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Everything You Need to Know About Car Financing

what is financing a car
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Knowing where, how, and when to buy is crucial, but understanding how car financing works is more important when it comes to saving money. Financing a car is when you borrow money to buy a car and then you make monthly installments to repay the loan, although there is a lot more information you need to keep in mind such as interest rates and the length of the loan. Let’s learn more about the process of applying for auto loans and where you can get the best financing options.

What Is Car Financing?

Car financing is when you take a loan and pay back the principal amount plus interest and other fees. It’s a scheme that allows you to own a car if you can’t afford it outright. Like other loans, lenders make money by charging fees and interest. That means the sum you’ll eventually pay off will be more than the car’s MSRP. Car financing is also available for leasing. With this option, you pay less down payment and monthly installments.

In most cases, you’ll need to make a down payment. This is a certain percentage of the value of the car and it varies for different lenders. After making the payment, you can repay the rest of the amount over a set period. Note that lenders can repossess your car if you can’t pay off the remaining installments.

Where To Get Car Financing

When shopping around for an auto loan, do your homework because where you get the financing determines how much you’ll pay in interest, fees, penalties, and other charges. Some lenders also provide auto loans even if you have poor credit. Some have low APR rates, while others have generous repayment terms. Ensure you find a lender that provides flexible and affordable financing options.

Banks and Credit Unions

Most people get car financing from banks and credit unions. These institutions are popular lenders because they provide quick financing so long as you meet all their requirements. Note that you need to know the average retail price of the car you want to buy before heading to your local lender.

Banks and credit unions provide auto loan preapproval, as they usually give borrowers a letter confirming that they are eligible for car financing. You can get lower interest rates and APRs from your local banks and credit unions than at the dealership. In most cases, these institutions work out the most flexible options for you, enabling you to access an auto loan suitable for your financial situation.

A car purchase is a big financial decision, and in the end, you want to take out a loan from a lender that gives you the best rates. Auto loans from credit unions are known for their low-interest rates and flexible repayment plans. Since credit unions are not-for-profit organizations, their rates can be 1% to 3% lower than those offered by banks. The average rate for a five-year APR from a credit union is 2.78%, while it’s 4.69% at the banks.

Car Dealership Financing

You can also get car financing from your dealership. It makes sense to buy and apply for an auto loan at the dealership if you qualify for several incentives, such as zero percent APR, car rebates, and cashback deals. The caveat is that you need to have excellent credit for the dealership to offer you these incentives.

Dealerships also form partnerships with various lenders, allowing you to apply for an auto loan from their financing department instead of the actual lenders. This saves you the time you’d have used to shop around for financing options, but it may come at an extra cost as the dealership can have markup interests on the loan.

Some car dealerships also give customers a chance to build their credit with their car loans. Where you cannot access a loan from other lenders because of poor credit, your local dealership can offer you one. While buy-here, pay-here options in a dealership can work if you have poor credit, interest rates, and other fees can be steep. Most car buyers consider this as the last option. It’s the last resort when you direly need a car, but other lenders have denied you a loan.

Automaker Financing

Don’t confuse this with dealership financing. Automakers can have special financing for specific models, which are often very appealing. Automakers can offer loans with very low APR rates and minimal requirements to promote certain models of their cars. The disadvantage is that your choice is limited to the car on promotion. Sometimes you have to get the car from particular dealerships specified by the manufacturer.

Home Equity Financing

Homeowners with ample home equity can use their homes as collateral for auto loans. Home equity loans are flexible, attract low-interest APRs, and have long payback periods. Sometimes, the interests are tax deductible. However, note that this option puts your house at risk in case you don’t pay off the home equity auto loan. By the rule of thumb, it’s not a good idea to use home equity to finance a car purchase.

How Car Financing Works

With car financing, you apply for a loan that allows you to get the car you need right away. It allows you to own and drive the car while you pay for it over a defined period. Here is a step-by-step process on how car financing works:

  1. Shop for an auto loan: From the various options discussed here, choose a car financing option that meets your needs.
  2. Apply for the loan: Once you know where to get the financing, apply for the auto loan. You can either apply online or visit the lender’s physical premises.
  3. Secure the down payment: When applying for the auto loan, ensure you have the down payment ready. You don’t always need a down payment, but the more you put down upfront, the lower your monthly payments will be. A down payment also lessens the chances that you will need a GAP insurance policy.
  4. Negotiate APR rate and loan term: You’ve got room to negotiate with the lender on the annual percentage rate (APR) and loan term. These factors are crucial as it determines how much you’ll eventually pay for the car.

As you shop around for the best auto loan offers, most lenders will ask for basic information about yourself. This pre-qualification process means potential lenders will check your credit score, but this doesn’t affect your credit rating. However, multiple checks can cause your score to dip a few points. Therefore, it’s advisable to request several offers at the same time before the new score is registered.

Getting financing for a new or used car shouldn’t be difficult when you know what to do and where to acquire the financing. So, before heading out to shop for auto loans, it pays to know your credit rating and which dealerships and lenders provide financial deals suitable for your financial situation.

FIXD Research Team

At FIXD, our mission is to make car ownership as simple, easy, and affordable as possible. Our research team utilizes the latest automotive data and insights to create tools and resources that help drivers get peace of mind and save money over the life of their car.

We’re here to help you simplify car care and save, so this post may contain affiliate links to help you do just that. If you click on a link and take action, we may earn a commission. However, the analysis and opinions expressed are our own.

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FIXD Research Team

FIXD Research Team

At FIXD, our mission is to make car ownership as simple, easy, and affordable as possible. Our research team utilizes the latest automotive data and insights to create tools and resources that help drivers get peace of mind and save money over the life of their car.

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