How to Finance a Car [Complete Guide]

by Alissa Johnson, Consumer Loans

June 14, 2021

Topics:

  • Consumer Loans
  • Auto Loans


salesman shows a family a car's trunk

If you are planning to purchase a car and don’t have the money on hand to pay for it in full, you may be considering getting a car loan. Financing a car can help you afford the vehicle you need by borrowing money from a lender.

The process of applying for and financing an auto loan can seem confusing. However, it doesn’t have to be. We’ve created this guide to help. From start to finish, we’ll walk you through the process, so you’re informed and able to get the best deal possible.

Essential Car Financing Definitions

When you start shopping for a loan, you’ll probably hear these commonly used words and phrases. It’s a good idea to familiarize yourself with their definitions.

APR: APR is the annual percentage rate. It represents the total cost of borrowing money. It includes the interest rate and any other fees you accrue yearly.

Interest rate: This is the percentage that you are charged to borrow money.

Term: The loan term is the duration of the loan.

Principal: The principal is the amount that you borrow before interest or any fees.

How Car Loans Work

In general, car loans are pretty straightforward. When you take out a car loan, you will receive a lump sum of the principal to purchase the car. You then assume a monthly payment for the loan term, where your car payment goes toward paying back the principal, interest, and any other fees.

While the amount you pay each month for your car loan should be approximately the same, how much you pay toward interest versus principal each month depends on the specifics of your loan. Loans that have precomputed interest have the total interest divided each month equally over the whole term. Other loans with simple interest have interest that is amortized. 

With a simple interest loan, the amount of interest you pay is calculated each month based on how much principal you owe. Since you owe more toward the beginning of the loan, you will pay a higher proportion of interest. At the end of the loan, the outstanding principal is lower, and thus, the proportion of your monthly payment made up of interest is also lower. 

Understanding how interest works is essential to finding a loan that you are comfortable with. 

Factors That Affect Loan Costs

If you are looking for the best car loan, you will want to consider these three key factors:

APR: In general, the higher the APR, the greater the cost to borrow money.

Term: The longer the term, the longer you will be paying interest. Thus, even if the principal and APR are the same, you will pay more to borrow the same amount of money if you spread your repayment over a longer time.

Principal amount: The lower the amount you borrow, the less interest you will have to pay. If you can decrease your principal amount by buying a slightly cheaper car or making a down payment, you will save money on your loan.

Shopping For a Car Loan

The best way to get a good deal when financing your car is to shop around and know your options. Several factors affect the rates associated with a particular car loan. Two of the most important factors are 1) the type of financial institution you are borrowing from and 2) your credit score.

Online lenders, banks, dealerships, and credit unions all offer different rates. In general, since credit unions are not-for-profit and are owned by their members, they can offer competitive rates that are lower than the rate you might get elsewhere.

Your credit score can also have a significant effect on the APR you can get. If you plan to take out a car loan, it’s a good idea to try to build your credit as much as you can. This includes paying your bills on time, minimizing your debt, and being responsible with credit cards. Keep in mind that Fibre Federal Credit Union practices Rate Equality, so every qualified member gets the same low rate.

You should also shop around and make sure you are getting the best deal, but if you end up with a suboptimal car loan, you’re not stuck! You can almost always refinance

What to Expect When Applying for a Car Loan

The process of applying for a loan can vary from lender to lender, but in general, the gist is the same. Typically, the process requires you to provide information, including personal details, social security number, employment information, financial information, and requested amount.

Most lenders have an option for borrowers to complete the application online, but you can also typically visit a branch in person if you need help with the application. Check with your lender to determine the exact process.

You can also apply for financing at the dealership. Most auto dealers in the area participate in Credit Union Direct Lending (CUDL). Just let them know which credit union you’d prefer to finance with.

Applying for Pre Approval

Applying for a preapproval from a couple of lenders can be a good way to compare loans and their APRs while you are shopping. The preapproval process is very similar to the loan application process, but you’re not receiving final approval for the car loan. 

Instead, a pre approval indicates how much money you are likely to be approved to borrow (if you apply) and at what rate your loan would be issued.

It’s worth noting that if you apply for several loans within a short period — typically within 14 to 45 days — the checks will register as a single credit inquiry on your credit report. This minimizes any adverse effects that can come with too many credit applications in a short period.

To learn more about the benefits of pre-approval, you can check out our blog post on the topic.

Why Apply For An Auto Loan Pre Approval?