This article goes over how to get a loan to buy a car. If you are looking to buy a used car, see our article on buying and keeping a used car.
What should I do before I buy a car?
First, you should determine if you will pay cash or finance the car. To get the best deal when financing a car, you should do the following before going to the dealership:
- Determine how much you can afford to pay in monthly car payments. By lowering the monthly payments, you will probably be taking out a longer loan and will pay more in interest. Remember to also include ongoing costs such as insurance, maintenance, and repairs.
- Get your credit score. Your credit score will likely determine the amount of credit a lender will give you and what interest rate you will be charged. Banks, credit unions and other lenders use your credit score to determine how likely you are to pay back the money you borrow. Generally, the higher the score, the lower the interest rate. You can get a free credit report from the three big credit reporting companies every twelve months. To receive your free report, go to annualcreditreport.com or call 877-322-8228. However, you may have to pay for the actual credit score.
- Shop around for the best financing option. Although many people finance their cars through the car dealership, you are not obligated to do so. Look on-online. Contact several banks or credit unions. By knowing what type of financing is available, you can either get pre-approved for a car loan or be in a better spot to negotiate financing at the dealership.
- Consider if leasing is a better alternative. When you lease a car the payments are generally lower than a loan but you do not own the car at the end of the lease.
Common financing terms
- Annual Percentage Rate (APR) is the cost of credit expressed as a yearly rate in a percentage.
- Finance Charge is the cost of the credit expressed as a dollar amount. This is the total amount of interest and certain fees you will pay over the life of the loan.
- Amount Financed is the amount you are borrowing.
- Total of Payments is the sum of all the payments that you must make which includes the principal amount plus the finance charges.
- Truth in Lending Act is a federal law that requires, before you sign a contract, lenders give you written disclosure of important terms of the credit agreement, like the annual percentage rate, finance charge, monthly payment amount, payment due dates, amount financed, length of the credit agreement and any charges for late payments.
How is financing from a dealer different than financing from a lender?
If you go through the dealer, they will get information from you and forward it to one or more lenders. If the lender agrees to finance your loan, they give the dealer a buy rate. The interest rate the dealer offers you will likely be higher than the buy rate. This is because it may include an amount that goes to the dealer for handling the financing. You can negotiate with the dealer to get a lower interest rate.
What about car dealers that advertise no credit or bad credit is acceptable?
Some types of dealers finance auto loans directly. They typically advertise “Buy Here, Pay Here.” They do not work with an outside lender but instead directly lend you the money. The interest rate for this type of loan can be extremely high. Even if you have poor or no credit, check to see if another lender will offer you financing directly.
Which aspects of the loan process are negotiable?
- The annual percentage rate (APR) and interest rate. Getting a lower interest rate means you will pay less to borrow money.
- The length of the loan. A shorter loan term will lower total cost. A longer loan can reduce your monthly payments but you will pay more interest over the period of the loan.
- Whether or not there will be a pre-payment penalty. This is an amount you have to pay if you pay off the loan earlier than expected.
What can increase the amount of the loan?
- Optional products for the loan or vehicle can increase the amount financed. Such items would include extended warranties, gap insurance, and credit insurance.
- Optional features for the vehicle will also increase the amount financed. These items would include alarm systems, window tinting, and tire and wheel protection.
- Trade-in amount.
- The amount of the down payment.
- Under Illinois law, a dealer may add a documentary fee for processing documents and performing services relating to the closing of the sale, as well as taxes, license and title fees. In 2016, the documentary fee could not exceed $169.27.
What is gap insurance?
Gap insurance covers the difference (the gap) between what your vehicle is worth and how much you owe on the car. Gap insurance comes into play if your car is stolen or totaled before the car is paid off.
What is the deal with co-signers?
A co-signer is a person who is "on the hook" for your loan. They are just as responsible for the loan as you are. If you make late payments, they will impact the co-signer’s credit rating just as they will impact yours. So why have a co-signer? If your credit history is limited, or you have a low credit score, your interest rate will be much lower if you have a co-signer with good or excellent credit.
Can I get a car loan if my current vehicle is not paid off?
Usually. "Negative equity" is when you owe more than your current vehicle is worth. Depending on the amount of negative equity, and your own credit-worthiness, lenders will sometimes include the amount needed to pay off your current vehicle in a new car loan. This could make the new loan much more expensive.
What if I feel like a lender is discriminating against me?
A lender cannot discourage or deny your application for credit or offer different prices or other terms and conditions of the loan for any of the following reasons:
- National origin,
- Marital status,
- Public assistance, or
- Acting on your rights under the Consumer Credit Protection Act.
Warning signs of possible discrimination include:
- You are treated differently in person than on the phone.
- You are discouraged from applying for credit.
- You hear the lender make negative comments about one of the protected groups listed above.
- You are refused credit even though you qualify for it.
- You are offered credit with a higher rate than the one you applied for, even though you qualify for the lower rate.
- You are denied credit, but not given a reason why or told how to find out why.
Can I return a car I just bought?
Probably not. If you signed the sales contract, you own the car. Voluntarily returning the car does not relieve your duty to pay for the car. When you voluntarily return the vehicle, or if it is repossessed, the lender will sell your car. The difference in the price the dealer gets for your car and your outstanding car loan is still your responsibility.
Learn more about car repossession.
I was approved for financing and drove my car home. Later, the dealer called and said the financing was denied and I must bring the car back. What is going on and what are my options?
Sometimes dealers agree to take a down payment and allow the buyer to take the car home before financing is finalized. This practice is known as spot delivery. You should not sign a finance contract or take a car if there is any doubt about the financing.
Before signing a contract or taking the car, you should have the dealership put in writing that the financing is finalized. Sometimes car dealers use spot delivery to get the buyer to agree to a higher down payment or interest rate.
For example, the dealer may let you take the car home for a few days then call and say the financing could not be approved at the rate agreed upon and that the buyer must either bring the car back or agree to a higher interest rate or down payment. Buyers can and should bring the car back and walk away with their deposit and trade-in with no obligation.
Under Illinois law, if the purchase of a vehicle is conditioned on the buyer having an acceptable credit rating, and the dealer cannot get financing for the buyer at the agreed terms, the dealer must return the down payment and trade-in. Buyers do not have to put down a higher down payment, pay a higher interest rate, or find a co-signer. If the dealer cannot get financing at the agreed terms, the law requires the buyer to return the car and dealer to return the down payment and trade-in.
Do I have three days to cancel the contract?
No, dealers are not required to give car buyers a three day right to cancel. The right to return the car in three days only exists if financing is not approved. Some dealers may, by contract, offer a right to cancel.
What is the difference between buying and leasing a car?
When you lease a car, you get to use it but must return it at the end of the lease. When you buy a car, you get to keep it at the end of the financing term. When you lease, you are responsible for excess wear and damage and any missing equipment. You must also service the vehicle per the manufacturer’s recommendations and maintain insurance that meets the leasing company’s standards.
For more information on leasing a car, see the federal reserve website.
Are there any protections for military personnel who get called up to active duty?
Yes, the Service Members Civil Relief Act (SCRA) gives service members a reduced interest rate of 6% on credit card and other loan debt incurred prior to active duty. If your auto loan is over 6% and you get called to active duty, you likely are entitled to a lower interest rate. Contact your lender, the Illinois Attorney General’s Office, the Consumer Financial Bureau or the Department of Veterans’ Affairs.