What Does it Mean to Finance a Car?

With some new cars costing almost as much as a small house, the need to finance the purchase of an automobile is as great as ever.

Whether you are interested in a new vehicle or a used one, if you don’t have the money, you will have to turn to financing. While the idea behind financing-being able to pay over time so you can get the use and enjoyment out of the car now, may be a help to many consumers, the real beneficiaries of auto financing are the Dealers and financial institutions that make the loans.

When you step into the new car showroom and start looking at some of the nice new cars, a salesman will quickly approach you. The sales process begins with a few questions about what you are looking for, is usually very non-threatening and makes you anxious to want to take home a new vehicle. As you proceed through the sales process and get serious about actually buying a vehicle, the conversation will turn toward financing. At some point, the salesman will ask for your drivers license and some other personal information and turn it over to the finance manager. The finance manager will run a credit check to determine if you are eligible for financing.

As you sit at the table with the salesman, thinking about your beautiful new car, the finance manager is busy checking with different banks and financial institutions to see what kind of terms he can give you. Some customers with excellent credit may qualify for a 3% loan over a term of 4 years, while other, less credit-worthy customers, may have to settle for a 12%, 5 year loan. Still, others may be unable to qualify and will either need to come up with a bigger down payment or settle on a less expensive car.

Financially speaking, it does not make much sense to finance a depreciating asset such as an automobile. Unlike a house, which usually appreciates over time and builds equity, a car loses value the minute it is driven off the lot. The interest portion of the loan payments can run into the thousands over the course of the four or five years it usually takes to repay. If you are making payments of $200 per month for 48 months, it would not be unusual for $50 each month to go strictly for interest. That would work out to $600 per year and $2,400 above the sales price for the 4 years of payments on the vehicle. After 4 years, the $20,000 brand new car you bought, will probably be worth $10,000 or less. Hopefully, after you’ve paid it off, it will still be in excellent condition and you can use it for many more years.

A few tips when seeking financing for a car. Often you can prearrange financing at a favorable rate with your local bank or credit union. If you have money sitting in a low interest bank account, it may be smart to pay cash and then make monthly payments to yourself (ie. self-finance) on your own terms. If you do accept financing through the Dealer, ask questions and do not be afraid to negotiate for a better rate. The Dealer will almost always offer a better deal instead of losing the sale.