Understanding Auto Financing: Options for Funding a Car Purchase
By Natalie Moritz | Legally reviewed by Melissa Bender, Esq. | Last reviewed May 17, 2024
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With prices averaging more than $47,000 for a new vehicle and $27,000 for a used vehicle, most consumers need financing or leasing to buy a vehicle.
While auto financing has its advantages, it also means you'll ultimately pay more for the vehicle due to interest. Before signing a vehicle financing agreement, you'll want to understand annual percentage rates, types of financing, and the role your credit score plays in the process.
This article breaks down what you should know before financing a car purchase. Learn about:
- Direct lending, dealership financing, and auto loan assignments
- What happens if you pay off your loan early
- Financing a used vehicle
See FindLaw's Buying a Car section for additional information, resources, and answers to FAQ.
Direct Lending vs Dealership Financing
Instead of dealership financing, some car buyers use direct lending. This means they obtain a loan from a finance company, online lender, bank, or credit union.
Whether you get your auto loan through a bank, credit union, or dealership financing, you agree to pay the financed amount and the cost of interest over a set period of time.
With dealer financing, the dealership works with a network of lenders to arrange the loan. Some automotive manufacturers, like Ford, have their own financing arm. This means some dealership financing goes through the manufacturer of the vehicle you're purchasing instead of a network of lenders.
Some car dealerships retain the financing contract. Others sell the loan to a financial institution that manages the loan.
For the vehicle buyer, dealer financing offers:
- Convenience: Dealers offer buyers vehicles and financing in one place
- Multiple financing relationships: The dealership's relationships with various banks and finance companies mean it can offer buyers broader financing options
- Special programs: Dealerships may offer manufacturer-sponsored, low-rate programs to buyers
Prepare for Auto Financing Before You Arrive at a Dealership
Research loan options and vehicles before you go to a dealership. This can empower you to make more sound financial decisions and help you negotiate a lower interest rate with the dealer. Look into the following:
- Determine how much you can afford to finance and spend each month on a payment plan. Create a budget to see what you can comfortably spend on a new vehicle.
- Get a copy of your credit report so you know what creditors will see. Errors or inaccurate negative information can impact your ability to get credit and your finance rate. The better your credit, the easier it'll be to get preapproved for a loan.
- Assess your lifestyle and transportation preferences. Consider the size of the vehicle you need, whether you commute, and what the primary use will be. Avoid looking at vehicles with expensive, unnecessary features.
- Check auto buying guides, like Kelley Blue Book and Edmunds, to research the price range and other information for the vehicle you want to buy.
- Compare current finance rates by contacting various financial institutions. Compare bank quotes and dealer quotes. There may be restrictions on the most attractive rates or loan terms from any credit source.
- Get quotes for the value of your trade-in. Check Kelly Blue Book and instant cash offer services like Carvana and Carmax. You can even take your vehicle to other dealers for in-person valuations.
While your goal is to secure yourself lower monthly payments, be aware of what you're buying and how you're financing it.
What Happens When You Apply for Vehicle Financing
Most dealerships have a Finance and Insurance (F&I) Department, which provides financing services. The F&I Department will ask you to complete a credit application. Information on this application may include:
- Your name, social security number, and date of birth
- Current and previous addresses and length of stay
- Current and previous employers and length of employment
- Sources of income and total gross monthly income
- Financial information on existing credit accounts
The dealership will obtain a copy of your credit report, which contains information about current and past credit obligations, your payment record, and data from public records. For example, it would show a bankruptcy filing obtained from court documents.
For each account, the credit report shows:
- Account number
- Type and terms of the account
- Credit limit
- Most recent balance
- Most recent payment
The comments section describes the current status of your account, including the creditor's summary of past-due information and any legal steps regarding debt collection.
From Dealerships to Banks: Auto Loan Assignment
Dealers often sell your contract to an assignee, such as a bank, finance company, or credit union. The dealership submits your credit application to one or more potential assignees to determine their willingness to purchase your contract from the dealer.
These finance companies or other potential assignees will evaluate your credit application. They will weigh and score different aspects of your creditworthiness, including:
- Your credit score and credit history
- Length of employment
- Income and expenses
Since the assignee does not deal directly with the prospective vehicle purchaser, it bases its evaluation upon:
- What appears on your credit report
- The completed credit application
- The terms of the sale, including the total loan amount and your down payment
Each potential assignee decides whether it is willing to buy the contract and notifies the dealership of its decision. If applicable, the assignee will offer the dealership a wholesale rate at which the assignee will buy the contract, often called the buy rate.
Special Offers and Manufacturer Incentives
Your dealer may be able to offer manufacturer incentives like reduced finance rates or cash back on specific models. You may see these specials advertised in your area. Ask your dealer if the model you want has any special financing offers or rebates.
In general, discounted loan rates have limitations and restrictions. For example:
- They tend to be non-negotiable
- They may be limited by a consumer's credit history
- They are available only for certain models, makes, or model-year vehicles
When no special financing offers are available, you can negotiate the annual percentage rate (APR) and the terms for payment with the dealership, just as you negotiate the price of the vehicle.
The APR you negotiate with the dealer is often higher than the wholesale rate described earlier. This negotiation can occur before or after the dealership accepts and processes your credit application.
What Influences Your Interest Rate
Several factors influence your annual percentage rate (APR), or interest rate:
- Your credit history and score
- Current finance rates
- Competition among lenders and financial institutions
- Market conditions
- Special offers and incentives
A better credit rating will get you a better APR.
Will I Need a Co-Signer for My Auto Loan?
The creditor may allow you to have a co-signer sign the finance contract with you to make up for any deficiencies in your credit history. A co-signer assumes equal responsibility for the contract. The auto loan's account history will also appear on the co-signer's credit history.
For this reason, exercise caution if asked to co-sign for someone else. Since many co-signers end up being asked to repay the obligation, be sure you can afford to do so before agreeing to be someone's co-signer.
Paying Your Auto Loan Off Early
Paying off your car loan early will save you money in interest. It may also improve your debt-to-income ratio on your credit report.
However, some lenders issue a prepayment fee for car owners who pay off their loan before its maturity date, or the end of the loan. This is because lenders make money off the interest you pay on your loan. Make a careful review of the terms of the loan before you sign a financing agreement. Ask about prepayment fees or other penalties for paying the loan off early.
Consider your overall finances before paying off a car loan early. For example, prioritize other debts with higher interest rates, like those on credit cards. You also want a solid emergency fund in place before paying off your car loan.
Another option for reducing the total amount of interest is to add a little extra to the monthly payments for your loan. Be sure to indicate you want any supplementary payment applied to the principal balance. This strategy will result in you paying less in interest over the life of the loan, but any lender prepayment penalties may still apply.
Used Car Financing
Financing a used vehicle differs from financing a new vehicle. Knowing why can help prepare you for the buying process.
Loans for used vehicles often have higher interest rates than new car loans. This is because borrowers view used vehicles as higher risk due to their potential for mechanical issues. Even though used vehicles have a lower purchase price, you'll likely pay more in interest throughout the life of the loan.
Still, there are benefits to financing a used car instead of a new one. New vehicles have faster depreciation rates than used vehicles, putting new car buyers at greater risk of going upside down on their car note. This is a concern for new vehicles with longer-term loans. Because used vehicles don't have a quick depreciation rate, it's less common for owners to owe more than the vehicle is worth.
Legal Help for Car Loan Issues
If you're facing legal issues or disputes related to an auto loan, you may want to consult an attorney. While most consumers can resolve vehicle financing issues on their own, some situations necessitate professional help. Borrowers can misrepresent the loan terms or not follow fair lending laws.
A consumer protection attorney knowledgeable in both state and federal laws can assess if a borrower infringed on your consumer rights. They can also negotiate on your behalf for vehicle repossessions or situations of financial hardship.
Contact a consumer protection attorney in your area to learn how they can help you resolve your auto loan concern.
Can I Solve This on My Own or Do I Need an Attorney?
- Consumer legal issues typically need an attorney's support
- You can hire an attorney to enforce your rights for safe products, fair transactions, and legal credit, banking and related financial matters
Legal cases for identify theft, scams, or the Equal Credit Opportunity Act can be complicated and slow. An attorney can offer tailored advice and help prevent common mistakes.
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