What Does It Mean to Finance Your Car

Buying a car is a major purchase typically second only to buying a home. For most people, it means financing through an auto loan. The route to getting behind the wheels of your dreams can be found by saving up cash or leasing a car much like one would rent an apartment.

Unlike buying a home, you won't have a real estate agent to guide you through making decisions and the steps to acquiring financing. Use this guide to what it means to finance a car and why you should do it.

What it Means to Finance a Car

Financing a car involves taking out a loan with a bank or other financial institution. You then purchase the vehicle with the money loaned to you. You have the option of either financing the total cost of it or making a downpayment and then financing the rest. The loan is then paid off in installments that include interest and fees.

Your loan is secured by using the car you financed as collateral. Unlike leasing a car, you technically own it. However, the lender has the right to repossess the car should you default on payments or violate any terms of the agreement. Most lenders allow for hard times and will work with you for a couple of months before sending a repo company to your home to pick the car up.

You can finance a car through practically any lending organization including the car manufacturer, credit unions, banks, and online lenders. Once the loan terms are satisfied, the vehicle is solely yours.

Factors to Consider When Financing a Car

Financing a car is fairly easy but there are some factors, like the following, you should be familiar with.

Down Payment

Most financiers will loan money for a car purchase without a downpayment. However, since the downpayment must be made using cash you have on hand, doing so will increase your chances of getting the loan and getting a lower interest rate. A downpayment shows that you are committed to the loan.

Annual Percentage Rate

The APR you pay over the terms of the loan is what you pay the lender to borrow money. It's based on your creditworthiness as determined by your credit score. Buyers who have a good credit score are more likely to qualify for a lower APR.

Terms and Conditions

The time you are given to pay back the car loan is known as the loan terms. Although it's typically a period of 36 to 72 months, some lenders will let you borrow for shorter or longer terms. You will be given paperwork that outlines the terms and conditions of the loan.

Steps to Financing a Car

The traditional way to finance a car involves going to a dealership, browsing for the vehicle you want, and perhaps taking a test drive. After choosing the ride of your preference, the dealer then guides you through obtaining financing through a lender. These days, you can shop for a car online and even obtain financing without leaving the house. You can either pick the car up at a vending location or have the car delivered to you.

Either way, the process is the same, and you should follow these steps to finance a car.

Check Your Credit Score

Know your credit score before you begin. You can get a free credit report weekly from Equifax, Experian, or TransUnion.

Prequalify

If you take the step to prequalify for a car loan, you'll get a better idea of how much you can borrow. The prequalification process considers your credit score and other basic information such as your income. It is not a loan application and doesn't guarantee you'll get approved. It simply helps you shop for cars in your price range.

Pick Out Your Car

Now for the fun part: shop for a car in person or online.

Why You Should Finance a Car

Upfront Funding

It can take years to save up for a car. Not many buyers can come up with the cash right away. Financing lets you spread out the expense over time and makes it more possible to own a good car. Keep the car purchase within your budget by choosing one that costs no more than 20% of your monthly income after taxes. Include related expenses like gas and insurance.

A More Reliable Car

The newer the car and the better the condition it's in, the higher the sticker price. Enabling yourself to get a new or gently used preowned car will mean you'll have a more reliable car with fewer repairs. This can save you money in the long run.

Outright Ownership

Eventually, the car you finance will belong to you after all the payments have been made. This makes financing a car more desirable than leasing one. If you take care of your car, you'll build equity and can use it as the downpayment for your next ride.

Improved Credit Score

Paying your car note on time and eventually paying it off will increase your credit score and give you more future buying power.