auto financing guide
Rates, Credit, Loans & More
What Is Auto Financing?
Purchasing a new vehicle consists of two significant steps — finding the perfect car and securing auto financing. While most people invest time in researching the best vehicle options, many don’t do their due diligence when going through the financing process. Don’t be one of those people. This guide will serve as your one-stop shop for the basic principles related to qualifying for and selecting the best auto financing option for your next big purchase.
Unless you can pay for your vehicle in cash at the time of purchase, you will need auto financing to get a loan. Buying a vehicle using auto financing increases the amount you will pay over time. This is because you’re now paying interest and other costs associated with the loan on top of the price of the vehicle.
How Credit Impacts Your Auto Financing Options
Your credit score can determine whether you qualify for an auto loan or not and the annual percentage rate, also known as APR, of your loan. Qualifying for a low APR is important because the higher your rate is, the more interest you’ll pay. We recommend that you check your credit report 3–6 months before applying for auto financing. Doing this in advance provides you with the time to make improvements to your credit if necessary.
If you have good credit, you can move forward with obtaining financing. However, if your credit is less than impressive, and you can delay applying for a new loan, it would be best to fix the issues with your credit to improve your score.
How To Improve Your Credit Score
Here are a few tips to help you boost your credit score and qualify for better auto financing terms, which can save you hundreds or even thousands of dollars over the life of the loan.
- Pay off as much debt as you can to creditors — specifically high-interest debt
- Pay off any credit card debt you can — the goal is to keep your utilization rate below 30% if they’re not paid off in full
- Ask for an increase for your credit card limits, as doing so will immediately decrease your utilization rate
- Stop using your credit cards if at all possible unless you are paying them off in full each month
- Be sure to make all of your payments on time
- Don’t put any hard hits on your credit by applying for loans or credit cards
- Become an authorized user on a responsible person’s credit card to reap the benefits of their credit
If your credit doesn’t qualify you for the auto loan you want, you might consider getting a cosigner who can be a friend, relative, or significant other. Just be sure you can afford the payments because your cosigner will be responsible for them if you fail to pay.
Loan Rates
Your auto financing rate refers to the APR for your loan. You want to check your credit in advance of getting a new vehicle because the higher your credit score, the lower your interest rate, and the less you’ll pay on your loan over time. For example, if your credit score is between 690 and 719, your average interest rate will be 4.95%. On a $25,000 60-month loan, you will pay $3,273 in interest.
To the contrary, If your credit score is 100 points lower, between 590 and 619, your average interest rate will be 14.06%. On a $25,000 60-month loan, you will pay $9,949 in interest. A 100-point credit score reduction can cost you over $6,000 in interest alone. That demonstrates the power and importance of your credit score and the APR you qualify for.
Loan Terms
The average auto loan is for 60-months or five years, though some companies offer six and even seven-year loans. The best practice is to choose a loan that you can pay off as quickly as possible. While longer loans decrease your monthly payment, you pay more over the life of your loan.
For example, if you purchase a $25,000 car with a 4.95% APR on a 60-month term, you will pay $471 per month and $3,273 in interest over the life of the loan. If you purchase the same $25,000 car with a 4.95% APR on a 48-month term, you will pay $575 per month and $2,608 in interest over the life of the loan. That’s a savings of over $600 in interest, just by paying the loan off one year earlier.
Different Types of Auto Financing
There are many options available for securing an auto loan these days. Whether your score is in the upper 700s or falls below 600, there is generally a lender who can help you obtain a loan.
Banks & Credit Unions
Getting pre-approved by a bank or credit union allows you to walk into the dealership prepared to make a purchase with terms that work for you. Credit unions tend to offer the lowest interest rates.
Dealer Financing
If you get financing through the car dealership, be prepared to negotiate terms because this can be one of the most expensive options.
Buy Here, Pay Here
These dealerships tend to market their services to customers with less than perfect credit. Since they are working with buyers who have fewer auto financing options, their interest rates tend to be the highest. If this is your only option, we recommend that you improve your credit to qualify for better terms.