Shopping around for a car loan at the same time (or even before) you look for a car can strengthen your bargaining position and lower the total long-term cost of the vehicle. Car salespeople often wrap those two together—the car and the loan —which makes it hard to sort out how much each is really costing you.
They talk in terms of monthly payments, trying to keep you focused on that much smaller number. For your financial benefit, you need to look at the full price of the car and the total cost of financing separately.
What You Need To Know Before Taking on A Car Loan
Before you borrow more than $20,000 to buy a car, do your homework. Find a car that’s suitable for both your life and your budget—don’t buy more cars than you can afford. Save up as much as you can toward a down payment, and seek out the best loan you can get.
It’s even better if you can walk into the dealer with loan preapproval. That neutralizes one of their favorite selling tactics—keeping you focused on the monthly payment instead of the price of the car.
New versus Used
New cars lose a huge portion of their value the second you get behind the wheel, which leads most financial professionals to advise against buying new.
In most cases, used cars are much better choices, especially because new cars become used instantly. New cars do, however, come with two plusses: They have lower repair and maintenance costs, especially for the first few years, and new car loans usually come with lower interest rates.
Used cars may come with some question marks (especially if you buy from a person rather than a dealer) and higher repair costs. Still, used cars themselves cost much less than new ones, which can also save you money on total interest even if you’re paying a higher interest rate.
How much you want to pay for the car
Whether you decide to buy new or used, know how much you want to pay before you start shopping. Car dealers like to lump everything together and turn it into a monthly payment, making it harder to see how much you’re really paying for the vehicle.
It’s in your best interest to separate everything out: your trade-in or down payment, the price of the car and any extras, and the financing. By separating these factors and doing some research, you can figure out the best price for the car you want.
Armed with that information, you can start talking with dealers. They may try to steer you toward different cars (the ones they want to sell rather than the ones you want to buy) and keep you focused on that “low” monthly payment. Be firm and stick to your plan by staying focused on your budget and the price of the car.
Total Car Costs
The price of the car and the financing are just the beginning when it comes to costs. Having and using the car also involve a lot of ongoing costs, which include:
- Gas Repairs and maintenance
According to AAA, the average cost to own and use a car is $8,849 annually. Depending on the type of car you have, your costs may vary widely from that average. Small sedans, for example, rack up an average of $6,777 per year, while midsize SUVs run to $9,697.
You have two key variables to play with in a car loan: interest rate and time. Rates (according to LendingTree) run from 5.33 percent for people with stellar credit to 21.10 percent for people with poor credit (scores under 560); the average interest rate hovers at around 8 percent.
Rates will also vary among lenders, so it pays to shop around before you’re ready to buy. Most car loans last between three and seven years. Shorter is better for your net worth, especially because cars lose value quickly (so you could end up owing more than your car is worth).
Shorter loans will have higher monthly payments, but save you thousands of dollars in interest over time. If your loan doesn’t come with prepayment penalties, you can pay it down as quickly as you want. Carefully read your loan terms, because prepayment penalties aren’t always named that. Also, some lenders will not accept principal-only payments (or won’t make it easy to submit them).
How to Get a Car Loan
The price you pay for your car is half the financial battle. The other half involves the financing. You can plan ahead for this loan by using online calculators (try www.cars.com or www.bankrate.com) to figure out how much the loan fits into your budget, both in monthly payments and overall financial plan.
Play around with the numbers until you know how much car you can afford and how different rates and loan terms (the number of months until the loan is paid off) will affect both the payments and the lifetime interest paid.
1. Check your credit report
You will be able to borrow a certain amount and at what interest rate based on your credit score and your income.
If you are considering an auto loan, check your credit report first. The lender may refuse to give you a loan or offer you only a loan with a high-interest rate if your report contains errors or incorrect information.
You can get a free copy of your credit report every 12 months from each of the major bureaus (Equifax, Experian, and TransUnion). Due to COVID, you can now request copies of your credit report every week through December 2022. If you find errors or evidence of fraud when you check your credit report, you should file a dispute to correct it before applying for a car loan.
Scores are calculated based on credit reports. The major banks, credit card companies, and personal finance sites also offer free credit scores and reports online. However, they might not be the scores that lenders use to approve you. Often, lenders use special scores based on how you repaid your auto loans in the past.
You may want to improve your credit score before applying for a loan if your credit is subprime or poor – typically a score of 600 or lower – and you don’t need a car right away. You can bolster your credit score by paying off your credit card balances on time and making timely payments.
To get an idea of interest rates for people with your credit score, you can look up average car loan rates.
In most cases, your credit history is as important as your credit score. Basically, if you’ve successfully paid off previous auto loans, then you’re more likely to receive approval or receive a lower interest rate. Conversely, short credit history or no prior auto loans can be offset by prime credit scores.
In addition to credit requirements, you must also show stable work history and meet minimum income requirements.
Learn more about how to read your credit score.
2. Get quotes from multiple lenders for your auto loan
Following a credit check, you should look at auto loans and lenders, which can be categorized as:
- Large national banks, such as Bank of America or Capital One.
- Credit unions or community banks in your area.
- Providers of only auto loans online.
- Dealership loans, or financing through an automaker’s “captive” lender.
Even if you plan to take dealership financing eventually, you should compare quotes from the first three types of lenders first. If you agree to automatic loan payments from your bank account, you may be eligible for a preferred rate. Auto lenders can also be compared online.
You should make sure each lender you consider seriously will allow you to buy your car from a private party instead of a dealer or broker. Many lenders restrict your purchase options.
It is important to familiarize yourself with the car financing language before you apply for a loan.
3. Get preapproved for an auto loan
As soon as you’ve narrowed down your search to a few lenders, you’ll need to request interest rate quotes. This will help you get the best interest rate. Car loan interest rate offers can also differ because lenders weigh factors in your credit report differently.
Prequalification or preapproval for a loan can be achieved when applying to lenders. There are differences between these, and you need to know what they all mean.
Based on limited information about your credit history, a pre-qualification estimates the interest rate and the loan amount you may qualify for. Your credit score will not be lowered by a “soft” credit pull for pre-qualification. If your credit history is reviewed in full, the estimated rate you are given may change considerably.
Prequalification is the first step toward preapproval. In this situation, your credit score will temporarily be lowered as a result of a “hard” pull. In light of the lender’s detailed understanding of your credit history and personal information, the lender’s estimated rate is likely to be closer to the final rate you receive once your loan is approved.
When you’re really ready to buy a car, you should get pre-approved for an auto loan to give yourself more negotiating power at the dealership as well as prevent you from being overcharged.
One hard credit inquiry is counted as multiple inquiries in a short period of time.
Neither pre-qualification nor preapproval guarantees approval of your auto loan. Both can be helpful when planning and budgeting your car purchase, but preapproval lets the dealer know that you’re a serious buyer capable of securing financing.
4. Set your budget based on the loan offer
You’ll see the maximum amount you’ll be able to borrow on your preapproval offer, but that won’t be the price of the car you can purchase. Taxes and fees should be added to the loan amount. To design your loan, use an auto loan calculator. To find the right payment for your budget, enter your down payment, the trade-in value of your current vehicle, and the terms of your loan.
You can borrow much less if the preapproval offer is too much for you. Keep in mind that the preapproval offer is merely a limit. Even if a bank says you can afford more, it’s more important to be able to pay your loan comfortably.
5. Find your car
After you know the maximum price you can finance and have received financing offers, it’s time for the fun part: choosing your new car.
Be sure to check the loan offers for these things once you have your heart set on a car:
- Excluded brands. A few lenders exclude certain manufacturers or types of vehicles, such as electric cars, from funding.
- Dealership requirements. Capital One, for instance, requires you to shop through a specific dealer network.
- When purchasing a car from an individual, the lender’s requirements.
- Time restrictions. You usually have 30 days to use the loan. If you run out of time, you can extend it with the lender.
6. Review the dealer’s loan offer
As soon as you take a test drive and find a car that suits your needs, you may be able to negotiate a better interest rate with the dealer.
They sometimes offer below-market interest rates on loans they offer to dealerships exclusively for auto purchases. The finance manager will likely try to beat your preapproved rate once he finds out you’re preapproved. It’s not harmful to apply to see what your interest rate can be.
You still need to tell the salesperson that you’re already preapproved even if you don’t want to play that game. If you tell the salesperson you are a “cash buyer,” then you can negotiate just on the car’s price, not the monthly payment.
7. Choose and finalize your loan
You can be assured of getting a great financing rate if the dealership beats your preapproved rate (and the other terms are the same). So ignore your other offers and take the dealership’s offer. Be sure to read the contract before you sign, to make sure there aren’t any sneaky provisions, such as:
- Hidden fees. Besides the price of the car, you will have to pay sales tax, documentation fees, and registration fees. If there are other fees, ask.
- A longer loan term. You can end up paying hundreds more if you extend the term of your loan by even 12 months. Make sure to avoid a longer loan for a better dealership rate.
- Add-ons you didn’t ask for, such as gap insurance, which is usually cheaper elsewhere.
- A penalty for early payoff. This is not part of most auto loans, but it is a good idea to check.
Use your preapproved offer to complete your loan application and finalize funding by following the lender’s instructions. The dealership representative may contact the lender on your behalf or you may need to contact the lender directly.
Private sellers usually require cash or a cashier’s check when you purchase a car. Once you’ve selected the car, you’ll have to contact the lender to complete the deal. After signing the paperwork, you’ll get the car. However, if you do not finance through the dealership, you’re much more protected from add-ons. Check the contract for the items above.
8. Make payments on time
You’re ready to hit the open road after locking in your auto loan. Remember to make your car loan payments on time as well. If you set up automatic payments through your lender, you will most likely have access to your loan information online. You can build an on-time loan payment history, a critical contributor to your credit score, and the ability to get a loan with a better interest rate in the future.
When to Refinance
If you’re stuck with a high-interest auto loan that has a few years left on it, look into refinancing. The trick here is to lower your interest rate without adding time to the loan term (which effectively eats into your interest savings).
Refinancing your car loan makes sense when:
- Your credit score has improved substantially
- The loan has a very high-interest rate (usually a dealer loan)
- Interest rates have dropped and you can get a better rate
In some cases, you may need to refinance your loan because your circumstances have changed and you can no longer afford the payment. Here, it makes sense to stretch out your loan term to lower your payments. Yes, you’ll pay more interest over time, but you won’t have to miss payments, which will lead to your credit score plummeting and your car being repossessed.