In the market for a new car? Besides researching car models, don’t forget to look at financing options! We break down what is the best way to finance a car.
Not everyone can afford to buy a car with hard cash! If you’re a regular American, the best way of affording a car is to take out a loan. Things used to be pretty straightforward when only banks were the ones doing the lending. However, today you are spoilt for choice – there are multiple financing options to choose from.
So what will give you the best value when taking out a car loan? We break down everything you need to know.
What is financing a car?
Financing is the process of applying to a lender for a loan and then repaying it over a certain period. No matter how large the amount, car financing will let you break it up into affordable monthly installments. The cost incurred by the lender will be recouped through interest charges paid over the course of the loan.
What options do you have to finance a car?
Gone are the days when you only had the local bank to approach when you wanted to take a car loan. Earlier, you were given one choice, one APR, and one set of loan terms. If you didn’t like the terms, you just had to grit yourself and sign on because of the lack of other choices.
Today there are an amazing array of car financing options. Besides the presence of multiple banks, you can approach credit unions, private lenders, dealerships, and more places to shop for a wide range of options!
1. Bank Financing
Walking into your nearest bank and applying for an auto loan used to be pretty simple a few decades ago. Today, each bank has a separate division catering exclusively to auto loans, with a range of loan terms and APRs. You can even get pre-approved in just a few minutes by entering some basic details. The advantage of borrowing from a bank is that you won’t have any additional charges like dealership fees.
The bank will give you a letter of commitment, which you can give to the dealer to show that you can easily access the required funds. This will also help you negotiate the price and limit it to what’s on paper.
2. Dealership Financing
The only difference between bank financing and dealer financing is that the dealer does the work of processing your application, filing them with their partner lenders, and conducting the credit inquiries. You needn’t hop from bank to bank to search for the best rates – you’ll get a few to compare at the dealership itself.
The convenience of choosing, paying, and taking home a vehicle easily is what makes dealership financing appealing. However, dealers generally charge higher interest rates because they add processing charges into the final amount. However, it’s a great choice if you’re financing a used car.
3. Other Online Lenders
The proliferation of financial companies has led to multiple private companies offering loan services at very affordable rates. Not only do they have quick turnaround times for approvals, but they are also more accurate in their assessment and interest rates offered due to their expertise and technology.
Examples of such lenders include LightStream, myAutoLoan, Carvana, CapitalOne, LendingClub, and more.
4. Credit Unions
A credit union is a financial institution that offers banking and lending services exclusively to their members. Most credit unions are incorporated as not-for-profit institutions and hence charge their members much lower rates than banks.
Examples include PenFed Credit Union, Consumers Credit Union, Digital Federal Credit Union, and more.
Is it better to finance a car through a car dealership or a bank?
Financing through a bank
Financing through a dealership
Bottomline: You can choose bank financing if you want to borrow a large amount, prefer a trusted financial institution, and are okay with a longer approval process. On the other hand, go with dealership financing if you prefer a quick approval process, have a co-signer, or prefer longer terms.
Tips to follow when financing a car
Build up your credit score
The easiest way to score lower APRs and get preferential deals is to wait until your credit score has increased. Typically, you can get great rates if your score is above 700. Often, building a consistent payment history for just 6 months before financing a car can save you money in the long run.
Pre-qualify with lenders
If you are wary of applying to multiple lenders and suffering a credit drop each time, you can go through the pre-qualification route. Since pre-qualification only uses a soft credit pull, it can help you shortlist lenders who fit your criteria. After that, you can apply to either one or two to minimize damage to your credit.
Follow the 20/4/10 rule of financing
Whether you’re buying a new or used car, you must be wary not to end up in a bad car loan in the future. For this, follow the 20/4/10 rule which suggests the following:
- Make a 20% down payment
- Sign on for a loan term not longer than 4 years
- Limit your vehicle expenses (loan payments, premiums, transport costs) to 10% of your gross monthly income
Pay cash for extra charges like taxes and fees
Banks won’t charge you any markups on your loan amount, but dealerships will. It’s one of the ways they make money over-and-above the vehicle costs. However, it will cost you more in interest charges if you roll these charges into the loan. Instead, pay for them upfront in cash.
Trading in a car? Keep your documents ready
You can finance a new car even if you haven’t paid off the one you currently own. However, the bank or dealer must agree to pay off your lender when you take a new loan. Keep all the loan and vehicle documents ready so the process can be completed smoothly. It’s also best to ensure you have positive equity in your current vehicle.
Frequently Asked Questions (FAQ)
What is the best place to finance a car?
You can choose to finance a car through a bank, dealership, credit union, or any private lender. Borrowers generally choose bank financing if they have large amounts to finance and are okay with a longer approval process. Credit unions offer preferential rates for their members. On the other hand, go with dealership financing if you prefer a quick approval process and longer terms.
How much down payment should I make when buying a car?
According to the 20/4/10 rule, you should ideally make a 20% down payment towards your new car loan. This will help you avoid going underwater on a car loan since most cars depreciate at least 20% in the first year. If you don’t make a minimum down payment, you will end up owing more than what the car is worth.
Can you trade in a car that hasn’t been paid off?
Yes, you can trade in a car that hasn’t been paid off, as long as your new lender agrees to pay off the remaining loan balance. If you have positive equity in the vehicle, the dealer may pay you the difference between that and the trade-in value. However, if you have negative equity in the car, you will have to pay the difference to the dealer.