Buying a car is a huge deal. Besides purchasing a home, a vehicle is likely the most expensive object you’ll own. The average new automobile costs a whopping $34,648, reported Kelley Blue Book. But whether you’re buying a new or used car, expect to pay thousands.
If you’re like most people, you don’t have $30,000 sitting in a bank account waiting to be spent. In fact, an Experian study shows the majority of buyers rely on loans to buy a car rather than paying cash. But figuring out how to finance a car can be tricky for new shoppers.
How to finance a car
Financing a vehicle means you’ll borrow the money you need to purchase the car. You’ll have to repay it over a set period, plus you’ll pay interest to the lender.
Your loan’s interest rate can vary depending on your credit score and income. If you have poor credit, you’ll pay more in interest than a borrower with excellent credit.
However, it’s possible to get a loan with less-than-ideal credit. If you’re trying to figure out how to finance a car, here are five approaches to consider.
1. Dealer-sponsored loans
Car dealerships try to make the buying process as quick and easy as possible to maximize their chances of making a deal. That’s why most dealers offer to finance within the dealership itself.
Dealer-sponsored car loans can certainly be convenient, but they tend to be best if you have excellent credit or if you’re buying a late-model car. To complete the sale and get the cars off the lot, dealers often offer valuable incentives if you finance the purchase through them. In some cases, you might even be able to get a zero-interest loan.
If your credit is less than stellar, a dealership might say you’re ineligible for a low-interest loan. You could still borrow money from the dealership, but you might be hit with high interest rates and more expensive payments.
For example, say you borrowed $20,000 at 2.00% APR, and had five years to pay it back. Your monthly payment would be $350 a month and you’d pay back just $21,033 in total.
However, if the dealership thinks you’re a risky borrower, you could be offered a loan with a much higher interest rate (if you got a loan at all). Say you get the same loan as above, but with an interest rate of 8.00%. At that rate, you’d pay $405 a month and pay $24,332 over the life of your loan.
2. Credit union loans
If you don’t qualify for a dealership’s promotional offers or low rates, the best way to finance a car could be through a credit union.
Credit unions are nonprofit organizations that work differently than traditional banks. That means they often have more generous loan acceptance rates and lower interest rates.
To finance a car with a credit union loan, you would need to visit the credit union either in person or online before going to the dealership. If the institution approves your loan application, it could take a few days to access the money.Although getting a loan through a credit union can take more time and work, it can be worth it to receive a loan at a cheaper rate.
Although getting a loan through a credit union can take more time and work, it can be worth it to receive a loan at a cheaper rate.
3. Conventional car loans
Many traditional banks offer loans specifically for buying a car. If you already have a savings or checking account with a bank, check out your local branch to see if they offer car loans as well. In some cases, banks are more willing to give loans to current customers, even when their credit isn’t perfect.
It’s a good idea to shop around with a few different banks to compare loan offers. Luckily, banks such as Chase and Capital One allow you to get auto loan quotes without negatively affecting your credit score.
Like credit union loans, you’ll need to complete a separate application and wait to be approved before you go to the car dealership. However, you might be able to get a lower rate or increase your chances of getting a loan by securing financing on your own.
4. Peer-to-peer loans
If you have a low credit score or issues on your credit report, one option to consider is peer-to-peer lending with a company such as LendingClub. With this structure, individual investors pool their resources to offer loans to people who need them.
Peer-to-peer loans usually have higher rates than conventional loans — especially if you have poor credit — but they could be a useful approach if you need a car now. And, you’ll typically pay less with a peer-to-peer loan than you would with a subprime loan, as described below.
5. Subprime loans
Lenders offer specific types of loans — known as subprime loans — for people with poor credit. These loans might not be the best way to finance a car, but they can get you the money you need to buy now.
Subprime lenders charge extremely high interest rates on their loans. In fact, you could end up paying upwards of 29.99%.
When you’re desperate for transportation, you might overlook the high rate and sign on the dotted line anyway. However, make sure you understand exactly what you’re borrowing.
For example, say you found a used car in good condition for $6,000. If you borrowed $6,000 at a 29.99% interest rate and had a five-year repayment period, your monthly payment would be $194 and you’d pay back $11,645 over the length of your loan — nearly double what you originally borrowed.
If there are any other options available to you, avoid these types of high-interest loans.
Do your homework before buying a car
Before ever setting foot in a car dealership, research your options and know what kind of financing you’re eligible for ahead of time. Identifying how to finance a car can help save you money over the long run.
Not sure where to start? Begin by figuring out just how much car you can afford.
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