How does auto financing work?
Buying a car is not always easy. As well as having to spend enough time researching makes and models, we also need to be pretty clear about how we’re going to pay for it.
Although some drivers can make the purchase in cash, many people choose to finance their car, this involves obtaining a loan and then paying the lender the principal plus interest.
If this is your case, you must know very well how car financing works so that your purchase is successful. We will explain it in detail below.
How does auto financing work?
When you buy a car with financing, a financial institution lends you the money you need to buy it.
In exchange, you pay the lender interest and possibly fees for borrowing that money for a specified number of months.
Car financing options include banks, credit unions, online lenders, finance companies, and some car dealers.
Obtaining car financing through credit unions or banks may be less expensive than applying at dealerships because dealerships may raise interest rates to earn a management profit.
Some dealers provide their own financing but often charge much higher interest rates than other types of lenders charge.
If you want to buy a car and you don’t have enough money to pay for it in cash or you don’t want to invest all your savings in a vehicle, you should focus on auto financing.
If you are approved for a loan for your car, you will have to make monthly payments until you finish paying off the loan.
Each payment you make will be divided into:
- Payment of capital, to repay a part of the balance of your loan.
- Interest payment
A part of your payment can also be used for certain fees, such as late payment fees, for example.
Your monthly payment will be determined by the amount of your loan (the purchase price of the car minus the down payment and trade-in), the annual percentage rate or APR, and the term of the loan.
The APR is one of the most important factors to consider as it affects how much money you will end up paying for the car.
There are different factors that influence your interest rate, such as credit, the term of the loan and whether you are buying a new or used car.
Once you pay off the loan in full, the lender will typically send a lien release document (depending on your state) to your state transportation agency. The car title will be updated and transferred to you.
How financing a car in the USA works with respect to credit score
In the United States there is no universal minimum credit score to apply for financing for a car.
Each lender sets its own minimum credit scores and takes factors like the type of car you’re buying or your income into account differently.
Some lenders may be willing to work with people who have recent bankruptcies or foreclosures on their credit history and others may not.
Still, the average credit score was 718 for new car loans and 662 for used car loans in the third quarter of 2019 , according to Experian’s State of the Automotive Finance Market report.
The report also shows that only 38% of all car financing went to people with credit scores below 660.
If you can wait, it’s important to take some time to build your credit before applying for auto financing. If your credit score is low, you may receive fewer offers than someone with good credit.
And if you’re approved for a loan, you’ll likely get a higher interest rate than someone with a better credit rating.
People with credit scores above 780 paid an average interest rate of 4.01% on their new car loans, while those with credit scores of 500 or less paid an average rate of 14.3%, according to Experian’s report.
This could make a big difference in the amount of interest you pay over the life of the auto loan.
Read also: The best car rental companies in the USA
Car Financing: How Much Does It Really Cost?
As we mentioned earlier, the cost of a car loan depends on a few factors. There’s the APR, which stands for Annual Percentage Rate and will be the interest rate you’ll pay on the car loan.
Interest is essentially the fee your lender charges for the loan, and the lower the APR, the less you’ll have to pay them over time.
The initial payment is also an important factor, it is the money that you contribute to make the purchase of the vehicle.
The term of the loan is the period of time you have to pay off the auto loan, often between 36 and 72 months.
And finally, there is the principal, which is the initial amount of the car loan. Over time, you will pay off the principal plus interest that you owe.
What is needed to finance a car?
The requirements to finance a car may vary slightly depending on the financial institution but, normally, it will be necessary:
- Being over 18 years
- Provide data and personal information: Full name, social security number and date of birth.
- Depending on your immigration status, you will be asked for a passport, residence card or any other valid document.
- Valid driver’s license : It can be issued in the United States or in any country, although that will depend on the financial institution
- Provide accurate address and proof of address: Typically, you will be asked to provide proof of address, such as an electricity, gas, telephone bill, etc.
- Provide employment data: You must provide information and documents that prove your current occupation, your salary and all sources of income.
They will also ask for your employer information.
- Financial information: The financial entity will request a credit report to know your credit score and your financial commitments. You will also want to know if you have any assets in your name.
- Hire an auto insurance policy : the financial institution will request an insurance policy for your car in order to minimize its risks.
You already know how auto financing works, but is it a good idea to request it?
Now that you know how financing a car in the United States works, you should carefully analyze your situation and the different options before making the final decision.
If you pay in cash, you may be able to avoid paying interest and loan fees . However, you could run out of savings and find it difficult to deal with an emergency.
Also, if you later need to buy tires or if you have to buy auto parts , you will not have money available to do so.
Read also: Places where used car parts are sold
You must also analyze the amount you finance with respect to the value of the car you are buying.
If you don’t make a down payment and decide to finance the full cost of the car, you could end up owing more than the value of your car in a year or two.
Car financing could be a way to take advantage of dealer incentives and special offers from automakers, such as 0% financing or rebates.
But keep in mind that, typically, to qualify for these offers you must obtain financing for your car through the manufacturer’s finance company.
IMPORTANT: If you sign a contract, get a copy of the signed documents before you leave the dealership or another creditor’s office.