Do you want to finance a car in the near future? Whether you’re in the market for your first car or looking for a replacement for your current car, it’s important to be educated about the car financing process.

couple buying a new car

Financing a car might seem overwhelming at first. Many people wonder things like, “What kind of credit score do you need to buy a car?” and “How much do you need to put down on a car?”

The truth is that the answers to these questions will vary based on your lender, your cash flow, and the type of car you want to buy. However, if you conduct enough education and research ahead of financing a car, you can go into the process confident and prepared to get the best possible rate.

Luckily, you don’t have to go far to get this information. In this post, you’ll find everything you need to know about how to finance a car. It’s the ultimate guide that will hopefully answer all your questions about this process and help you get on your way into a new car at a value you can afford.

This guide is organized by five important steps. You should complete each step in order to finance a car at the best possible rate.

Step 1: Check Your Credit Report

Before you spend time researching the type of car you’ll be driving into the sunset, you need to check your credit report. Usually, the better credit you have, the better the interest rate you’ll get when you finance a car.

Credit reports sometimes have errors on them, and inaccurate credit reports could lead to lower credit scores. So, go to www.AnnualCreditReport.com to get your credit report. This is a secure portal that will allow you to look at your credit report from all three main credit bureaus. If it’s been a long time since you’ve checked your credit report, take the time to look at your report from all three bureaus.

You should be able to enter your personal information such as address, social security number, and more to verify your identity. However, if that doesn’t work, the credit bureaus might ask you to request your report in writing. Be prepared that the latter could take a few extra days.

Step 2: Repair Any Adverse Accounts

Once you’re able to see your credit report, you might notice adverse accounts at the top of your report. These are accounts that have been sent to collections or bills that are past due. Underneath that section will be your accounts that are in good standing. You’ll also be able to see the balances on those accounts if balances still remain.

How is your credit score calculated?

The information on your credit report directly impacts your credit score. Your credit score determines the type of car loan you can get. Your credit score is calculated based on five different factors:


How Your Credit Score Is Calculated

Impacts on Your Score by Percentage
Payment History
35%
Amounts Owed
30%
Length of Credit History
15%
Credit Mix
10%
New Credit
10%

As evidenced by the chart above, the best way to improve your credit score quickly is to improve your payment history and your amounts owed. These impact your score the most.

When you owe a collections agency money, that reflects negatively on the “Payment History” portion of your credit score. When you pay your bills on time, you will have a good payment history. Lenders like to see this because it implies you will also pay them on time when you finance your car.

What kind of credit score do you need to buy a car?

Many people wonder what kind of credit score you need to buy a car. There are many lenders who will offer car loans to people with poor or fair credit scores. However, if you are approved for a car loan with a poor or fair score, your interest rate will likely be higher than someone with a very good score.


FICO Score Ranges

FICO Score Rating

800+

Excellent


740-799

Very Good


670-739

Good

580-669

Fair

579 & below

Poor

If you have a poor or fair credit score, a lender might ask you to make a larger down payment or show proof you earn a certain type of steady W2 income.

Can you buy a car with bad credit and no money down?

Yes, technically you can get a car loan even with bad credit. Additionally, you can finance a car with no money down if a lender approves you. However, it is in your best interest to improve your score before financing a car.

If your interest rate is too high on the car you buy, you risk becoming “underwater” on your car loan very quickly. Being underwater on a loan means you owe more on your car than it’s worth. This can make it hard to sell without losing money. Also, if you total the car in an accident, your insurance check might not cover the value of the car if you’re underwater.

That’s why it’s so important to take a deep look at your finances before financing a car, which takes us to step three.

Step 3: Create a Car Budget

We all have dreams of the car we want to drive someday. However, before getting your heart set on driving a certain vehicle, first create a car budget.

In order to know how much car you can afford, first take a look at your income and expenses. List all of these in a document, and you can see what your overall household budget is month to month.

Example of a Budget

When you create a budget, make two columns, one with your income and one with your expenses.

In the income column include:

  • W2 Income from your day job
  • Income received from side hustles
  • Income received from investments

Once you know your income, then fill in your expenses.

Expenses usually consist of:

  • Your house or rent payment.
  • Your household bills like electricity, cable, Internet service, and water.
  • Insurance (life insurance, house insurance, health insurance, & car insurance)
  • Phone bill
  • Gas/Transportation costs
  • Student loan payments
  • Daycare bills/babysitters
  • Groceries
  • Out of pocket medical costs
  • Your car payment

The Importance of a Car Budget

Once you have a firm understanding of your household budget and how much room you have to spare for a car payment, you can then create a budget for your car. You should have a budget for your car because it’s likely going to be one of your biggest monthly expenses. And, your income needs to be able to cover all of your expenses, preferably with room to spare for saving and investing. So, when you’re looking for your next car, run the numbers.

Ask yourself if there is even room in your budget to purchase a car. If so, can you afford a brand new car or do you need to purchase a used car? Can you purchase a luxury brand or are you happy with any brand of car so long as it runs well? Can you purchase a car with low miles or will you only be able to purchase a high mileage car?

Buying a car is a big decision, so you should take as much time as you need to run these numbers. Once you know the price of a car you can comfortably afford, it’s time to apply to lenders and ask them if they will finance a car.

Step 4: Apply to Multiple Lenders

There are many different ways to finance a car:

  • Through the dealership.
  • Through a large bank.
  • With a small credit union
  • With a private, online lender.

You can arrive at the dealership to test drive cars. If you decide you want to buy one, your dealership likely has their own financing program or the ability to apply to multiple lenders on your behalf.

However, some people find it very helpful to apply to multiple lenders ahead of time just to see what they qualify for. It would be heartbreaking, not to mention embarrassing, to sit down at the dealership ready to buy a car only to be denied a loan.

So, if you apply to multiple lenders ahead of time, you will know whether or not you’re approved and for how much. That way, you won’t test drive a car that’s too expensive for your budget.

In order to get pre-approved for a car loan, lenders will check your credit score, credit history, and they might ask you for proof of income as well.

Is it better to get a car loan from your bank?

The best car loans are the ones with the best terms and lowest interest rate. So, if you have a good relationship with your bank, they might offer you a low interest rate and little to no fees. However, if a different bank or a credit union in town offers you a better deal, sometimes you could save hundreds or thousands of dollars by getting a loan from them instead.

How much does financing a car cost?

There are a few costs to consider when financing a car. Remember, the cost of your car is more than just your monthly payment. You need to consider the total cost of the loan, the interest you’re being charged, and the taxes you have to pay.

Here is a list of costs to consider:

  • Your down payment.
  • Your total payments (over a 48 or 60 month loan, for example)
  • Your total loan interest
  • Insurance
  • Taxes and title costs

We recommend using an auto loan calculator to find out how much interest you’ll have to pay over the life of a loan. It might be tempting to get a long 72-month loan because of the low monthly payment, but remember that cars depreciate in value quickly. You want to avoid being underwater on your loan. A high interest rate combined with a lengthy loan term could mean you owe more than your car is worth over time.

How much do you need to put down on a car?

You can get a car loan without money down if a lender approves you. However, making a downpayment shows a lender you’re willing to take buying and financing a car seriously. Even a $100 or $500 down payment is better than no down payment at all.

How long will they finance a used car?

The longest car loans are for 7 years or 84 months. According to Edmunds, more and more people are now financing cars for more than 5 years. Keep in mind that the longer the loan, the higher your interest rate usually is.

Plus, if you finance a car for 7 years, you risk owing more on the car than it’s worth. So, even if a lender will approve you for a used car loan for 7 years, think long and hard before signing on the dotted line.

Step 5: Select the Best Lender and Finance Your Car

Once you’ve reviewed all your lending offers, it’s time to select the best one and finance your car.

When you get your loan paperwork, be sure to read the fine print. Make sure that everything in your loan paperwork matches what you agreed on. Double check that the monthly payment and the term of the loan are what you want.

Once you approve of the loan paperwork, sign on the dotted line and make regular payments. Remember from the chart earlier in the article that your payment history makes up 35% of your credit score.

If you stick to your household budget and make your car payment on time every month, it will help improve your credit score. It will also serve you well should you choose to repeat the car buying process a few years into the future.