How to finance a car

Wondering about the ways to finance a car? You’re in the right place. Regardless of how you decide to finance your car, in terms of where you obtain the loan, the process is similar. We’ll walk you through the steps of getting a loan for your next new car, whether you decide to finance through the dealership or find a bank loan.

Check your budget

Before you start shopping for a car, figure out how much you can comfortably pay per month. Then start looking at vehicles in that price range. Resist the temptation to stretch your budget, or your loan term, for a bigger or nicer vehicle, since interest and insurance will add to this monthly total, too. 

Review your credit score

Check your credit score and figure out what tier you’re in, so you know what to expect in terms of interest rates. If there are errors in your credit history, correct them. If your loan will likely have a higher interest rate than you expected, go back to the previous step and slim down your budget.

Get preapproved

Check rates at your regular bank, as well as credit unions and other advertised deals. You want to head into a car dealership with a preapproval at the lowest interest rate you can find — the goal is to make the dealership beat your current offer with a lower interest rate.

Choose your car at the dealership

Here’s where you shop for your new car, keeping in mind your budget and your priorities. Don’t tell your salesperson you have preapproval until you’re ready to buy.

Review loan options and choose the best suited one

Dealer. This option certainly has convenience going for it. Dealers often have dedicated finance and insurance (F&I) staff on hand to find you the best deal, as the salesperson will tell you. The caveat is that they will find the best deal amongst the lenders they work with, and may not be as good a deal as you can find on your own.  

Financial institution. Banks, credit unions and online lenders are closing the gap in convenience versus dealer financing by extending loan department hours, often by telephone. Typically, you can expect better interest rates than dealer-based financing, more flexibility in terms and pre-approval options.

Manufacturer. Not to be confused with dealer financing, this option is linked with the automaker’s financial arm. Offers vary and can be very appealing. Bear in mind this is not for just any car at the dealership, though. It will be restricted to new and certified pre-owned (CPO) units, and usually only those already in stock.  

Lease. As manufacturers’ purchase offers have become more favorable, lease popularity has cooled overall. One notable exception is among luxury car drivers, who still keep this option popular. A lease allows you to get into a more expensive new or CPO car for your dollar. At the end of the lease, you can simply turn the car in or purchase it for the established residual price.

Cash. This isn’t just an option for a few wealthy people; they don’t always pay cash, anyway. For that matter, a lot of private-party used-car transactions are financed by cash. Whatever the price bracket, your cash flow may be better than your credit. Maybe you’re shopping for something that causes lenders to shy away, like an older sports car. Or it could be that you would pay more in loan interest than you could earn in interest for that amount. All are instances that make paying cash the preferred method.

Bank or dealership: Which is better to finance?

The best way to finance a car is however you get the best interest rate. The easiest way to handle it is to get some preapprovals, and take the best one with you when you’re ready to buy. If the dealership can beat it, go with the dealership. If not, go with the preapproval and rest easy knowing you did your research.

Tips on financing a car

If you’re planning to buy a new car, make sure to consider the following factors. There are other variables that add to the complexity and overall cost of financing a car, well beyond the actual cost of the car. Take a look at the factors that can affect your new car financing, and before you sign the pile of paperwork, make sure you’re prepared for the additional costs that are tacked on to a financed car.

Putting down a down payment

Experts generally recommend a down payment of 20% of the purchase price of a new car. Granted, considering the prices of new cars, this is a tough target for a lot of consumers. Keep the following factors in mind. First, the less you agree to pay for your new car, the less that 20% will be. So hone your negotiation skills. Second, a solid down payment may help you qualify for a lower interest rate, which reduces the entire amount you’ll pay for a new car. Third, the more you pay up front, the lower your monthly payments will be. And finally, if you are financing through a dealership and have a vehicle to trade in, the value of your trade in can be counted toward your down payment. So again, be prepared to negotiate. All that in mind — that is, for all the benefits gained from a substantial down payment — financial experts don’t recommend draining your savings account for a down payment on a new car. If your financial situation is precarious enough that scraping up a down payment will wipe you out, perhaps consider a used car or a cheaper new car. 

Car loan terms

If you finance your car, keep in mind that technically, the financial institution loaning you the money owns your car until it’s paid off. Therefore, that institution can set conditions on what you do with your car, and the most common and reasonable of those conditions is insurance. 

Insurance

If you’re trying to decide whether to finance a new car or buy a used car outright, keep in mind that there are additional costs you might not yet have factored in. If you take out a loan for a new car, the bank or institution that lends the money owns your car until it’s paid off, and with that comes conditions. Typically, lenders require comprehensive and collision insurance policies, which are generally considered optional in most states. Gap insurance is another type of extra-cost policy often required in the event of a loan. Since the lender owns the car, the lender wants to ensure they’re compensated if the car is damaged or totaled. However, this insurance coverage is another cost of a new car that falls on the buyer of the new car — you. 

Interest rate

Finally, figure out how much the interest on your new car is going to cost you over the life of the loan. There are a number of online calculators that can help with that. Consumers who need a new car and have good credit, and don’t have a particular make and model in mind, might do well to shop manufacturers’ low interest promotional deals, to help get a good new car with the lowest possible payment.