What we'll cover
Key questions to ask yourself before financing your next vehicle
Should you buy or lease a car
How long can you finance a car
A car is the largest purchase most people make in their entire lives, apart from buying a home and paying for college. So, it’s wise to be prepared before signing on that dotted line.
If you’re in a position to pay cash for a car, that’s great. However, many of us rely on financing. This adds a whole new set of decisions and considerations above and beyond the vehicle itself.
To help you make the best choices at the dealership and with the banks, ask yourself these nine questions in advance.
1. Is it smarter to lease or buy?
The first question to consider is whether to buy or lease. From a payment perspective, leasing a vehicle operates much like financing a car. But ownership works differently.
When you buy a car with auto financing, you borrow the amount of the car’s purchase price, which you will pay back in addition to the finance charges. You make monthly payments for an agreed-upon term, and you own the vehicle at the end of the period.
When you lease a car, you’re renting it long-term. You make monthly payments for an agreed-upon term. At the end of the period, you return the car or take advantage of several standard options to buy it.
Both buying and leasing have pros and cons. For example, buying a car means you own the vehicle when you’re finished paying, but leasing a car could put you in a newer vehicle for less money per month. When you’re ready for a new car, consider both options.
2. How much of a payment can I afford?
Just like with purchasing a home, you should sit down with your budget and figure out how much you can realistically afford to pay each month based on your income and expenses.
A good rule of thumb is to go into the bank or dealership intending to spend less but know your ceiling and stick to it no matter how good a higher-payment deal seems.
3. How long can I finance the car?
Auto financing generally runs for up to seven years for a brand-new car in a higher-end model. It can go up to five years for an older, used vehicle. Longer-term financing means lower monthly payments, but more money paid out in interest or finance charges over the lifetime of the financing term.
For example, if you borrow $18,000 at 3% APR to buy a car:
A three-year term would have a $523 monthly payment, for a total of $845 paid in finance charges over the course of the term.
A six-year term would have only a $273 monthly payment, but the total finance charges paid would be $1,691 — nearly twice as much as the total for a three-year term.
Regardless of the term you pick, look at your financial prospects for the upcoming years. Do you expect anything that would make carrying auto financing more challenging, like wanting another child, starting school, or plans to retire?
Make sure you can afford the payment over the entire course of the term before committing to a longer-term option.
4. How does financing fit with my overall debt goals?
What are your goals for your debt? What are the interest rates on your current loans? What upcoming purchases do you want to make in cash instead of paying for them with credit?
Ask what taking on auto financing will do to those goals. Does the extra payment seem doable given your disposable income? Does it slow down your progress and put a monkey wrench in your plans? If the latter, can you adjust your objectives to make things work even with auto financing?
If auto financing doesn’t fit with your overall debt goals, it can often work to tie it in with one benchmark or another.
For example, say you’re paying $500 a month on a credit card and want a car that would require a $360 a month payment. If you got the car now, you’d be paying a total of $860 a month toward debt. But if you wait until you pay off your credit card bill, you’ll have an extra $500 a month to work with. You’ll be able to pay for the car and still have $140 left over in your budget.
5. What are the maintenance costs?
Don’t forget to consider how much it will cost you to keep your vehicle running. Most good, mid-range cars won’t cost you much more than gas and regular oil changes, plus a tune-up once every couple of years. Both ends of the cost spectrum, however, tell different stories.
If you’re looking at a high-end, luxury, or performance automobile, it may require specific routine services to keep it working properly and maintain its resale value. Get some estimates, often available from the dealer, of what they recommend and how much it’s likely to cost.
If you’re going for an older, cheaper car, you should prepare yourself for repairs. Talk to mechanics or look to online forums to get an idea of how much it will take to keep it running.
In both cases, add that number to the expected car payment to find out the actual monthly cost of purchasing the car.
6. What are current & expected interest rates like?
This is less of a concern if you need to get a car right away, such as to replace the one you just lost to theft or an accident. With a tight timeline, you may have to settle for whatever rates are available at the moment.
However, if you have time to shop and consider, look into the recent trends and forward expectations for auto financing charges.
If they’re rising, you’ll want to be decisive so you can finance your purchase at the lowest possible rate. If they’re dropping or expected to drop soon due to a market cycle or predictable downturn event, it can make sense to hold off on buying until you can take advantage of those lower rates.
It also pays to compare average rates when considering any given financing rates. Your offered rate will vary, but it’s good to see how it compares to what’s out there so you can make an informed decision.
7. Is my credit score important?
As with any type of financing, a good credit score typically qualifies you for better terms such as lower rates, while a below-average score gets you less attractive terms. In general, a credit score above 661 will increase your odds of qualifying for auto financing.
If your score is on the lower end and you have a few months before you need to buy your car, consider the following steps that can give your credit rating a short-term boost:
If you have to choose, prioritize paying off debt over other non-essential expenses for a while.
Call companies where you have past-due accounts and set up payment plans.
Pay down the balance on your credit cards.
Avoid applying for anything that will result in a new hard credit inquiry until you’re ready to explore your auto financing opportunities.
You should also check your credit reports with all three credit reporting bureaus and notify them of any problems or mistakes. These errors often take one to two months to correct, so the process may not help with the financing you’re looking for right now. Though, it’s still worth doing.
8. What down payment can I afford?
You might be surprised by how much difference a down payment makes.
The first is in the cost of the auto financing overall. For a $20,000 car purchase with a four-year term at 3% APR, not making a down payment would result in a $443 monthly payment. Putting $2,000 down reduces the monthly payment to $398 and putting $4,000 down drops it to $353.
You can also end up in a stronger negotiating position at many dealerships if you’re offering a down payment because it results in cash in hand for the dealer, which is more attractive than the promise of future payments.
9. How will insurance impact everything?
When you finance a vehicle, the finance provider will typically require you to carry comprehensive and collision insurance to protect their investment. Otherwise, if your car gets wrecked, they have no collateral to rely on if you can’t make your payment.
These insurance costs might be lower if you choose a less expensive car, or one with a higher safety rating, but many people upgrade to a newer model when they purchase a car. This could mean your insurance bill may go up.
Even if you don’t know the type of car you’re buying, talk with your insurance agent about the vehicles you’re researching. Get an estimate for what insurance is likely to cost for each one. You should calculate this expense into your total monthly cost the same way you did with repairs and maintenance.
Final thought: Make a plan
To help ensure your new car aligns with your budget and goals, write down a basic game plan before you visit a dealership.
This plan will vary from person to person, but it should include things like how much you want to spend, what kind of car you want, how much you’ll put down, the minimum you’ll take for a trade-in, your preferred interest rates, and what things will make you walk away from the deal.
Proper planning can save you thousands of dollars in the long run.
