How to Finance a Car and Get a Car Loan

You’ve done the research, and you’ve found your dream car. Now it’s time to figure out how to pay for it.

For most car buyers, it’s the last step, but ideally it should be the first. Knowing your finance options and your budget is a critical part of the buying process. A little preparation and knowledge can save you thousands of dollars.

Many of the best car deals come from special financing offers from carmakers, so it’s important to check out what’s available on your chosen model. See our Best Car Deals and Best Lease Deals pages for the latest manufacturer incentives. To help you find dealers that are offering the lowest prices, check out our Best Price Program, which can save you thousands off of MSRP.

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Most car shoppers need a car loan to buy their next new or used car. Knowing the car financing basics covered below can help ensure you get the best financing deal on your new vehicle.

The Basics of Car Loans

A car loan is one way for you to purchase a new or used vehicle. You borrow money from a lender and pay them back over time, usually with interest, unless you’re able to take advantage of a manufacturer’s special zero percent interest offer. The amount you borrow is called the loan principal or financed balance.

Lenders almost always charge interest, which is how they cover their administrative costs, cover losses from people who fail to make timely payments, and make a profit. The interest rate is a percentage of the loan that you must pay back in addition to the loan principal. Interest rates are presented as an annual percentage rate.

You’ll need to use a financial calculator to determine how the interest rate affects your monthly payment (use the U.S. News Car Payment Calculator). Changes in interest rates can dramatically change the affordability of that dream car. If it costs $20,000 and your 60-month loan rate is 5 percent, you’ll have a payment of $377 per month. If you’ve done your research and find a rate of 2.9 percent, you can drop it to $358 per month.

That might not sound like a huge difference on the monthly payment, but over the life of the loan, you’ll pay $22,620 for your $20,000 car at 5 percent, while you’ll only pay $21,480 at 2.9 percent – that’s a $1,140 difference. While you’re paying back the lender, you’re also responsible for all taxes, fees, and expenses, like gas, insurance, and maintenance.

Many people think that when you finance a car, the finance company lends you the money and the car is yours. In reality, however, the lender is buying the car and letting you use it. The lender actually owns the car, and they’re nice enough to let you drive it while you’re paying off the loan. In fact, you won't have the title to the car and own it outright until you make your last loan payment. If you don’t make your car loan payments, the lender can repossess the car. If the car is destroyed or stolen during the term of the loan, you are still responsible for paying the loan back, which is why lenders require you to carry insurance on the car that names them as the lienholder.

If you fail to provide proof of insurance to the lender, they will purchase insurance on your vehicle to protect their investment. You don’t want that to happen, however, as it’s very expensive insurance, and it only protects the lender, not you. 

The Car Loan Term

The length of the loan, or loan term, simply refers to the amount of time that it will take to pay the lender back. If you sign up for a five-year term, over the next 60 months you'll pay the money back and then own the car free and clear.

The vast majority of auto loans are repaid in monthly installments. You send the lender a set amount each month and slowly pay off the loan. Most financial institutions can set up automatic payments, which are a great way to ensure that an installment is not late or forgotten.

With the rising cost of new cars, there’s been a trend in the industry to extend longer and longer loan terms to consumers; many lenders now offer eight-year car loans. While such long terms create somewhat lower payments, they can also create situations in which you owe significantly more money than the car is worth.

Your Credit Score

When it comes to how much interest is charged on a car loan, some people get charged more interest, and some get charged less. Obviously, you want to be the one who gets charged less. The interest rate lenders charge is based on a number of factors, one of which is your credit score. Your credit score is sometimes called a FICO score, though FICO is only one of a number of credit scoring methods used by lenders.

A credit score is a number that credit bureaus assign to you based on how much debt you have, the number of accounts that you have open, how much credit you have been offered, how good you've been about paying bills on time, and how long you’ve been using credit. Your lender will use information from your application and credit report to determine your debt-to-income ratio (the amount of debt you have compared with how much money you earn).

Lenders use the score to predict your ability and likelihood to pay them back. If your score is low, lenders will assume that you’re at high risk for not paying the loan back, and they will charge you a higher interest rate to cover the higher risk. Lenders may also require a larger down payment from buyers with lower credit scores, or only extend a loan offer for a shorter term.

The last place you want to find out that your credit score is low is a dealership’s finance office. You should know what your credit score is before you apply for a car loan and do your best to make sure it's as high as it can be. Generally speaking, credit scores of 720 and above get the best loan rates.

Though you are entitled to free credit reports from the major credit bureaus each year, you’ll often have to pay a few dollars extra to get your actual credit score. If your score is not as high as you'd like, paying off old bills (like credit card debt) and paying all bills on time for six to nine months should bring your score up and help you get a better interest rate. If you don’t have any credit card debt, closing unused cards can help raise the score. If you do have card balances, closing cards can actually hurt your credit by raising your percentage of credit utilized.

You’ll also want to take a look at your full credit report to ensure its accuracy. If someone stole your identity and opened a credit card in your name and you aren’t aware of it, it could affect your ability to get a car loan, or the terms of any loan that you are offered. You need to report the fraudulent activity right away to the credit bureaus so any errors can be fixed before you apply for auto financing. Dealing with the credit bureaus takes time, so getting out ahead of issues is critical.

Apply, Apply, Apply

You wouldn't just apply to one job or one college, so you shouldn't apply to just one lender for a car loan. Contact your bank, local credit unions, other lenders (both brick and mortar and online), and auto manufacturers to find out what they're offering. You'll have to fill out loan applications, which will ask for your social security number, employment and income information, monthly expenses (like mortgage and rent), and any outstanding debts, including credit cards and student loans.

When you fill out auto loan applications through multiple lenders, be sure to do it over a short period of time. If you spread your applications out, the multiple applications for financing can lower your credit score, as it might look like you need multiple loans. Do all your applications around the same time, and the credit bureaus are smart enough to see that all of the inquiries are pointing to a single potential loan.

Do not exaggerate your income or misstate your expenses and amount of debt. The lender will pull your credit history and credit score. If you lie, you’ll get caught. Evidence of dishonesty on a loan application can cause the loan to be rescinded at any time during its term.

If you are planning to use your vehicle for a ride sharing service such as Uber or Lyft, be sure to tell potential lenders. Many will then consider the potential loan a business loan, which is subject to different underwriting standards. Failure to disclose such use can result in a lender requiring immediate full repayment of the loan.

Taking out a car loan is a complex transaction, but carefully looking over the loan offers and ensuing documents is vital. The interest rate and the monthly payment shouldn’t be the only things you look at. Avoid offers that charge you high fees unless a lower interest rate or shorter loan term offsets the initial costs. Watch out for variable rate loans that start at a low rate, but climb based on time or some other rate index. With interest rates expected to rise for the next several years, it’s probably best for most buyers to lock in a low fixed rate today.

Watch out for loans that have a prepayment penalty, which is a fee charged if you pay the loan off early. Paying the loan off early may not be something you'll be able to do, but if your long-lost Aunt Mabel dies and leaves you a fortune, paying it off could save you a lot of money, and you don't want to pay extra fees to do it.

Don't Feel Dejected about Getting Rejected

If your car loan application is rejected, you’ll probably feel terrible, but in the long run that rejection is likely a good thing. A rejected loan application means the lender didn't think you'd be able to pay the money back. As hard as that is to hear, that lender likely saved you from getting into more debt than you can handle. When loans are not approved, the lender is required by law to provide you with the reasons why. You may even find in the explanation that the lender relied on erroneous information, and you should have been approved.

If the rejection was based on solid information, it’s time to reassess your budget to determine what you can truly afford – not just monthly, but over the life of the loan. Try finding a less expensive car to buy, or save up more money so you have a larger down payment, reducing the amount you’ll need to borrow.

Whatever you do, don’t fall into the trap of a lender who promises that they can find financing for anyone, regardless of their credit. Such high-risk loans are likely to have such unfavorable terms that they can do tremendous damage to your overall financial picture for years to come.

Show Up with Financing

As with nearly every aspect of the car buying process, financing is negotiable. Unfortunately, it’s also confusing, which a dealer can take advantage of to make more money. In many cases, the dealership makes more money from the financing than they do from the sale of the car. So while a dealership might offer you a spectacular price on that dream car, they’re likely to come out ahead by selling you on expensive financing.

While many car buyers want to believe that the car dealership is offering them the best financing rates, that’s not always the case. While you should certainly consider the loan the dealership offers, the best way to get the lowest interest rate is to bring a pre-approved loan from your bank, credit union, or third-party lender when you go to the dealership. If the dealership can beat the interest rate, fees, and other loan terms, you can decide to take the dealer’s offer. If not, you already have financing in hand, and you can focus on the price of the car and your trade-in.

Now that you understand the basics of financing a car, you’ll be able to get the best car loan for your budget. Remember the foremost rule of car-buying: Knowledge is your best friend.

Some of the best car deals come from special financing offers from carmakers, so it’s important to check out what’s available on your chosen model. See our Best Car Deals and Best Lease Deals pages for the latest manufacturer incentives. To find dealers that are offering the lowest prices, check out our Best Price Program, which can save you thousands off of MSRP.