Buying a car is one of the biggest purchases you’ll ever make. New car prices now average $47,000! With price tags like that, you might doubt you’ll ever actually be able to own your vehicle.
The best way to buy a car you can’t pay for outright is by financing it, which essentially means taking out an auto loan. Here is everything you need to keep in mind about car financing before you decide to go for it.
Car Financing Overview: What Does It Mean?
In short, financing a car means that you take out a loan in order to own a new (or used) vehicle. When you don’t have enough liquid cash to pay for a car, a car loan can help cover the difference between the total cost of the car and the amount of money you can afford to pay outright.
When you take out a car loan to pay for a vehicle, there is a set amount of money you have to pay back to your lender, plus interest. Interest rates are either fixed or variable, meaning they are a set rate decided at the time you take out the loan (fixed) or they vary based on the index rate (variable).
The Top 5 Things You Need To Consider Before Financing A Car
Taking out a car loan takes a lot of planning, shopping, and strategizing to do responsibly. Here are our top tips:
- Financing vs. leasing
- Know your budget
- Check your credit score
- Get pre-approved before shopping for a vehicle
- Understanding dealership financing vs bank financing
1. Financing vs. leasing
When you finance a car, every payment you make is a step toward paying off the car for full ownership. Leasing, however, is more like renting a car. Every payment you make goes to the dealer for using the car, with no money going toward ownership.
Monthly leasing payments are typically lower than financing payments, and is a great option if you only need a car for a fixed amount of time. However, you should also note that monthly car insurance premiums are typically higher for leased vehicles than financed vehicles, as dealers want as much coverage as possible on borrowed cars.
If you need a car for the long-term, financing is typically always the smarter financial option, as payments stop once you pay off the loan in full.
2. Know your budget
Before deciding to finance a car, you should determine how much you can afford to spend every month on a vehicle. Knowing how much you can set aside for a downpayment, as well as how much you can afford to pay for your monthly insurance and loan payments, will help you narrow down your search for a car and loan that works.
3. Check your credit score
Your credit score is used to determine whether or not you’re approved for a loan, the loan amount you qualify for, your interest rate, and your monthly payment. If your credit score is subprime (650 or below), you may have trouble getting a good value loan.
So, check your credit score and understand how that will impact your monthly payments. However, not all lenders use credit scores the same way. Where other lenders consider your credit score subprime, another may consider it near-prime and give you a better deal, so don’t be discouraged if you have less than perfect credit.
4. Get pre-approved before shopping for a vehicle
Having a loan set to go before starting your car search means you have a solid idea of what you can spend before stepping foot in a dealership. This will help you avoid falling in love with a car you can’t afford.
Moreover, walking into a dealership with a pre-approved loan can serve as a bargaining chip for you, as you can haggle the car price down to a number that fits the bill, or even get a better rate offer from the dealer.
5. Understanding dealership financing vs. bank financing
Both dealership financing and bank financing work the same way– you apply for a loan, they check your credit score, and they come back with loan offers for you to compare. The only difference is that banks typically provide the loan themselves, while dealers act on your behalf and apply to multiple lenders.
There’s no harm in browsking loan offers from both dealerships and banks. However, you should note that dealerships sometimes offer you a higher interest rate than you qualify for and pocket the difference as compensation for facilitating the loan.
The Bottom Line
Buying a car is a huge financial undertaking, and it is important to go about it in a methodical, responsible way. Follow the 5 steps above to ensure you finance a car at a good rate within your budget.