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The Ultimate Guide to Auto Financing

Buying a new car can be exciting until you head into the Finance Manager's office and your head starts spinning with all of the numbers thrown at you. Before you step foot into a dealership to purchase a vehicle, you should know what your financing options are so that you can make a sound decision while in the office. When you know the basic terms, qualification requirements, and options, you can be a force to be reckoned with when the dealer tries to get you to agree to your billing options.

New or Used Car Financing

The first step is to understand the difference between new and used car financing as there is a large difference. New car financing is strictly for brand new vehicles. Many dealerships offer incentives for these loans because of the lower risk involved and the higher profits they stand to make. They typically have a much larger principal amount than those needed for pre-owned autos, which means the lender makes more money. It also means that the overall value will not dip as fast as it would for a pre-owned vehicle that already depreciated. It is not unusual to see new vehicle financing reach as much as several points lower than that for a used vehicle due to the lower risk level alone. In general, lenders base the risk of the financing on the history of the make and model of the car in the Kelly Blue Book. If there has been significant depreciation already, chances are getting financed on it will be more difficult.

The Used Car Risk

Used cars pose a high risk for lenders based on the car's age. In fact, many lenders have a cut-off age for a car that they will provide financing for – typically that age is 10 years old, but some lenders cut it off sooner depending on the make and model of the vehicle. The major concern with the age of the vehicle is its value. The older it is, the less it is worth, which if it ever hits below the amount of the loan, it is much more likely that a borrower will default on his payments, which leaves the lender in the red when it comes to recouping the money owed on the car. They cannot sell it for a profit or even for as much as the loan is worth, making it a very high risk for the bank.

Credit Scores and Auto Loans

Your credit score plays an important role in the type of financing you are eligible to receive whether for a new or used car. The FICO score is provided by one of the three credit bureau agencies – TransUnion, Equifax, or Experian. Some lenders use just one credit bureau to determine your credit score while others use a tri-merged report, which combines all three scores from each agency, from which they use the middle score for qualification purposes. In general, scores range between 300 and 850, but the average is around 687 throughout the United States.

Credit Scores and Interest Rates

Generally, your interest rate directly correlates with your credit score, although lenders will take into consideration other factors along the way. In general, the higher your score, the lower your interest rate. For example, the average rate for someone with excellent credit, which means between 720 and 850, is 3.3 percent, but a person with a score between 500 and 589 is 14.79 percent. Someone with a score around the national average of 687 could expect to receive a rate around 6.7 percent. Of course, these rates depend on whether or not the car is used or new, the term of the loan, which can vary between 36 to 60 months for a new car, and your debt-to-income ratio.

General Qualifications

In order to qualify for car financing, whether new or used, you need to prove that you are financially responsible and can afford the loan. In addition to your credit history, which will give a snapshot of your financial responsibility, you will need to provide proof of your income, proof of any liquid assets you want to use to make your application look stronger, several methods of identification, proof of residency, as well as proof of insurance.

Your credit score will be the largest driving factor regarding whether or not you get approved for auto financing, but the other factors help to support the decision. For example, if you have a slightly lower than average credit score, but you have very stable income that supports your current debts very well, meaning that you have a low debt-to-income ratio, the lender may look at that as a compensating factor when determining your risk level. While you might not get the lowest interest rate available because your credit history has blemishes that brought the score down, you may still be eligible for favorable financing because of the other factors you were able to provide to make your financial situation look less risky to the lender.

Motorcycle Loans Are Different

There is a major difference between financing a car and a motorcycle, not only because of the type of vehicle, but because of the risk level involved. In general, motorcycles are less expensive than automobiles, which make them less risky at first glance. The shorter the term, the less risk involved for the lender because there is less inflation to worry about and the lender gets their principal back quicker. The longer the term, the more the bank stands to lose. This makes the case for motorcycle loan interest rates to be lower, but that is not always the case. Your individual factors play a vital role. For example, if you also have an automobile payment at the same time as you purchase the motorcycle, the motorcycle financing is immediately high risk because you will more than likely pay the car loan before you pay for the motorcycle because a car is more dependable.

Bad Credit Car Loans

Even if you have bad credit, it may still be possible to get auto financing. The key is to stick with lenders that advertise auto loans, not just bad credit loans. Your credit situation might not be as bad as you think it is in the eyes of the auto financing company. Cars are easier to finance than homes because they are easier to repossess as well as less expensive, so the term is shorter and the risk is less than is found with mortgage lending. If you do have trouble getting a loan, you can use a co-signer or show the lender that you have compensating factors to make up for your bad credit. If you have assets to use in conjunction with the collateral the vehicle provides, your risk becomes minimized. In addition, if you have stable income, stable work history, and very few debts, you can show the lender that you are able to turn your financial life around. The key is to stick with known lenders and not the fly-by-night "bad credit" lenders that promise you the world in order to get lucrative financing on your car.

Auto financing can be clear cut and easy to obtain if you know what you are getting yourself into before you start shopping for a car. Start by getting your credit in order – paying off any collections or old debts, and ensuring that your income and job stability are in line before you apply and you should have an easy time getting the financing you want for your new fancy wheels.