Most car buyers can’t afford to pay for a new car in cash, which is where auto financing comes in. By spreading the cost of a vehicle out over monthly payments, you can get the whip you want without breaking the bank. 

While you never want to make a commitment that’s out of your budget, you probably need a car to get to work and live your life — financing can give you the flexibility to do it. 

Think of car financing like a loan — the total cost of the car is paid by your loan provider, and you pay them back over time. dsfdsfdsfdsfdsfdsf

Top things to consider when financing a car

You’ll pay more than the cost of the car

Like any type of loan, car financing comes with interest. This means you’ll pay the principal (the cost of the car) plus a percentage of the remaining balance — this is how financiers make money. 

The interest rate you get depends on factors like your credit history, which basically determine the level of risk you pose to the lender. The lower your credit score, the more you’ll pay over time. 

With all of this in mind, there are 3 main factors to consider when financing a car with a loan: 

Loan Amount

In general, you never want to take out a loan that’s higher than the cost of your new car. This will make your monthly payment higher than it needs to be and produce a higher level of financial risk.

You might find that some lenders will only offer a minimum loan amount that exceeds the cost of your car. In this case, you can always shop around, or settle for the closest option.

Annual Percentage Rate (APR)

APR is the interest rate charged to a borrower over the course of a year. It’s expressed as a percentage of your remaining principal.

Obviously, you want an APR that’s as low as possible — the lower your rate, the less you pay.

Loan Terms

When you take out a car loan, you’ll have the option to set your terms, meaning the length of time that you’ll take to pay off the loan. 

The most common term length in the US is 72 months, though you can opt for a shorter or longer term. 

Like anything, each option comes with pros and cons. The longer your term, the less you’ll pay each month, which can be helpful. On the other hand, a shorter term will help you pay back the loan faster, saving money on interest. 

The perfect car loan comes down to the individual — there’s no one size fits all. Taking each factor into account, you need to find a loan that you can afford, and that keeps you sitting in a positive financial position. 

Where to get a loan

When it’s time to finance your car, you have some options. You can hit up your bank or credit union, or work with the dealership or financing company. 

Again, the best place to look isn’t always the same. Depending on your car, credit history, and banking relationships, the ideal financing partner could be any of these options. 

It’s always a good idea to shop around — you might even be able to play lenders against each other and negotiate a lower rate. 

To start, take a look at some of the bigger players in the car financing game like Carvana or Ally Bank. 

Types of Loans

As you shop around, it’s important to understand the complicated loan language that you’ll see. Depending on your financial situation, the correct type of loan could make a huge difference in terms of how much money you’ll save while you pay it off. 

Secured vs. Unsecured

When you take out a car loan, it’ll either be a secured or unsecured loan. The difference between the two comes down to the presence of a lien, which you can think of as collateral for the lender. 

With a secured loan, the lender places a lien on the car. This means that if you fail to pay off your loan as agreed, the lender is entitled to repossess your car. With an unsecured loan, there is no lien, but the lender can still recoup payments through other legal avenues. 

Most car loans are secured, and generally come with a lower interest rate than unsecured loans. Since unsecured loans present a higher level of risk for the lender, they’ll always cost you a bit more in interest. 

With this in mind, the only real reason to consider an unsecured loan is if the car you’re buying doesn’t qualify as collateral with your lender. 

Simple Interest vs. Pre-Computed

Another aspect of your loan to consider is how the interest is calculated. 

With a Simple Interest loan, your interest owed is recalculated on a daily or monthly basis based on the remaining principal. This means that as you pay off your principal, the amount you owe in interest shrinks. 

With Pre-Computed interest, the amount that you pay in principal and interest stays the same each month. 

To illustrate the difference, let’s look at an example — say you take out a $10,000 loan with a 10% interest rate that you plan to pay back over 50 months. With either type of interest, you owe $10,000 in principal and $1,000 in interest, and your monthly payment will be $220.

If you’ve taken out a Pre-Computed loan, that monthly payment is broken down the same way each month — $200 in principal and $20 in interest. 

If it’s a Simple Interest loan, you’ll pay more in principal and less in interest as you get further in the term. For example, once the principal is down to $5,000, you’ll only pay $10 in interest, but $210 in principal. 

So, if my monthly payment is the same no matter what, why should I care about the type of interest? 

Good question, and one that could save you some money.

With a Pre-Computed loan, you owe the entire principal and interest, no matter what — but with a Simple loan, you only owe interest on the remaining principal. This means that if you pay your loan in full halfway through the term, you won’t be responsible for the remaining interest. 

Direct vs. Indirect

As you look for a loan, you’ll see options for either direct or indirect financing. The difference between the two is pretty simple — Direct Financing happens when you secure a loan straight from the lender. With Indirect Financing, you’ll work with a middleman (like the car dealeship). 

The main benefit of Direct Financing is that you’re getting your options right from the source. You can easily weigh your options, though you might need to fill out several applications to find the best fit. 

Indirect Financing simplifies things in some ways since the intermediary will usually present all of your options based on a single application. 

The problem is that this creates more mouths to feed. The third party offering the loan typically gets a cut from the lender, and that added cost is passed on to you as the consumer.

With all this in mind, Direct Financing is usually your best bet, but unfortunately, it isn’t always an option — some lenders might only offer auto loans through their network of partner dealerships.