Financing a car is a big commitment for almost any budget. This kind of installment credit is the most common way to purchase a vehicle. Learn more about how the process of buying a car with financing works.
Financing Basics
Financing is a way to buy a car if you don’t have the money to pay with cash. Commonly called an auto loan, financing a car is a way of funding your vehicle purchase. You borrow money from a lender to pay the seller for your new ride.
In turn, you sign a contract and agree to make monthly payments to the bank, credit union, or other financial institution until you repay the borrowed money and any interest.
RELATED ARTICLE: Financing Terms Explained
How Does Financing a Car Work?
Whether you’re financing a used car or a new one, the first step is to evaluate your budget. How much cash will you put down toward the total purchase price? How much can you comfortably pay each month? The payments will include interest, which is how much the lender charges for the loan. This amount is calculated as a percentage and will vary based on your credit history and other qualifying factors. Use the car payment calculator to help confirm your budget.
You can finance a vehicle through the dealer in many cases. However, we recommend shopping around for the best interest rate. Lenders will offer different rates based on your creditworthiness. The most well-qualified buyers are those who have a higher credit score and pose minimal risk of defaulting on the loan.
The only way to know how much credit a lender will offer you is to apply for an auto loan. You can do this at any point in the shopping process, but if you do it before you get to the dealership, a pre-approval works like an allowance and maps out how much you can comfortably spend.
Once you agree to move forward with a lender, the finance office will outline the terms of your credit contract. This contract will show your payment schedule over the life of the loan and will include a host of terms and conditions. Take your time and read the documents carefully. An auto loan is legally binding after you sign on the dotted line.
*Note: A lease is also a finance agreement, but the phrase “financing a car” usually refers to a purchase contract. Read more about leasing a car to see if it’s right for you.
RELATED ARTICLE: Car Payments: The Basics Explained
How Long Can You Finance a Car?
The bank typically spreads out monthly payments over 24 to 72 months when you finance a car. We recommend 48-month loans if your monthly budget can afford the payment. Some lenders may have repayment terms as short as 12 months or as long as 96 months. Not all lenders have the shortest- or longest-term options.
If you’re trying to finance a car with bad credit or limited credit history, you’re more likely to have a higher interest rate. A longer contract term may help lower the monthly payments and make the cost more manageable. However, there are significant tradeoffs with stretching the loan length.
The longer you finance a car, the more you’ll pay in interest. It’s always more advantageous for you to pay off the loan sooner rather than later to avoid owing more than the vehicle is worth. If you’re locked into a higher interest rate upfront because of a low credit score, work on cleaning up your credit so you can refinance in the future at a lower rate.
