One of the biggest mistakes people make when buying a new car is not including the cost of auto financing in the total price.
Theoretically, your monthly payment just went down by $30 For example, if you are able to convince the dealer to lower the sticker price by $2,000, that is great! This would theoretically mean that your monthly payments would decrease by $30.
The dealer gets you excited about the car to get you to put no money down and to extend your loan from 3 to 4 years so that your monthly payments will be lower. This sounds good on paper, but in reality you will end up paying $3,000 more in interest.
If you want to negotiate the price of the car, don’t forget to take the car’s financing rates and terms into account. I made this mistake when I first bought a car, and I promised myself I would never do it again.
If you’re planning to buy a new car, you shouldn’t wait until you’re at the dealer’s office filling out paperwork to think about financing.
How to finance a used car
If you’re able to pay for a used car in cash, you won’t have to worry about interest or financing fees. However, not everyone has enough money saved up to buy a car outright, especially if it’s not new. If you need to take out a loan to finance your next car, follow these steps to get the best deal possible and save some money.
STEP 1: CHECK YOUR CREDIT FILE
If you have a high credit score, you are more likely to be approved for multiple auto loans with low interest rates and good terms. In 2020, people with strong credit received an average APR of 5.49%, while the average APR for all buyers was 9.46% on the LendingTree platform.
If you’re concerned about your credit score, you can check your credit reports for errors that might be bring it down. You can get all three of your credit reports for free from AnnualCreditReport.com without having it affect your credit scores.
There are several
lenders that work with people with damaged credit, but you might pay a higher interest rate. This is why it’s important to shop around — fair credit borrowers who compared rates on LendingTree saved about $900.
STEP 2: CALCULATE HOW MUCH YOU CAN AFFORD
Before you start applying for loans to buy a car, you should figure out how much car you can afford. A lender will be able to tell you how much they are willing to loan you, but this number is based on a limited review of your finances. Ultimately, it is up to you to decide what is affordable for you, taking into account all the associated costs of car ownership like the down payment, monthly payments, gas, insurance, repairs, and annual registration fees.
STEP 3: RESEARCH THE CAR’S VALUE
New cars have an MSRP, but used cars’ values depend on the condition and history of the car. Here are a few ways to find out what your future car might be worth:
COMPARE SIMILAR VEHICLES
To get an accurate estimate of a car’s worth, you can look at websites like Kelley Blue Book or Edmunds, which will show you the prices of similar cars.
REVIEW THE VEHICLE HISTORY REPORT
You shouldn’t just take the seller’s word for how good condition the vehicle is in. Checking the vehicle identification number (VIN) can give you important information about the car, like the title history and unresolved safety recalls. A full vehicle history report will tell you more about the car, like previous owners and any accidents that have happened. Dealers will often give you a vehicle history report for free, or you can buy one from a company that is verified by the National Motor Vehicle Title Information System.
GET AN INSPECTION
It is important to have a used car inspected by a mechanic before buying it, even if it looks fine, because there could be major safety issues that are not visible.
Where to find used car financing
It’s time to find the best way to finance your used car now that you have checked your credit and estimated how much you can afford.
| Ways to finance a used car | |||
| Benefits | Drawbacks | Best for… | |
| Banks and credit unions |
|
| Poor or thin credit (credit unions); pre-existing members or customers |
| Online lenders |
|
| Quick, convenient transactions; managing your account electronically |
| Manufacturers |
|
| Buyers with strong credit |
| Dealerships |
|
| Convenience — borrow and buy in one location; buyers who have been denied elsewhere |
PRIVATE PARTY AUTO LOANS
If you buy a used car from a private seller, you cannot use dealership or manufacturer financing. Private sales can be a great way to get a good deal on a car — prices are almost always cheaper than with a dealer. However, you’ll have to do more legwork, including setting up your auto loan. Banks, credit unions and online lenders can help you get preapproved for a loan online. The lender will mail you a check for the exact amount that you can then give to the seller. Keep in mind that some lenders won’t finance vehicles that are more than 10 years old or have more than 120,000 to 150,000 miles. Lenders may also charge a higher rate for a private party auto loan than for a used car loan that you could present at the dealership.
How to get your best used car loan rate
Cars that have been previously owned represent a bigger risk to lenders because the lenders have no way of knowing the full extent of the car’s maintenance or wear-and-tear. Consequently, used cars typically come with higher auto loan interest rates.
If you are worried about higher rates, shop around for the best used car loan rate and get preapproved with different lenders. If you are buying from a dealership, you can use these offers to negotiate a lower rate. If the dealer can offer you a better rate than what you have already been approved for, then great! You will know that you are getting the best deal.
You can get better terms on your loan by making a bigger down payment, or by finding a cosigner.
TIP:
Wondering how long can you finance a used car? Terms vary, but 72 months is a common maximum. Borrowers who can trim that in half may be able to score better rates, though, as some lenders reward shorter terms with lower starting rates.
Understand your credit score before you go to the dealership
To get an idea of what sort of car loan you might be able to get, it’s a good idea to check your credit report and score. You can do this for free by visiting Credit Karma.
Dealerships will often advertise low interest rates on new cars; however, these rates are usually only available to car buyers with excellent credit scores.
The dealers and banks will still provide a loan for a car even if your credit score is low. The reason behind this is because they know that they will gain a lot of interest from you and if you are unable to pay, they can simply repossess the car while you are inside Trader Joe’s.
If you have a credit score in the low 700s, you can still get a lower interest rate, but you may not qualify for the best promotions. After that, rates go up quickly. If you have a below-average credit score (under 650), you may be offered car loan rates of 10% or more.
If you have a lower credit score, it is more important to compare rates from different banks to make sure you are getting the best deal possible. Although you may have to pay a higher rate than someone with a better credit score, you may not have to pay the first rate somebody offers.
car shopping If you have a bad credit score, try to get financing quotes before you go car shopping. This way, you will know what to expect in terms of interest rates and monthly payments.
If you have a credit score of 750 or above, you’re likely to get the best financing rates from the dealership. I’ve never said this before, but in this case, you don’t need to shop around for the best rates.
The dealer will act as a broker and show those with good credit the best options from multiple lenders competing for their business.
The dealership will try to take advantage of you if you have a bad credit history, and you won’t get low interest rates.
Keep the term as short as you can afford
A dealer will try to sell you a car with low monthly payments, zero down, and a long car loan term regardless of your credit score.
This is the opposite of what you want.
Lower monthly payments are a manipulative and old-as-dirt sales tactic. Dealers like them because:
- They make it seem like you can afford more car than you really can.
- They make it seem like you’re getting a deal (when you’re actually getting screwed).
- They create breathing room to sell you extras.
- They confuse buyers and pacify negotiations.
- They please their lenders since they’ll make gobs of interest off of you.
A $470 car payment would suddenly become a $350 car payment, but you would end up paying more in interest in the long run.
In general, the longer you take to repay a car loan, the more interest you will pay. In many cases, banks charge higher interest rates for loans that are repaid over a longer period of time, which will end up costing you more in the end.
It’s easy to be tempted to choose a longer car loan in order to lower your monthly payments, but this means you’ll end up paying more in interest and being “upside down” on your loan (i.e. owing more than the car is worth) for almost the entire duration of the loan.
If you want to make sure you never miss a payment, you should set up automatic payments for your loan.
Put 20% down
You also want to reduce the amount of money you borrow.
The main amount of the loan is the total amount borrowed, on which interest is charged. When a dealer offers a loan with no initial payment, they are essentially saying that they want to increase the amount borrowed so that the lending company can charge more interest.
Don’t do it!
If you put 20% or more down on your new car, you can reduce the amount of your loan, and thus the total amount of interest you’ll pay.
If you cannot afford to pay 20% of the cost of the car upfront, you probably will not be able to afford the monthly payments and interest on the loan.
Don’t fall for the gap insurance speech
Gap insurance is coverage that protects you if your car is totaled and you owe more than what your insurance will pay out.
This is an example of how gap insurance would work. If you crashed your car and the insurance company paid out $10,000, but you still owed $12,000 on the loan, gap insurance would cover the remaining $2,000.
If you have a 20% down payment and a short, three-year term on your auto loan, you shouldn’t need gap insurance. With good loan terms, there should never be a scenario where you would owe more than the car is worth.
If your car dealer tries to sell you gap insurance, it might mean that you need to reapply for a loan.
If you are not looking at a 0% APR or another low APR, the best way to buy a car is with cash. If you have to get a car loan, it is better to be practical.
It is a good idea to find out your credit score in advance, and to shop around for a loan before you go to a car dealership. You can use offers from other lenders as bargaining tools to get a lower APR from the dealership. If possible, it is best to get a loan from your local credit union.
The following tips can help increase your chances of loan approval. If you ultimately discover that you cannot afford the car you wanted, it is better to learn that now than after you have already purchased it.