Once you’ve committed to buying, the next question you need to tackle is how you’re going to pay for it. While paying cash can save you money on interest charges, that may not be feasible.  According to data from Edmunds, the average used car retailed for $19,232 during the third quarter of 2016, with prices climbing steadily over the previous decade. 

When you don’t have the cash to buy a used car, financing is likely to be the solution. Taking out a loan eliminates the burden of having to come up with a large sum of money all at once, but it does mean adding another payment to your monthly financial obligations. The higher your interest rate, the more expensive the loan – and your new-to-you-vehicle – becomes so it’s important to approach financing carefully. Here’s how to finance a used car without compromising your bottom line.

How to Finance a Used Car: Dealer vs. Bank Financing

When purchasing a used car, you may have a few different financing options available. First, the dealership may offer to handle financing for you.

Dealer financing has some advantages. For starters, it’s convenient. It’s possible to finance your car and drive it home the same day, whereas it may take a few days for a bank or credit union to process your application for an auto loan. A dealership may be less stringent than a traditional lender in terms of credit approval, making access to a loan easier for buyers with lower credit scores. There’s a potential catch. In exchange for financing, the dealer may charge a higher interest rate or loan origination fee, both of which increase the cost of buying. (See: The True Cost of Owning a Car.)

For example, according to Experian, used car buyers with subprime credit paid an average interest rate of 15.7% (rising to 17.6% from independent car dealers) for a car loan in 2016. Buyers with deep subprime credit paid even more, with an interest rate averaging 19.03%. Higher rates translate to a higher monthly payment and more money spent over the loan term. 

If you have a better credit rating, a bank or union may be a preferable source for a used car loan. Start with the financial institution that holds your checking and savings accounts. If you already have a history with a particular bank or credit union, it may be willing to give you a discount on the interest rate or fees for a loan.

Do, however, take time to compare the rates different banks are offering to ensure that you’re getting the best deal possible. It may be helpful to take a look at your credit report beforehand to have an idea of what lenders are going to see when you apply for a loan. You can use that information to guide you as you shop around for the lowest rate. (See: 6 Ways to Cut the Cost of Your Car Loan.)

If you’re going to finance a vehicle outside of the dealership, you’ll need to provide proof of funding to the dealer. In some cases, you may have to take the check directly to the dealer from the bank before you can drive the car off the lot. If you’re going the bank-loan route, it’s a good idea to make sure you’ve got a shot at getting financed before you fall in love with a used car. 

Choosing the Loan Terms

If you’ve settled on a lender, you still have to work out the actual details of the loan. That means setting the ground rules for how much money you’re going to put down, how long the loan term will be, the interest rate and the amount of your monthly payment. (See: How Interest Rates Work On Car Loans.)

When it comes to your down payment, you don’t necessarily need one for a used car but it certainly helps. The more money you put down, the less you have to finance. A bigger down payment could also persuade the lender to offer you a lower rate. Ten percent down is a good target to shoot for but you may put down more or less, depending on how much the car costs and the amount of financing you’re approved for.  

Next, think about how long you want to take to pay off the loan. A longer loan term means a smaller monthly payment but you’ll eventually pay more in interest. A shorter term, on the other hand, can cut down on the amount of interest paid but you’re also going to be looking at a larger payment. Choose the term that’s most accommodating to your monthly budget, but still keeps the interest charges to a minimum.

Finalizing the Loan

If you’ve been approved for a loan and you’ve negotiated its terms, the final step is to sign off on the paperwork. Review everything carefully first. Make sure you understand the amount you’re financing, the terms of the loan and the total cost of borrowing. Your lender or the dealer should be able to provide you with a complete loan schedule breaking down the payments, interest, fees and finance charges.

Also, keep in mind that the dealer may require proof of insurance before it lets you take possession of the vehicle. If you have insurance on another vehicle, a copy of your insurance card may suffice. Some dealers, however, may require you to put insurance on the car on the spot. Once you have insurance on the car, you’ll need to have the insurance company send proof of coverage to your lender. Remember, the lender or the financing company may require you to maintain full coverage until the vehicle is paid off.

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