, though you should be wary of those that require you to buy something, such as a credit monitoring service, to see your score.
If you don’t understand why you have the credit score that you do, or you think there might be an error, you’ll want to delve into your credit reports for more information. You’re entitled to a free copy of your credit report from each of the three bureaus once each year. The only site authorized to give you the reports with no strings attached is AnnualCreditReport.com. Other sites with similar names will frequently try to capture your personal information, try to sell you information about your credit, or enroll you in costly credit monitoring services.
Your credit report has information about the accounts that you have open, your credit limits, how many times you’ve applied for credit, and your history of making on-time payments. From the data in the credit report and information on your car loan application, lenders try to build a complete picture of your ability to repay the amount of money that you want to borrow. They want to be confident that you will make every monthly payment, and make them on time.
Lenders will look at the amount of credit that you are using and compare it to the amount that you have available. It’s called your utilization of credit, and they don’t want to see it too high. They’ll also look at the credit that you are using compared to the income you report on your application. Your debt-to-income ratio is a key component of any loan decision.
Repair Your Credit
You’ll want to look for errors when reading your credit reports, along with areas where you can improve your score. It takes time to do both, and that’s why patience is part of getting a used car loan. Paying toward your debt, making on-time payments, and getting overdue accounts up-to-date will have the most significant positive effect on your score.
If you have tons of credit card debt, you’ll want to pay at least the minimum on every card with a balance. To bring the overall balance down the fastest, pay more than the minimum payment on the card with the highest interest rate. That way, you’ll be paying down debt that accrues the most interest.
Whatever you do, don't start closing accounts in an effort to raise your credit score. Doing so increases your percentage of credit that is utilized, which has a tendency to lower your score, not raise it.
If your credit score is on the cusp of a different tier – you have fair credit, for example, but it’s almost in the range of what is considered good credit – it might be worth putting your used car purchase off for several months. During that time, you can focus on improving your score and putting some money away for a down payment. When you’re close to being in another tier, a little bit of work can go a long way in getting you better loan terms.
Many used-car buyers don’t even think about an auto loan until they are in the dealership’s financing office. If you’re looking for low auto loan rates, however, that’s not the best way to find them. While the dealer financing may be a great deal, they’ll have no incentive to do so unless you have a preapproved offer in place that they have to compete with.
Instead, you’ll want to shop at lenders outside of the dealership, and have a preapproved financing deal in place before you step through the door of the dealership. Doing so also allows you to keep the focus on the vehicle’s purchase price, instead of confusing mashup of the vehicle’s price, the financing, and any trade-in you’re selling.
Fortunately, there are lots of places where you can pre-qualify for financing outside of an auto dealer. Some financial institutions even have special programs for first-time car buyers and consumers with bad credit.
Large National Banks
America’s biggest banks – such as Bank of America, Wells Fargo, Capital One, and Chase – have massive auto lending operations, with a vast array of services and the ability to assist you at thousands of brick-and-mortar branches and comprehensive online sites.
Large banks tend to have higher interest rates and fees than other lenders, though they occasionally offer specials with lower interest rates. If you have bad credit, the rigid lending policies of many large banks could make it tough to get affordable auto loan rates, if they loan to you at all.
Credit unions are member-owned cooperatives that serve specific member groups or communities. They typically offer better deals than other lenders because their profits are returned to their member-owners through lower interest rates for loans and higher interest rates for savings accounts.
Not everyone can join a credit union, though most people can find a community credit union that they are eligible to join by using the credit union locator at MyCreditUnion.gov. Before you can apply for a loan, you’ll need to become a member of the cooperative by purchasing a share of stock for between about $5 and $25.
Credit unions range in size from tiny, single-employee operations to large operations rivaling the size of many national banks. If you have challenged credit, a small or midsize credit union may be a good option. You are more likely to be able to make a personal connection during the loan process and explain your financial situation.
Community banks are smaller financial institutions with more geographically limited branch networks. Like smaller credit unions, community banks can be more flexible – and more willing to listen to your personal story – than massive national institutions.
Online banks, such as Ally Bank, operate entirely on the internet, without costly brick-and-mortar branch operations. Because their footprint is completely digital, many online lenders offer streamlined loan application and approval processes that you can complete without leaving your couch, along with more affordable auto loan rates.
On the flipside, having no branches means that you have little opportunity to talk with someone outside of an impersonal call center about your specific circumstances.
Once more common than they are today, finance companies only make loans and don’t offer many of the other products offered by many financial institutions, such as checking accounts. Instead, they borrow money from banks, which they then lend to you for your auto purchases.
Many finance companies now cater to niche customers in the automotive market, such as those with bruised credit. Other finance companies include the auto lending arms of automakers, such as Ford Motor Credit, Honda Financial Services, and others. Some of those “captive” manufacturer finance companies offer used car deals, with rock-bottom pricing on loans for certified used cars.
Lenders will have potential borrowers complete a car loan application before they consider approving a loan. It will ask questions about the money you owe, your monthly expenses, your income, and the amount of money that you are asking to borrow. With some lenders, you can fill out the entire application online, including the ability to e-sign the paperwork, while other lenders still require paper applications and traditional signatures from applicants.
The application helps the lender build a complete picture of you, including the odds that you are financially stable and you have the ability to repay the car loan. While they might ask some personal questions on the application, they are limited by law as to what they can consider when making an auto loan decision. Sometimes you’ll find questions on loan applications that ask for things such as ethnicity. In many cases, these questions are for legally mandated reporting purposes, and your answers cannot factor into a decision to approve or decline.
Be prepared to provide personal information, such as your social security number, bank account numbers, and credit card information during the loan process. Your social security number allows them to access your credit report, while other account numbers are used to match the information on that report to your application.
It is crucial that you give prospective lenders complete and honest information on the application. If you are caught being less than truthful during the loan process, they’ll likely decline your car financing automatically. If the lender discovers that you provided false information after you already have the loan, they can immediately demand repayment of the full loan amount or declare you in default.
You can, and should, apply at several lenders so you have a choice of different loan offers. You’ll want to make all of your applications in a short time, though, so the credit reporting agencies will see them as one inquiry and only ding your credit score a few points. Spread the applications out over multiple weeks, and credit bureaus will see them as multiple inquiries and take your score down a few points with each one.
While it’s tempting to focus on the monthly payment or interest rate of a loan offer, those factors shouldn’t be the only ones you use when deciding whether it is a good offer or not. Choosing a car, or its financing, on the monthly payment alone is a potentially expensive car-buying mistake. While some lenders offer variable-rate auto loans, most borrowers should seek simpler fixed-rate loans.
Instead of looking at monthly payments, you want to compare the total cost of the car, including the total of all of the payments due during the loan, plus the amount you have to pay up front, including any fees. You’ll need a used car loan calculator to figure out the monthly payment, but the rest of the math is pretty simple.
Here’s an example of how to do it: You’re buying a three-year-old Chevy Traverse SUV for $25,000 and paying $5,000 of that price as a down payment. You'll then need an auto loan for the remaining $20,000. We'll say you have found an offer for a five-year auto loan at a 6% annual percentage rate.
Using our auto loan calculator, you can see that the monthly payment is $387. To find the total cost of the car, we’ll multiply that $387 payment by 60 (the number of months you’ll be paying), and then add the $5,000 down payment you made. The total cost of the SUV is $28,220.
You can use the calculator to compare offers, as well. Say another lender offered you a three-year loan, but with an interest rate of just 4.5%. Your monthly payments jump substantially to $595 per month, but the total cost of the loan is $26,420. By taking the shorter car-loan option, you would save $1,800.
Now that you have a preapproved auto loan in place, you should explore our used car rankings and reviews to find a car that meets your needs and budget. Not only will you arm yourself with the information you need to buy the right car, having a financing offer in your pocket will give you the confidence that you’re going to get a good financing deal.
Buying a used car involves a couple of steps you don’t have to complete when buying new. You’ll want to get a vehicle history report, such as a Carfax or AutoCheck report, so you can be sure that the car has not been in a major accident or has title issues. You’ll also want to have it checked out by an independent mechanic. If the dealer resists your efforts to accomplish either of those tasks, you should take it as a sign that you should walk away from the deal.
Negotiating the Deal
Car salespeople will almost inevitably try to merge the price of the car, your trade-in, and your financing into one transaction. Bundling the deal allows them to move savings and costs from one component of the deal to another, confusing you about whether you're getting a good deal or not. For example, they may give you a great price on your trade-in by boosting the cost of the car you're buying.
As a buyer, you want to keep each of those transactions separate, initially focusing on just the price of the vehicle you’re considering. You can keep the trade-in out of the conversation by selling it yourself to a private party or to another dealer.
Remember to be firm, but polite, through the negotiation process. Buying a car is a business transaction – nothing more, nothing less. You want the best deal you can get, and they want the most profit they can earn. Both approaches are fine, as long as both sides are ethical and use tactics that are legal. Remember, though, that you only buy a car every few years, and they sell cars every day. Salespeople and finance managers are skilled sales professionals with the ability to move you incrementally towards the deal that they want you to accept.
Why Do Dealers Want to Finance the Deal?
Both new and used car dealerships make much of their profit from financing the sale of vehicles. While most don’t lend the money themselves, they mark up the financing packages that they arrange from third-party lenders and take the difference as income. In some cases, especially when you don’t have a preapproved loan deal in place, the dealer will offer you the financing package that makes them the most money, rather than offer you the best rate.
By having a pre-qualified financing deal before you head to an auto dealer, you limit their ability to mark up any financing deals.
The Power of a Down Payment
You’re much more likely to get a good deal on a used car loan if you make a significant down payment. Putting something down reduces your loan amount, enabling you to get lower monthly payments, a shorter loan term, or both. It also lowers your loan-to-value (LTV) ratio, which shows how much the car is worth in proportion to how much you owe on it. The lower your LTV, the more likely that a lender will give you a good deal on their auto loan rates.
Making a substantial down payment also reduces the possibility that you will owe more than the car is worth. In that case, you have what is called negative equity, and some refer to the situation as being upside-down or underwater on your auto loan. If the vehicle is totaled or stolen when you are underwater on your loan, you'll still owe the bank the difference between your insurance settlement and the balance of your loan.
Signing the Papers
Buying a used vehicle can take a long time. As you near the end of the process, you’ll probably just want to get the paperwork over with and drive home. You need to slow down, however, and check each of the loan and purchase documents. Make sure that they reflect exactly what you discussed and don’t have any errors or blank spots. Pay particular attention to the interest rate and loan amount. If they have discrepancies, politely request that they be completed before you sign. It’s a whole lot easier to correct any issues before the papers have your signature on them.
It’s a good idea to check the math using a car loan calculator on your smartphone. Just demonstrating that you’re checking may dissuade an unscrupulous dealer from trying to sneak something into the deal.
When you’re in the market for a car loan, there are several things you should watch out for. From dealers that don’t have your interests at heart to long-term car loans, avoiding these traps can save you and your wallet from years of pain.
Look Out for Deals That Seem Too Good to Be True
Not every dealer has your financial future in mind. Often you’ll see dealerships that advertise that they can finance anyone, regardless of their credit. While the advertiser may be able to do that, it will likely come at a high price, with less-than-stellar loan terms. Bottom line: if you have to stretch your payments out six years or more, or pay triple the going interest rate, you cannot afford the car that you are looking at.
For buyers with bad credit, the dealership of last resort is often a “buy here pay here” dealership. When you purchase a used car at a buy here pay here dealer, you're expected to visit the location as often as weekly to make your car payments. Not only do they typically charge incredibly high interest rates that create debt traps that are hard to escape, but they also aggressively pursue repossession if you are even a day late with your cash payments.
The Dangers of a Long Car Loan
Many lenders are willing to loan money for six, seven, or even eight years or longer. While doing so will usually get you a lower monthly payment, it’s one of the riskiest financial moves you can make. Long car loans typically come with higher interest rates and are significantly more expensive in the long-run than a shorter-term loan. Even if you qualify for long-term financing, you risk having the car’s depreciation outpace the rate that you pay it back, resulting in a situation where you owe more than the vehicle is worth.
When you have a long car loan on a used vehicle, you’re also at risk when your car suddenly needs expensive repairs. Costly problems become more common as cars age, and the last thing you want is to have to pay an expensive repair bill and a car payment at the same time. Even if you put very little mileage on the car, if you take out a long-term loan, the car will likely be out of warranty while you’re still making payments.
Don’t Finance the Fees and Extras
It's easy just to roll any fees and costly add-ons into your financing, but it's a horrible idea to do so. For one, it can make your loan exceed the value of the car, which puts you in financial jeopardy if anything terrible happens to the car. Second, it masks the true cost of the items that you're adding. If, for example, the dealer tells you that the paint protection package just adds $15 per month to your car payment, they probably don’t want you to do the math and realize that on a six-year loan it costs you $1,080.
Beware of Yo-Yo Financing
Sometimes dealers will encourage you to take the car home, without the final financing paperwork in place. Several days later, you’ll get a call from the dealership saying that your financing fell through and that you need to come back to sign new papers. Usually, the new auto loan offer will make the car cost much more than the agreement you negotiated earlier. It’s called yo-yo financing or spot financing, and it can be hazardous to any customer’s wallet.
While sometimes there are legitimate problems with the financing, other times the dealership knew all along that you would never qualify. In the latter case, "spotting" the car to you is a ploy to get you attached to the car and willing to pay whatever they tell you it will cost. In some states, yo-yo financing is regulated in a way that benefits consumers, while in others the rules favor dealerships.
If you get the dreaded call from a dealership telling you to return to sign new papers, you should start contacting local lenders instead. Getting an affordable financing deal from an outside lender can foil the yo-yo financing scam. If you can’t find another loan offer, you should return the car to the dealer and demand they unwind the transaction. Whatever you do, don’t let the dealer bully you into a car loan you simply can’t afford.
When you buy a car from a private party, you’ll have no choice but to get financing from a bank, credit union, or another non-dealership lender (unless you pay cash for the car). Before you buy, it is critical that you get a vehicle history report. Some lenders offer them as a benefit of using their auto financing.
Getting a private-party loan from a lender can take some extra steps. Our guide to private-party auto loans spells out the tasks in detail. While most banks have streamlined processes they use with auto dealers, purchasing from a private-party seller can take some time.
Unlike when you work with a dealer, you'll have to do all of the paperwork yourself, and ensure that the title gets expeditiously transferred to your financial institution, who will hold it until the vehicle is paid off.
Some private sellers may be willing to accept peer-to-peer financing, taking third-party lenders completely out of the picture by accepting a payment plan on the vehicle they are selling you. Such auto financing is pretty rare, however.
Get the Right Auto Insurance
Most lenders will require you to carry collision and comprehensive insurance with sufficient coverage so that the lender can be repaid if you wreck the car or it is stolen. The protection that a lender requires is different than the car insurance that you’re legally required to carry. State mandated insurance protects the people or property you might injure or damage with your vehicle.
Some lenders mandate gap insurance, to protect their financial interest in the car, even if you have negative equity. The U.S. News auto insurance hub will help you find the coverage you need, discounts you may qualify for, and the best insurance companies in your state.
Making Your Payments on Time
When you take out an auto loan, you sign a contract agreeing to pay back the loan by making monthly payments. Doing so will protect your good credit and allow you to build equity in your car. Failing to do so opens you up to major dings on your credit report, loan default, and the repossession of your vehicle. In many states, if the lender is not able to fully pay off the loan by selling your repossessed car, you’re liable for the difference between what they were able to get and the loan amount.
One great way to ensure that you’re never late on a payment is to set up autopay from your checking or savings account. This ensures that you make your automatic payment on a specific day each month, and you don’t have to worry about forgetting to send in the money.
Refinancing Your Used Car Loan
Many buyers can save money by refinancing their auto loan to lower their interest rate or change the length of its term. If you don't think you got a great deal from your original lender, you can shop for a car loan refinance almost immediately, so long as your initial financing doesn't have any prepayment penalties built into it.
If you had bad credit when you initially took out the auto loan and have been paying faithfully for a year or so, you’re a great candidate to refinance. Not only is your credit score likely to be higher, but a significant chunk of the loan will have been paid off, so your loan-to-value ratio should be lower (as long as your payments outpaced the rate that the vehicle depreciated).
According to the credit reporting bureau TransUnion, the average auto loan refinance lowers the interest rate 2.4%.
Refinancing a car loan is similar to getting your initial loan. You’ll have to fill out a loan application and wait for a loan approval. Some lenders have streamlined procedures to refinance a car loan, so check with your lender and others in the marketplace to find one that will both save you money and not take too much time.
If your circumstances change or you have an emergency that prevents you from being able to make your car payment, it’s best to talk to your lender before that installment is missed. They may be able to let you defer a payment or two, or refinance into a loan with a more affordable monthly payment. With few exceptions, they don’t want you to default on the loan any more than you want to default.
When repossession is imminent, it is best to take the car to your lender and voluntarily surrender it. The cost of repossession can be added to your loan balance in many states, and you'll be responsible for paying it. By freely letting your car go back to the lender, you minimize their repossession cost, and the amount they can charge back to you.
When you start shopping for used car financing, you’ll see that it typically comes with higher interest rates and shorter loan terms than you find on new car loans. There are frequently restrictions on the age and value of the vehicles that are financed.
Why the difference? It has to do with the risk of the loan. Lenders can demonstrate that there is more risk when they lend money on used cars. That additional chance of not being repaid is priced into the loans by charging higher interest rates. The shorter terms and other restrictions lower the likelihood that the lender will take a major loss if the loan is not repaid as agreed.
Depending on the car that you choose, some lenders will treat it as a new car. Vehicles that have low miles and aren't very old are the most likely to be treated this way. Many lenders will offer new-car interest rates for any manufacturer-certified used car.