Car Financing 101

Here are some steps to take when financing a car:

• Set a budget: Consider your monthly payment, fuel and/or electricity costs, and insurance. You'll also need to pay for taxes, tag costs, and fees, which can vary by state.
• Check your credit score: A lower credit score may require a larger down payment or higher interest rate.
• Pre-qualify for a loan: This gives you more flexibility and bargaining power at the dealership.
• Research your options: Consider loans from your bank or credit union, and check for dealer incentives.
• Calculate your loan amount: Use an affordability calculator to determine how much you need to borrow.
• Consider your trade-in: The value of your trade-in can be used toward the loan amount.
• Don't discuss financing until you know the final cost: Wait until you know the final price, including all fees and taxes.

Your interest rate will depend on your individual situation and the offers you receive. To ensure you choose the best offer, compare multiple ones and consider the following factors:

• Used vs. New: Interest rates on used cars are usually higher than those for new cars.
• Credit unions: Credit unions often offer lower costs and better rates than traditional banks.
• Loan term: Longer loan terms result in lower monthly payments but keep borrowers in debt for longer.
• Down payment: Borrowers with poor credit may need to make a larger down payment to receive a more favorable interest rate.

Yes, but don’t trade in a car that’s worth less than what you owe. In other words, if you get less when trading it in than the loan payoff, don’t do it. In the finance world, this is what’s called being “upside down” or “underwater.” The result of trading in a vehicle in which you are underwater is that you are transferring that same issue to your next vehicle. That’s because the difference between what you owe and your car’s value is rolled into the amount financed on your next car. Consequently, right off the bat, you ensure you’ll be deeper upside down into the loan term of your next car.

Car financing allows you to pay off the purchase price of a vehicle over a period of time, typically in monthly installments. The period of financing time can vary but usually lasts several years. The main benefit of financing a car is that it allows you to buy a vehicle without paying the total purchase price upfront. In most instances, you’ll need to make a down payment, but dealers and car-financing companies sometimes make special offers that don’t require one.

Credit Unions: Credit unions are owned and financially controlled by their members. This often means lower costs and better rates for members compared to traditional banks and other financial institutions. While it may be more challenging to qualify for membership at a credit union, joining one can mean access to lower interest rates on your next car loan.

• Credit Union Pros: Owned and operated by members, lower interest rates
• Credit Union Con: Often requires a credit score in the "good" or "excellent" range

Banks: Traditional banks, both large and small, offer car loans to customers as part of their overall lending services. They’re for-profit and usually have access to a broader range of financial products and services. For this reason, they can offer more competitive interest rates, which could work in your favor if you have a strong credit score. While it’s typically easy to apply online, some banks may have a more complicated application process and require you to submit paperwork in person.

• Bank Pros: More financial products and services, competitive interest rates
• Bank Con: Longer application process for borrowers with subpar credit

Dealerships: Dealerships are arguably the most convenient option for financing a car. When you’re planning a big purchase, it’s nice to have a “one-stop shop” and do everything in one place. Bigger car dealerships often work with various national banks and lending partners to provide attractive financing options. Customers can also claim incentives and promotions when financing directly through the dealer, making it the more attractive route. Still, this financing option typically comes with higher interest fees — even if you have excellent credit.

• Dealership Pro: Many dealers include incentives, cash bonuses, and promotions when you finance with their lending partners
• Dealership Con: Finance negotiations often take longer

There are several factors to consider when deciding whether or not to finance the purchase of a car.

• Pros
• Financial Flexibility: Most car shoppers can’t comfortably pull tens of thousands of dollars from their bank accounts. Financing a car can prevent you from overextending how much you spend on a vehicle in the short term. Financing also allows you to invest cash you currently have in other investments that have a positive return over a longer period of time, whereas a vehicle will depreciate as soon as it's purchased.
• Wide Selection of Vehicles: Car loans typically give you a more comprehensive selection of vehicles to choose from because you are not limited to what you can afford at the moment
• Incentives: Manufacturers often offer buyers with stellar credit scores lower interest rates and sometimes zero interest on a new vehicle.
• Building Credit History: Financing through a bank or dealership is one way to demonstrate you are a good borrower, which would be necessary for future large purchases like a home.
• Cons
• Interest Payments: Depending on the terms of your loan, financing a vehicle can cost sometimes thousands of dollars more in interest, especially if you have a lower credit score.
• Penalties: Missing interest payments can result in damage to your credit history or possibly the repossession of your vehicle.
• Commitment: Financing a vehicle is a commitment over multiple years. The average loan length is between five and six years.
• Depreciation: The value of the vehicle will decrease while you are still making payments. In some situations, you risk being “upside-down” on the loan, owing more than the car is worth.

A down payment between 10 to 20 percent of the vehicle price is the general recommendation. A common rule of thumb is to put down at least 20% of the price for a new car and 10% for a used car. However, you should base your down payment on what you can afford and what makes sense for your financial situation. A larger down payment will lower your total loan costs, and will result in smaller monthly payments. For an accurate estimate of your vehicle loan costs, check out Kelley Blue Book's Auto Loan Calculator.

The monthly cost of a $20,000 car loan depends on the term of the loan and your interest rate. For example, a $20,000 loan at 5% interest over 60 months could cost around $382 per month, while the same loan over 48 months would cost around $466 per month. Factors to consider when taking out a car loan include interest rate, loan term, down payment, credit score, and affordability. For an accurate estimate of your vehicle loan costs, check out Kelley Blue Book's Auto Loan Calculator.

There is no universal minimum credit score required to get a car loan, but lenders tend to prefer a score of at least 600 when financing a vehicle. Keep in mind that a higher score is generally better when it comes to car loans. Scores of 700–850 can mean lower interest rates and more flexible loan terms. Lower credit scores can make it more difficult to get approved for are generally associated with higher interest rates, which means higher costs in the long-run. For an accurate estimate of your vehicle loan costs, check out Kelley Blue Book's Auto Loan Calculator.