Guide to Financing
Everything You Need To Know About Vehicle Financing
- Should you buy or lease?
- If you buy...
- If you lease...
Financing with a bank vs. a dealership:
- If you finance with the dealership
- If you finance with your own lender
- Know your credit score when you apply for financing
- Get Pre-approved
- Getting pre-approved financing from a bank or credit union
- Stick to a budget
Remember, there's more to consider than just the sticker price:
- The 20/4/10 Rule
Things to Remember:
- Begin going to the dealership
- At the dealership
- After you've signed
Remember hearing those family stories about your grandfather spending $500 on a new car? Several decades later, he's still complaining about the high prices of yesterday while you're trying to imagine how amazing it would be to pay that price for a new car in today's economy.
Buying a new vehicle is one of the most complicated processes one can undertake. There are so many major considerations, from brand to color to options, plus whether to buy or lease, and how to finance the purchase. It's important to completely weigh each option, because they can add or subtract a large amount of money to the final price tag.
We understand that all of this can be really overwhelming to process and take in. This guide will explain, and help you to navigate, some of the financial options available to you.
When it comes to getting a car, you have several purchasing options. The dealership wants to see you behind the wheel of a new ride, so it will do what it can to help you decide on and purchase a vehicle; from a salesperson's standpoint, a satisfied customer means cash in the till. One of the first decisions you will need to make is whether to lease or buy the vehicle. Each option has its pros and cons, and it is important to consider each factor carefully.
Buying a car means you can own it for as long as you want, can drive it until the wheels fall off or pass it down to your oldest offspring when he or she turns 16 if you so choose. Once you pay off your loan, it is entirely yours. But with the complete ownership of the car comes the stress of dealing with a decline in its market value if the time comes to sell – unless you keep it long enough for it to be considered vintage, and therefore desirable in some cases. Still, the nice part of owning your own car means that there are no restrictions on, say, how many miles you can rack up. Again, it is your car to do with what you choose.
Buying a car is a great option if you can pay for it outright or, more likely, afford the monthly payment. But before you sign for a loan and drive off the lot in your new set of wheels, consider the following:
Are you entirely satisfied with what you're doing?
When you buy a car, it doesn't have the same return policy as a new outfit from Macy's. You also don't have the option of turning it in early like you can with a lease. Don't sign your name and take the keys before you are truly satisfied with your choice.
Are you absolutely certain you can afford the payments?
Buying a new car comes with all sorts of additional fees like registration charges, new insurance costs, and simple car repairs (oil changes, tire rotations, etc.). If you don't have the money to afford those fees in addition to the car payments, you should re-evaluate if this is the right time to buy.
Do you know what your credit history looks like?
Your credit history is going to have a big impact on how much you pay in fees and interest in the long run. Knowing what your credit looks like before heading to the dealership will help you avoid any surprises or anxiety when it comes to the financing portion of your purchase.
Leasing a car is kind of similar to renting an apartment. You establish an agreement with the dealership that allows you to use the car for a predetermined amount of time. Once that time passes, you return the car, pay end-of-lease fees, and walk away. Or you may enter into an additional agreement to purchase the car.
Most of the time, the monthly payments on a lease are lower than finance payments. When making a lease payment, you are paying for the vehicle's depreciation during the lease period, a rent charge, taxes, and fees. The bad thing about leasing is the fees that can accumulate. For example, if you end the lease early, you may have a substantial early termination charge. If you go over a certain number of miles on the car, you may be charged a fee as well.
Still, there are some advantages to leasing in addition to a sometimes lower monthly cost; namely, not having to worry about eventually selling it. But before you sign those papers and drive off the lot, consider the following:
What costs are associated with the lease?
When you are leasing the car, you still have to meet the leasing company's insurance standards and service the vehicle as recommended by the manufacturer. You may also have to put down a security deposit up front, but this is usually refunded at the end of your lease.
Am I getting the best lease offer and terms?
Make sure to pay special attention to the mileage limits. It's pretty standard to have a lease that limits you to 15,000 miles or fewer per year. Negotiating a higher limit means an increase in monthly payments. But you need to have a lease that is practical and functional for you and your needs.
How long will I want to keep the vehicle?
When you finish your lease, you have to return the vehicle. Unless you make a deal with the dealership, there is no purchase involved here. But if you do decide to purchase it after the lease term is over, you will ultimately be paying a higher price than if you had bought it outright in the beginning. If you want the peace of mind that you have a car at your complete disposal for a long time to come, then you shouldn't lease.
After you pick out your car and decide to buy it rather than lease it, it is time to make the decision about who to finance it through. It is natural to be nervous about making a long-term commitment to spending quite a bit of money, and worried about being taken advantage of. Still, there's no reason to panic – instead, take a breather and realize that you have options. You don't have to go with the financing offered by the dealerships. You can use your own bank, a credit union, or even an online lender. There isn't one right answer to the question of who you should finance through. There are just as many pros and cons to financing through the dealerships as there are for financing through a third-party company.
In some cases, dealerships act as their own "bank" and lend to customers; in others, the dealership works with several lenders to find the best rate for a purchaser. Not all dealership finance departments are a pit of hungry crocs hiding and waiting to devour you – and your wallet. There are actually a lot of good things about using them to finance your new set of wheels. Here are a few reasons to consider sticking with the dealership.
In-house financing is more convenient.It's readily available, either through an online application or right there in the dealership. It takes very little effort or forethought and makes buying a car a one-stop job.
Dealerships have access to more lenders.They often have several lenders that they can send your credit information to in order to find you the lowest rate. That means they do the shopping around and comparing for you. Often times, dealers have what TrueCar.com calls a wholesale-type relationship with the lenders that might allow them to offer you lower rates than you could find anywhere else.
Interest rates are negotiable. Their first offer may not be their best offer, so it's an opportunity for you to negotiate an even better deal for yourself.
Using the dealer's financing might make you eligible for special offers.Sometimes they are willing to throw in extra rebates, flex cash, or deals with 0 percent APR (for manufacturer loans) when you use their in-house financing, saving you even more in the long run.
People with poor credit can sometimes be approved this way.Though you will pay a higher annual percentage rate, it is more likely for those with shaky credit.
However, there are some disadvantages as well.
Here are a few possible deal-breakers that may lead you to seeking finance options elsewhere.
Sometimes there are tack-ons. Dealerships are often given a kick-back from the lenders for bringing them business, which can mean a mark-up of somewhere between 0.25 and 2 percent on your interest rate.
Dealers use lenders from all over.Getting a loan through the dealer may mean that you will be working with a bank halfway across the country. So if you have problems, you won't be able to just stop by the bank and resolve them.
Banks are a good choice for a loan if you have good credit. It is generally harder to get a loan from a bank, but if your credit is solid, you will likely get a lower annual percentage rate than with a dealer finance company. Some people would rather play it safe and just not have anything to do with dealership financing. It's understandable, especially if you established a trust and familiarity with that choice lender. However, you should know that going with a third-party lender – even one that you know – also has its positive and negative points. But let's start with the good:
You have the freedom to choose.Your personal bank, an online lender, and yes, even that small-town credit union you've had an account at ever since you were 14, are all possibilities. Each of them has the ability to finance your new ride, which means you can choose to go wherever you feel safest and most comfortable.
They may be easier to work with.No one ever plans to be late on payments or have trouble with their loan, but life happens. Your local connection may be more understanding, forgiving, and willing to work with you than a larger finance corporation.
The bank (or other financial institution) might offer better rates up front. Choosing your own place to finance your car may get you lower rates right from the start. For those who feel uncomfortable negotiating, this means less stress and anxiety about trying to make a deal.
You'll have more bargaining power.By getting yourself pre-approved for a loan through your chosen institution, you will already know what rates you are eligible for and have the knowledge and power to negotiate a better deal.
And now for the downside:
A private lender's first offer is usually its best offer.
A bank, credit union, or any other type of lender will pretty much give you its best offer right up front, so if you are the kind of person who likes to talk your way into a better deal, this would not be the way to go.
You have to do the work. This route requires you to go out and do research on your own. It means that you can't just spontaneously decide to run out and trade in your car for a new one whenever you feel like it. This route takes forethought, preparation, and some shopping around on your own time.
You have to have good credit.Again, while you'll get a lower annual percentage rate from a private lender, getting approval for the loan in the first place has stricter standards than those associated with dealer finance.
Ultimately, the trick to finding yourself a great deal doesn't just depend on who you get your financing through. No two cases are the same; no one has the same credit history, for instance, which means that lenders have to consider each loan application based on its own merits. There are some things to consider, however:
Before you even take the first steps in determining your financing plans, you need to check your credit reports with the three major reporting bureaus: Experian, Equifax and TransUnion. Do this far enough in advance of your vehicle purchase so that if you find any errors – not at all uncommon – you can have them corrected so that they won't negatively affect your ability to get a loan or your interest rate. You should also know exactly what your credit situation looks like so you don't have any surprises come up. You can get a free copy of your report from each of the three nationwide reporting agencies every 12 months. To order, visit www.annualcreditreport.com.
When you're all set to fill out a credit application, you will need to provide the following information:
Your credit application will be evaluated by the finance company using a credit scoring technique. Your credit history, income, expenses, and employment are factors that will be scored. Once they finish, you will usually get a free credit score disclosure notice. This notice will list your credit score, the source of that score, and details about where your score ranks among other consumers.
If you are using a private lender, or if the make of vehicle you are purchasing offers online applications, your best bet is to get pre-approved for a loan before you go into the dealership. This will allow you to know how much you can spend before you even leave the house.
Getting pre-approved financing from the dealership
Each auto manufacturer has its own financing department and will allow you to get pre-approved before you get to the dealership. If you are easily stressed by the financing part of your purchase, doing this in advance will help relieve some of that anxiety. Here's how it works:
- Go to the manufacturer's website and look for its financing section.
- Log in to their free online pre-approval system to begin the application. If you are buying a car with a co-applicant, you will have to go to the dealership to fill out the application. If you aren't applying with a co-applicant, you can continue the application as long as you are at least 18 years old, have a social security number, are a legal resident of the United States, have verifiable income and/or employment, and have an email address.
- Select the dealership you want to work with. Your information will also be sent to its finance department, so make sure you have the right one listed.
- Fill out the short application with your contact, employment, and income information. When you finish, hit that submit button!
- If you apply for financing during regular business hours, you should receive an answer by email within minutes. If you apply during your night-owl hours or on a Sunday, your notification should be in your inbox on the next business day.
- If you aren't pre-approved, don't panic. The dealership might have finance options all their own, separate from the manufacturer's, and there is always the bank/credit union option.
Most major banks, such as Chase and Bank of America, have a pre-approval program on their websites that you can use. But a local credit union or bank might require you to come to their location to fill out an application. Regardless of how you fill out the application, the process is fairly straightforward. Here's what you should expect:
- Stop by your banking location of choice and ask to speak to someone in its loan department. Explain to the loan officer that you are interested in purchasing a new car and would like to get pre-approved financing. If you are applying online, just visit the website for the bank you want to work with and look for their "Auto Loans/Financing" section.
- The application process will require a credit check but shouldn't include specific details on the vehicle you are looking to buy. If you know this information, giving it to the loan officer or filling it out on online can help you get the best loan. But the pre-approval will help you narrow down your choices if you are still shopping around. Keep in mind that some banks and credit unions have set limitations on what vehicles they will and will not give you a loan for.
- It will take you a few minutes to fill out their application and just as long to get an answer.
- If you are filling out the application online, a confirmation message will be sent to you as well as a message from the loan offer. If you weren't pre-approved, a message will be sent to you about any necessary follow up information and/or phone calls.
If your credit history isn't strong, some lenders will require you to have a co-signer on your contract. A co-signer assumes equal responsibility for the financing and is responsible for making the payments that the buyer doesn't. Because of that fact, it's important to trust those you are co-signing for and know that you can handle those payments on top of your other monthly finances should the worst happen. Of course, a co-signer is subject to the same credit check and approval as his or her co-applicant.
We know that there are those times when you have a transportation emergency and have to come up with a large chunk of money quickly to get back on the road. But if you can take the time to create a budget before jumping into the purchase process, we guarantee that you will save money, time, and headaches.
Keep in mind that affording a car goes beyond the purchase price – and even the purchase process itself. Sales taxes can add anywhere an additional 3 to 8 percent to your final total. Licensing and registration fees are different in each state and can cost an additional $35 to 200, in addition to a possible $10-30 fee for an inspection. Insurance also varies based on the car type, the coverage you want, and where you live.
One additional fee you don't want to forget to factor in is the interest rate, also known as the annual percentage rate. Whether your loan comes from the dealership, a bank, or a credit union, that institution has to make a profit to stay in business. For example, a 5-year loan for $25,000 at 2.5 percent interest will cost you $1,620.80 in interest alone over the life of the loan. Depending on your credit history and the facility you get the loan from, your interest rate can be very low or very high. The only way to completely avoid an interest rate is to pay cash for your car. The great majority of us can't do that, so shopping around for the best rate before making the purchase is the next best alternative.
You should also factor maintenance and repairs into your budget for a new car. For most sedans, maintenance will cost at least $350 per year for things such as oil changes, tire rotations, new tires, and new air filters. Repairs usually start to become more regular after the car is about three years old. If you aren't aware of these costs and don't prepare for them beforehand, they can really give you a financial wallop. Budgeting a little bit of money each month for maintenance or emergency repairs is the best way to avoid any surprises.
If you can swing it, use the 20/4/10 rule to buy the vehicle that you really want. Here's the process: put down at least 20 percent of the total up front so your payments are smaller and more manageable, finance the car for no more than four years, and spend no more than 10 percent of your gross income on total transportation costs. If you utilize this plan, you will save a minimum of $70 per month on your car payment for the purchase of a $15,000 vehicle if your annual percentage rate is 5 percent. That's more than $3,300 less than if you put no money down.
This is a lot of information to take in at once, so let's break it down into what you need to do before going to the dealership, while you're there, and when you're leaving.
- Figure out what it is you need from your new mode of transportation.
- Make sure you understand the differences between buying a vehicle and leasing one.
- Get an insurance estimate from your insurer of choice.
- Order a copy of your credit report and make sure all of your information is correct before trying to finance your vehicle.
- Use worksheets and budget formulas to figure out your financial situation and the budget you need to stick to.
- If you are trading in your current car, study up on the market value of that car. You may not get that full amount from the dealership, but you will have an idea of what numbers are acceptable and which are not.
- Stick to your budget and stay within your price range.
- Negotiate your final price and final financing or leasing terms. Don't settle until you are comfortable with the offer.
- Read every word of the contract carefully and ask any questions about the terms before you sign. Once that piece of paper is signed, you are legally obligated to the terms outlined in it.
- Be sure you have a signed copy of the credit contract or lease agreement in your hand before you set foot off the dealership's property. Don't have them mailed to you later.
- Make your payments on time. If you are late or have a problem making the payment, contact the creditor as soon as possible to come up with a solution.
- Know that if you aren't making your payments, your car will be repossessed and your credit will take a hit from which it might take years to recover.
We know that all of this financing talk can be confusing. Let us take a minute to clear up that confusion. Here is a list of the most important financing terms:
- Assignee — The bank, finance company or credit union that buys the contract from the dealer and supplies the money up front for the purchase; this is to whom the owner makes payments.
- Cosigner — An additional party who assumes equal responsibility for an auto loan, typically a very close friend or family member with strong credit who helps out a purchaser with less than stellar credit.
- Credit Report — A document that includes information on where you live, how you pay your bills (typically on time or delinquent), and whether you have been sued or have filed for bankruptcy.
- Credit Score — A number that generally ranges from 300 to 850 that reflects the credit risk you present based on information in your credit file. It is based on the following: payment history (35 percent), debt burden (30 percent), length of credit history (15 percent), types of credit used – the more, the better (10 percent) and recent searches for credit – the fewer, the better, because potential lenders are wary of lending money to people who are trying to get several loans at once (10 percent). The better your history of credit, the higher your score. Your credit score may be used to help decide the rate and other terms you are offered.
- Debtor — Another name for the borrower.
- Depreciation — The decrease in the market value of a vehicle over time.
- Down Payment — The initial amount you pay to reduce the amount you finance. The more you put down, the lower your payments will be and the less you will pay in interest over the life of the loan.
- Fair Credit Reporting Act — A federal law that regulates the disclosure of consumer credit ratings by credit reporting agencies. What this means is, everyone has the legal right to know what is in his or her credit report.
- Fixed Rate Financing — Financing where the finance rate stays the same over the life of the contract.
- Guaranteed Auto Protection (GAP) — Optional financial protection that pays the difference between the amount you owe on your vehicle and the amount you would get from your insurance company if the vehicle is stolen or destroyed before you have paid off your credit obligation.
- Lemon Law — Refers to various state laws protecting consumers against the purchase of vehicles found to be persistently defective.
- Manufacturer — The original producer of a vehicle.
- Manufacturer's Rebate — A program offered to buyers directly from the auto manufacturers to increase sales and reduce excess inventories. This is separate from any discounts offered by an individual dealership
- Manufacturer's Suggested Retail Price (MSRP) — The vehicle sale price that appears on a label affixed to the car window. This is also known as the sticker price.
- Prepayment Penalty — A fee that some lenders charge if you pay off the loan before the end of the term. This exists because while it would seem that lenders would appreciate getting their money back earlier, they don't like missing out on the extra interest they would have made if the loan had gone to term.
- Refinancing — The process of obtaining a new loan to replace an existing loan or lease balance. This is done if interest rates fall and a debtor has solid credit and good payment history.
- Repossession —If you aren't making payments on your vehicle, the creditor will have every right to take the car back without going to court or warning you.
- Title —A legal document providing specific information about a vehicle and who owns it. If you borrow money from a bank to purchase the car, they will hold the title on it until you make all of the payments. At that time it will be signed over to you; if you sell it, you will in turn sign the title over to the new owner.
- Truth-In-Lending Act —A federal law that requires lenders to disclose all terms of their loan in a uniform manner that makes it easy for consumers to compare.
- Underwater —A situation in which you owe more on your vehicle than it is actually worth. This is also known as being upside-down.
- Vehicle Identification Number (VIN) —A 17-character code that uniquely identifies each vehicle manufactured in the world. The VIN can usually be found on the dashboard of the driver's side or inside the doorjamb of the driver's door.
- Wholesale Rate (Buy Rate) —The finance rate at which an assignee buys a retail installment sale contract from a dealer.
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