The Definitive Guide
Part 1: Getting Prepared
Part 2: Finding the Right Loan
Getting Your Credit Score
The first step to any major financial decision is understanding your credit. Your credit history will determine your interest rate, down payment, and loan term. Credit is the biggest determining factor in how much you will actually pay for your vehicle and the cost of your monthly payments.
Accessing Your Credit
The best way to have continued access to your credit score and history report is by utilizing the help of a credit reporting service. Transunion, one of the three major credit bureaus, offers affordable credit reporting allowing you unlimited access to your credit history. Some credit repair services also include credit monitoring.
Free Credit Report
Each year every American citizen is entitled to one free credit report from the three major reporting bureaus: Experian, TransUnion, and Equifax. You can request all three reports at AnnualCreditReport.com.
Free Credit Score
Right now, the easiest way to get FICO credit score for free, without unwanted sign-ups and charges, is through the Discover Credit Scorecard. This service is free and available to everyone, even if you are not a Discover customer. Services like Credit Karma can give you access to something called a Vantage Score. While not as pertinent or important as your FICO score this can be a good indicator of your credit health if for some reason you cannot access your FICO score or a credit monitor.
Budgeting for a Car Payment
Most experts recommend spending no more than 10%-15% of total income on auto payments and related expenses. For example, if you make $2000 per month you should aim for a car payment of around $250 or less. There are three factors that determine your monthly auto payment: principle, loan term, and interest.
1. Principle- This is the total amount financed or loaned from the bank, after any down payment or trade value. Your monthly payment is your principle spread over your loan term plus interest.
2. Loan Term- The typical loan term on a new or used auto loan is 60 months or 5 years. Those with high credit scores may have access to longer terms, usually up to 84 months. However, the shorter your loan term, the less interest you pay, lowering the amount paid for the vehicle.
36 Months = 3 Years
48 Months = 4 Years
60 Months = 5 Years
72 Months = 6 Years
3. Interest- Interest or APR (Annual Percentage Rate) expresses the amount you pay each year for the amount borrowed. Auto interest rates can range anywhere from 0% to 25% depending on your state, credit, and lender. If your interest APR is 10% then each year you will pay 10% of the value of the loan in interest. Interest does not pay off your principle, it is a fee paid to the bank, this is why it's important to pursue the lowest rate possible.
Interest rates will vary*
Down Payment and Trade
Down payments are an excellent way to improve the terms of your loan and lower your monthly payments, especially if you have bad credit. It is recommended to try and put at least 20% of the total price down on a new vehicle or 10% on a used vehicle. Not only will a downpayment lower your monthly payment, but it will also help shield you from depreciation. Financing the entire vehicle can make it more likely that you may become "upside-down". In other words. you owe more on the loan than the value of the vehicle.
If you choose to trade in your vehicle the trade value awarded to you from the dealer will act exactly the same as the down payment, coming off the top of the price. Many salespeople will try to mislead you by distinguishing between trade value and downpayment. For example, a $1500 down payment with a $500 trade value would be the exact same terms as a $500 down payment with a $1500 trade value. When making your purchase it is best to consider down payment and trade as the same money.
Based on 11% Interest over 60 months**
If you have poor credit or are getting an auto loan for the first time, you may want to strongly consider using a cosigner. While using a cosigner can help qualify you for better financing, lowering your interest rate and payment, there are some things to consider. When you purchase a vehicle with a cosigner, you will both be co-equal owners of the loan, in other words, you are both liable for its payment. Cosigners can get great benefit by seeing an increase in their credit score due to the driver's on-time payments, however, your cosigner will also be equally liable for fees and will see a negative credit impact for late payments.
Shopping Online vs Dealerships
No matter how you plan on purchasing your vehicle it is always recommended to begin shopping online. it is best to pre-qualify for financing before arriving at the dealer. At the very least you want to have a firm understanding of your credit situation, what you can afford and what your current vehicle is worth. Applying online can allow you to arrive at the dealer with the confidence of knowing you are approved. Those who arrive unprepared may lose money or waste time at a dealer that cannot approve them or does not have the proper vehicle.
Best Places to Pre-Qualify Online:
New vs Used Vehicles
If you have poor credit or are seeking your first auto loan it is highly recommended to purchase a used or certified pre-owned vehicle. Purchasing a pre-owned vehicle can help protect you from inflation and help ensure that you maintain equity for your next vehicle purchase. Those who finance new vehicles, while enjoying increased warranty coverage, can become stuck with those vehicles for a long time due to having negative equity or being "upside-down". Banks and dealerships that offer first-time buyer programs like Toyota also make these finance options available for pre-owned vehicles.
NEW VS. USED
1st Year Depreciation
A "Buy-Here Pay-Here" lot is a dealership that offers in-house financing for vehicles. Usually, when you buy a car at a dealership the contract is through a bank or other auto lender, which provides the loan. At a buy here, pay here loans are financed directly through the dealership without the need to get bank approval. These types of dealerships present a streamlined process that is a great option for those who have a poor or limited credit history.
Purchasing from a buy here, pay here is a much simpler process than getting a traditional bank loan. In addition, your in-house loan will likely also be reported on your credit, improving your history with little risk. However, these types of dealerships often have higher prices and a limited selection. Applying online could allow you to see if a buy here, pay here or traditional lender is right for you.
Addressing Credit Issues
Getting a loan with less than great credit, or what insiders call "Sub-prime' lending, can be a more difficult process because you do not have the leverage or buying power of balanced credit history. Many dealerships offer special finance programs, based on your specific credit situation, however, there are no guarantees and any fiance terms will be determined by your individual history and financial situation.
Late Payments - if you have poor credit due to late payments you can still qualify for special finance programs and sub-prime lenders. Adding positive payment history is the only way to improve your credit score, other than waiting for the negative accounts to pass their expiration. If you think there are accounts that are impacting your credit unfairly, you may want to consider credit repair.
Low Income - Credit is not the only factor in determining the terms of your loan and the cost of payment. If you have poor credit you may also be held back by your debt to income ratio. This is a representation of how much money you make less than the money you spend on bills. If you spend too much of your income on prior commitments the bank may have less confidence that you will make all your payments. If you have a low income or cannot prove your income you may still qualify at a traditional lender, but you may want to consider using a Buy here, Pay here. You can calculate your estimated auto payment here.
No Credit - Many lenders and dealerships offer first-time buyer programs that allow those with little to no credit history to get approved with relative ease. Depending on the vehicle you want you may want to strongly consider a cosigner or a decent down payment. Learn more about first-time buyers here.
Other Credit Issues -If you have recently filed for bankruptcy, or have experienced repossession or foreclosure, you may have a more difficult time getting approved or affording the terms that are offered to you. Some with delicate credit situations may find it more financially suitable to wait until there are fewer negative reports on their credit, so they don't spend too much on a high-interest payment. Those in need of a vehicle and cannot get approved through traditional lenders may consider in-house financing.