How to Finance a Car (And Is It a Good Idea?)

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In the third quarter of 2020 alone, the total owed amount on motor vehicle loans in the US exceeded $1.21 trillion. That’s a massive increase of $30 billion from the same quarter of 2019! It’s also one and a half times as much as the auto loan debt incurred by US consumers a decade ago.

With so many outstanding auto loans, it’s no wonder they now account for about 10% of US household debt.

It’s not all bad news, though, as these loans enable consumers to finance car purchases. These financing programs make it possible for folks to “buy” a car now and then pay for it later in increments.

If car financing is new to you, you may be wondering how it works and what you need to apply. Does it even make financial sense?

Don’t worry, as we’ll answer all those questions in this guide. Read on to discover all the crucial facts you need to know about car financing.

What Does It Mean to Finance Car Purchases?

The average transaction price of new light vehicles in the US now sits at $40,000. Car shoppers turn to auto loans as some can’t afford or may not be willing to shell out all that cash for a vehicle in one go. Vehicle financing gives them an immediate source of funds to pay for a car purchase.

With car financing, you enter into a contract with a lender who then lends you money for your car purchase. In doing so, you agree to pay back the amount loaned, plus a finance charge, over time. The loan “term” dictates the number of months you have to pay back the loan in increments.

Most vehicle financing companies offer terms of 48 to 60 months. The lender then divides the total loan cost over this period. This is the formula they often use to determine how much your monthly payments would be.

Suppose your total loan cost, including the finance charge, sums up to $40,000. Let’s also say you choose a 60-month financing contract. In this case, you’d divide $40,000 by 60 (months), so your monthly repayment would be $667 for the next five years.

How Do You Finance a Vehicle Purchase?

The first step is to determine your credit score, as this is a chief loan eligibility factor. In the US, 69% of consumers have a good credit score of at least 670. Lenders prioritize borrowers with a good score and offer them better interest rates.

Bad credit car financing does exist, but you can expect them to come with higher interest rates. If you’re unsure what your credit score is, you can pull out a free yearly copy from each of the three US credit bureaus.

Once you know where your credit score stands, you can then take the following steps.

Fix Your Credit or Credit Report Errors

If you have a less-than-stellar credit score and your car purchase can wait, fix your score first. One way to do this is to pay off as much existing debt as you can. This can help raise your credit score, as credit balances account for 30% of your credit score.

You should also dispute any credit reporting errors as soon as you find them. These errors are quite common, affecting one in five US consumers. They pull your score down and hurt your chances of getting a good deal on an auto loan.

Figure Out How Much New Debt You Can Afford

Next, take a closer look at your financial situation to ensure you can pay back the loan. If you know where your finances stand, you can avoid borrowing an amount that exceeds your budget. One way to do this is to create a budget that maps out your living expenses and discretionary income.

Discretionary income is the money “left-over” after paying all necessary living costs.

Let’s assume you have a discretionary income of $1,000 even after you’ve allotted some for your savings. It’s a smart idea to use only part of that left-over income to cover potential monthly auto loan payments. For example, you may want to allot only about $600 to $650 for your car loan.

Consider Making a Down Payment or a Trade-In

Suppose the vehicle you want to purchase comes with the average $40,000 sticker price. If you borrow that entire amount, you may end up paying interest fees of $2,000 or even more. That stems from the average car loan interest rate of 5%.

A down payment can help you trim your vehicle financing costs as it reduces the amount you need to borrow. Even if you only put a down payment of $5,000 for a $40,000 car, it could still save you $250 on financing or interest fees.

You might also want to consider trading in a fully-paid vehicle. The trade-in value may be enough to offset a few thousand dollars off of your new loan.

Compare Your Vehicle Financing Options

A good piece of advice from https://www.plenti.com.au/car-loans/compare/ is to shop and compare loan offers. In doing so, you can learn which lenders charge the lowest interest rate. A 0.1% gap in interest rates can already mean hundreds of dollars in difference over the life of a loan.

Send Your Application in

Once you find an ideal financing offer, check the lender’s paperwork requirements. Don’t worry, as most financing companies now accept online applications. They accept digital copies of financial, employment, and owned asset records.

In many cases, it takes about a couple of days to hear back from a vehicle financing company. If you find it agreeable, you can proceed with the contract so that you can get the funds you need to take that new car home.

Switch Gears in a New Ride With the Help of Vehicle Financing

There you have it, your ultimate guide on how to finance car purchases with auto loans. While a car loan will add to your total vehicle buying costs, it can still be the fastest way to afford a new ride. Besides, you can avoid paying exorbitant financing charges by choosing the right lender.

Ready for more automobile-related tips and tricks like this? Then please feel free to browse our site for other automotive guides!

 

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