How to Finance a Car in 5 Easy Steps

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Do you want to finance a car in the near future? Whether you’re buying your first car or looking for a replacement for your current car, it’s essential to educate yourself about the car financing process.

couple buying a  car

Financing a new or used car might seem overwhelming at first. Many people wonder what credit score they need and how much they need to put down on a car.

The answers to these questions will vary based on your lender, your cash flow, and the type of car you want to buy. By investing time in researching and educating yourself about car financing, you can enter the process with confidence and be ready to secure the best deal.

In this post, you’ll find everything you need to know about financing a car. Hopefully, this guide will answer all your questions about this process and help you get a new car at a price you can afford.

This guide is divided into five essential steps to help you obtain the best rate. Completing each step will ensure you get the best possible rate.

Step 1: Know What’s on Your Credit Report

Before you spend time researching which car you’ll be driving into the sunset, you need to know what’s on your credit report. Usually, the better the credit score you have, the better the interest rate you’ll get.

Credit reports sometimes have errors on them, which could lead to lower credit scores.

Go to www.AnnualCreditReport.com to get your credit report from all three major credit bureaus. If it’s been a long time since you’ve looked at your credit, take the time to look at your credit report from all three credit bureaus.

You should 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. So be prepared that the latter could take a few extra days.

Step 2: Repair Any Adverse Accounts

When looking at your credit history, you might notice adverse accounts at the top of your credit 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 a loan balance remains.

How is your credit score calculated?

The information on your report directly impacts your score. And your score determines how much you can finance. Your score is calculated based on five different factors:

CREDIT SCORE FACTORPERCENTAGE OF IMPACT
Payment History35%
Amounts Owed30%
Length of Credit History15%
Credit Mix10%
New Credit10%

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

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

What credit score is needed to buy a car?

Many lenders will offer car loans to people with poor or fair credit scores. However, if they approve you for an auto loan with poor credit, your interest rate will likely be higher than someone with an excellent credit score.

FICO SCORE RANGESFICO SCORE RATING
800+Excellent
740-799Very Good
670-739Good
580-669Fair
579 & belowPoor

If you have poor credit, a lender might ask you to make a larger down payment or prove your income.

What credit score is needed to finance a car with no money down?

You can get a car loan with no money down if a lender approves you. However, it is in your best interest to improve your credit scores before you seek auto financing.

If your annual percentage rate (APR) is too high on the car you buy, you risk becoming “underwater” on your car loan 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. Moreover, if you total the car in an accident, your insurance check might not cover the car’s value if you’re underwater.

That’s why it’s so important to take an in-depth look at your finances before financing a car, which brings us to step three.

See also: 5 Best Auto Loans for Bad Credit and No Down Payment

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.

To know how much car you can afford, first take a look at your income and expenses. Then, 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 creating a budget, make two columns, one with your income and one with your expenses.

Income

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

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 monthly car payment, you can 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.

Your income needs 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 pay for a car. If so, can you afford a brand new car, or should you get a used car? Can you get a luxury brand, or are you happy with any brand of car so long as it runs well? Can you get a car with low miles, or will you only be able to get something with high mileage?

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 for a loan.

Step 4: Apply to Multiple Lenders

There are many ways to finance a car:

  • At the car dealership
  • Through a bank or credit union
  • With a private, online lender

You can arrive at the car dealership to test drive cars. Then, if you decide you want to buy one, your dealership will likely have a dealership financing program. They may also have the ability to apply to multiple auto loan lenders on your behalf.

However, some people find it very helpful to apply to multiple online lenders, credit unions, or banks ahead of time just to see what they qualify for. So, if you apply to numerous lenders ahead of time, you will know whether you’re approved and for how much. That way, you won’t test drive a car that’s too expensive for your budget.

To get pre-approved for a car loan, lenders will look at your credit, and they might ask you for proof of income as well.

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

The best auto loans are the ones with the best loan terms and lowest APR. So, if you have a good relationship with your bank, they might offer you a low APR 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 for car buyers to consider when financing a car. Remember, the cost of your car is more than just your monthly auto loan 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 monthly payments (over a 48- or 60-month loan, for example)
  • Your total loan interest
  • Insurance
  • Sales tax 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 car loan. It might be tempting to get a long 72-month loan because of the low monthly payment, but remember that cars depreciate quickly. You want to avoid being underwater on your loan. A high interest rate combined with a longer 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 an auto loan with no money down if a lender approves you. However, typically, you should save at least 10-20% of the total cost of the car as a down payment.

Making a large down payment can lower the amount of interest you’ll pay over the life of the loan. It can also help you secure a lower interest rate on the loan, allowing you to save even more money in the long run.

Additionally, a larger down payment can also help you avoid paying a high amount of money up-front. This can help you keep more of your hard-earned money for other important expenses.

How long should I finance a car?

The length of the loan you choose should depend on your budget and financial goals. If you can afford to make larger monthly payments, you may want to opt for a shorter loan. Otherwise, you may want to consider a loan that is spread out over a longer period of time.

The longest car loans are for seven years or 84 months. However, according to Edmunds, more and more people are now financing cars for more than five years. Keep in mind that interest rates are usually higher for longer loan terms.

Plus, if you finance for seven years, you risk owing more on the car than it’s worth. So, even if a lender approves a used car loan for seven years, think long and hard before signing the loan agreement.

Step 5: Select the Best Lender

Once you’ve compared loan offers, you can select the best one. 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 the monthly payment and car loan term.

Once you approve the loan paperwork, sign on the dotted line, and make regular monthly payments. If you stick to your household budget and make your car payment on time every month, it will help improve your credit. It will also serve you well if you choose to repeat the car buying process a few years into the future.

Car Financing FAQs

What is the best way to finance a car?

The best way to finance a car depends on your individual circumstances. Shop around for a loan or financing option with the lowest interest rate and fees, and that allows you to make payments that fit your budget. You may also want to consider whether you want to buy or lease the car, and if you can pay cash up front.

Is it better to finance a car with a bank or dealer?

The best option for financing a car depends on your individual needs, credit score, and financial situation. It’s often better to finance through a bank because they tend to offer more competitive interest rates.

However, dealers may have special promotions and incentives that make their financing options more appealing. Ultimately, it’s best to compare offers from both sources and also online lenders to decide what works best for you.

What is the minimum credit score for a car loan?

The minimum credit score for a car loan will vary depending on the lender. Typically, lenders will require a credit score of at least 620 or higher for a car loan.

Does financing a car hurt your credit?

Financing a car can hurt your credit if you make late payments or default on the loan. Late payments are reported to the credit bureaus and can cause your credit scores to drop.

Additionally, defaulting on a car loan can result in repossession of the vehicle, which can have a more severe negative impact on your credit scores.

Otherwise, by making on-time payments, financing a car can help your credit a great deal.

What should you not do when financing a car?

Here are 10 things you should NOT do when financing a car:

  1. Skip any payments.
  2. Overextend your budget.
  3. Finance more than the car is worth.
  4. Sign a loan agreement without reading it thoroughly.
  5. Take out a loan with a high-interest rate.
  6. Forget to shop around for the best rates.
  7. Take into account other costs such as maintenance and insurance.
  8. Forget to investigate the dealership’s financing terms.
  9. Forget to ask about any additional fees or hidden charges.
  10. Agree to any terms or conditions you don’t understand or are not comfortable with.

Is it smart to do a 72-month car loan?

Most experts advise against taking out a 72-month loan due to the high interest rates and risk of going upside down. It is best to take out a loan with a term fewer than 60 months to get an optimal interest rate.

However, if you can afford the monthly payments and if the longer loan allows you to buy the car you want, then it may be worth it. Ultimately, it is up to you to decide if a longer loan term is the right option for you.

Catherine Alford
Meet the author

Catherine Alford is the go-to personal finance expert for educated, aspirational moms who want to recapture their life passions, earn more, reach their goals, and take on a more active financial role in their families.