If you're a first-time car buyer intimidated by financing, don’t worry; you’re not alone. Although you have a few choices to make and details to hammer out, the process can be surprisingly straightforward. We’ll run through the basics to help start you off.
Understand the Components of a Car Loan
When you finance a car, the loan you obtain has three major components: the amount financed, the annual percentage rate and the term length. All three factors affect your monthly payment. The amount financed, often called the principal, is the total sum of money you borrow. The APR is the interest rate you pay on the loan, while the term length is the number of months over which you’ll pay it.
Your monthly payment will vary based on the cost of the vehicle minus your initial down payment and any trade-in value on your old car, plus the APR you secure (typically based on your credit score) and the length of time you choose to pay off the loan. When you choose a loan, it’s important to assess your budget to find out what you can realistically afford on a monthly basis.
Choose a Lending Option
Once you’re ready to start exploring options, you should decide whether to secure financing through a direct third-party lender, such as a bank or credit union, or through the dealership.
Choosing a direct lender allows you to size up loan terms from several parties before you purchase the vehicle. The advantages are that you can compare offers from several lenders before deciding on one, and you can potentially leverage an exceptional loan offer to negotiate better dealership financing. That’s why it’s a good idea to have a strong third-party offer in your back pocket before you visit the dealer.
Dealer financing, on the other hand, gives you the convenience of securing financing — typically through the automaker’s credit arm — as you purchase your car, and may be your only option in cases of low-interest financing or other incentives advertised by the automaker. Dealers may also be able to access various financing options through banking relationships and incentive programs based on factors like a high credit score or shorter loan term. Find out if you qualify for these.
Shop for the Best Financing Deal
If you decide you want to finance through a direct lender, shop around to compare offers and find the most favorable terms. And don't be afraid to negotiate with each potential lender. If you have strong credit, you may be able to lower your APR and, as a result, the total amount financed.
This is also where it comes in handy to know your budget. If you can afford higher monthly payments, you’ll likely want to choose a shorter-term loan to fully own the vehicle sooner and minimize the amount you’ll pay in total interest. If you can only afford smaller monthly payments, you’ll have to look at longer loan terms. But be careful: While loan terms can range as long as 108 months, they typically come with high interest rates and more payments throughout the depreciation of your car. This puts you in danger of turning your loan upside down, where you owe more than the car is worth before you pay it off.
The more options you have to finance your purchase, the better off you’ll be. Just like you negotiate on the total cost of the car, you should negotiate on loan terms from several lenders to find the best possible option. Finally, and perhaps most importantly, choose the shortest term length possible and put as much money down as you can upfront. It’s obviously easier said than done, but the quicker you gain full ownership of the vehicle, the better off you’ll be in the race against depreciation.