How Car Financing Works & A Deep Dive Into Car Payments

Shopping for a car can be an exciting experience, but it can also be overwhelming, especially when it comes to finding the right financing options. The process of buying a car is not just about finding the perfect vehicle, it's also about finding the perfect financing plan that fits your budget and lifestyle. 

This guide will provide a complete overview of how car financing works, including different types of financing options, tips for negotiating car payments, how to pay off your car faster, and a useful car payment calculator (see above) that can set your expectations before making a purchase.

Types of Car Financing Options

When it comes to financing a car, there are several options available, each with its own set of pros and cons. The most common types of car financing options include:

Using A Bank Loan 

This type of financing involves borrowing money from a bank or credit union to purchase a car. The bank will require you to have a good credit score and a stable income to qualify for a loan. This type of financing typically offers lower interest rates than other options, but you may need to make a higher down payment.

Dealer Financing 

Many car dealerships offer financing options through their own lending institutions or by partnering with banks and credit unions. Dealer financing can be convenient, as you can usually complete the financing process and drive away in your new car on the same day. However, the interest rates on dealer financing can be higher than bank loans.

Instead Of Financing, You Could Try Leasing 

Leasing a car is similar to renting a car. You make a down payment and then pay a monthly fee for a set period of time, usually 2-4 years. At the end of the lease, you can either purchase the car or return it to the dealership. 

Leasing can be a good option for people who like to drive a new car every few years, but you will not own the car at the end of the lease.

Negotiating Car Payments

When it comes to negotiating car payments, it's important to do your research and be prepared. Things to know if you want to get a good deal include:

Know Your Credit Score

Your credit score is one of the most important factors in determining your interest rate and loan terms. It's important to know your credit score before you start shopping for a car, so you can negotiate with confidence.

Compare Interest Rates

Interest rates can vary widely between lenders, so it's important to shop around and compare rates. This can help you find the best deal and save you thousands of dollars in interest over the life of the loan. Try to get 3-4 options lined up before making a final decision on what’s the ideal interest rate for your budget.

Don't Be Afraid to Walk Away

If a dealership (or private seller) is not willing to meet your terms or offer a fair deal, don't be afraid to walk away and find another lender. There are plenty of options available and you should be able to find a financing plan that works for you.

Deep Dive Into Car Payments and Interest Rates

Car payments and interest rates are closely related, and understanding how they work can help you make the right decision when you are weighing your financing options.

Interest Rates 

Interest rates are the cost of borrowing money, and they can vary widely between lenders. 

The interest rate on your loan will depend on several factors, including your credit score, the price of the car and the length of the loan. A higher credit score and a lower loan-to-value ratio (the amount of the loan compared to the value of the car) will typically result in a lower interest rate.

It's important to understand that interest rates are not fixed, they are variable and can change over time based on market conditions (e.g. the overall economy). This means that the interest rate you qualify for today may not be the same interest rate you qualify for a few months from now.

Another important point to keep in mind is that there are two types of interest rates: fixed and variable. 

A fixed interest rate is a rate that does not change over the life of the loan, while a variable interest rate can fluctuate based on market conditions. Fixed interest rates are generally considered to be more predictable, but they can be higher than variable interest rates.

Variable interest rates can be lower, but they can also increase over time. If you’re trying to keep a consistent budget, fixed interest rates are the better option over a long-term payment plan.

Car Payments

Your car payments are determined by several factors, including the price of the car, the interest rate on your loan, and the length of the loan. A longer loan term will result in lower monthly payments, but you will pay more interest over the life of the loan. A shorter loan term will result in higher monthly payments, but you will pay less interest over the life of the loan.

When it comes to car payments, it's also important to consider the additional costs that come with owning a car, such as car insurance, gas, and maintenance. 

These costs can add up quickly and can make a significant impact on your budget, so it's important to factor them into your calculations when determining how much total monthly expenses you can afford for your future car.

How are car payments calculated?

To calculate a car payment, you will need to know the total cost of the car, the down payment you plan to make, the interest rate on the loan, and the length of the loan (in months). You can then use an online car loan calculator or use the formula: (Loan Amount + Interest) / Loan Term (in months) = Monthly Payment. 

The loan amount is the total cost of the car minus the down payment, and the interest is the annual percentage rate (APR) divided by 12 (to convert it to a monthly rate). Keep in mind that you should also factor in additional costs such as taxes, registration fees, and available car insurance options when determining your car payments.

If you don’t want to manually calculate your future car payments, you can just use the car payment calculator we have above.

How much should a down payment on a car be?

The amount of the down payment on a car is an important factor to consider when financing a vehicle. A larger down payment can lower the amount you need to borrow and can also lower your monthly payments, as well as the total interest you will pay over the life of the loan. 

The general rule of thumb is to put down at least 20% of the car's purchase price as a down payment. However, if you don't have that much to put down, most lenders will accept a down payment of at least 10% of the purchase price.

This isn’t hard rule though, there are dealerships that are willing to negiotate down payments. Some dealerships run promotional deals throughout the year, which gives additional chances to put a lower down payment.

Keep in mind, the more you put down as a down payment, the lower your monthly payments will be, and the lower the total interest you will pay over the life of the loan. Additionally, a larger down payment can also help you to qualify for a better interest rate on your loan. 

What happens if you miss your car payments?

Missing car payments can have serious consequences, including the repossession of your vehicle (e.g. your car getting repoed). The exact number of missed payments before repossession can vary depending on the lender and the terms of your loan. Make sure you review your loan agreement and ask what is the exact number of missed monthly payments are allowed before signing.

In general, most lenders will allow a grace period of 10 to 15 days before reporting a missed payment to the credit bureaus. If you continue to miss payments, the lender may begin the repossession process after a certain number of missed payments, typically 3 to 4 months. 

It's important to note that each lender has its own policies and procedures for repossession, so it's important to check with your lender for specific information about their policies.

Also keep in mind that repossession can have a significant impact on your credit score and can make it more difficult to obtain financing in the future. It's always best to try to work out a payment plan with the lender before the repossession process begins. 

If you are having trouble making your car payments, o reach out to your lender as soon as possible to discuss your options. Most lenders will be willing to work with you to find a solution that works for the both of you.

Tips To Pay Off Your Car Faster

No one wants to have an extra monthly bill to pay and after a while, having a regular car payment could be annoying. So if you’re able to afford it, there are several methods you can use aside from paying your monthly minimums to payoff your loan faster.

Make larger payments

One of the best ways to pay off your car faster is to make larger payments. By making larger payments, you will be paying more towards the principal (the amount of the loan) and less towards the interest (the cost of borrowing the money). This will help you to pay off the loan faster and save money on interest charges.

Pay extra payments

Another way to pay off your car faster is to make extra payments when you can. For example, you can make an extra payment when you get a bonus or a tax refund. 

Making extra payments will help you to pay down the principal faster and reduce the total amount of interest charges. And when you do make extra payments, make sure you are paying off the princpal amount (the total amount of what you owe). When you make extra payments, make sure it is a “principal-only” payment. 

In most cases when you make a payment and don’t note that it is for the principal, the lender will just apply the extra payment to the next payment due date. This helps make the the monthly interest charges lower as well.

Refinance your loan

Refinancing your loan can also help you to pay off your car faster. Refinancing means taking out a new loan with a lower interest rate to pay off the original loan. By refinancing your loan, you can reduce your monthly payments, lower the total amount of interest charges, and pay off your car faster.

Buying a car may be stressful, But We’ve got you covered

Car financing can be a confusing and overwhelming process, but with a little knowledge and preparation, you can find a financing plan that works for you. 

By understanding the different types of financing options available, negotiating car payments, and understanding how car payments and interest rates work, you can make an informed decision and find the perfect car at a price you can afford. Remember to also consider the additional costs that come with owning a car and make sure you can afford them, this will help you make the best decision for your budget and lifestyle.

Always shop around and compare rates from different sources, know your credit score and budget, consider the additional costs of owning a car and don't be afraid to walk away if a deal doesn't feel right. 

With a little research and negotiation, you can find the perfect car at a price you can afford. Don’t forget to use our calculator above (and bookmark it) whenever you’re planning out your budget for buying a car!

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