How to Determine How Much Car You Can Afford

Upon approving your credit application, a bank or credit union advances you a certain amount of money to cover some or all of the cost of an automobile purchase. The lender makes money by charging interest on the loan, meaning you’ll pay back more than you initially borrowed.

Getting a car loan is usually pretty straightforward. You can go directly to your bank or credit union and apply for a loan, or you can let a car dealership apply for a loan on your behalf through its network of cooperating banks.

Yes. You can either visit your bank or credit union and get approved for a loan before you go car shopping so that you know exactly how much you can spend, or you can apply online to individual lenders or dealerships’ financing departments.

Interest is calculated based on the age and condition of the car and your credit score. New car loans generally have lower interest rates because new cars are worth more than older cars. Used cars often have higher interest rates because the cars are less expensive overall and harder to resell and recoup the investment, should the lender have to repossess the vehicle. Banks also look at your credit history to determine if you have paid your bills on time and if you earn enough money to take on the loan.

There are lenders who work with nearly any type of credit score, whether very poor or excellent, but you’ll get better terms and a lower interest rate with a higher credit score. Lenders prefer responsible borrowers, so pay your bills on time to show that you can be trusted with a loan.

There is no set amount, and some loans won’t require any down payment. Keep in mind that the more you pay upfront, the less you’ll need to borrow, which in turn means lower monthly payments and less you’ll pay in interest over the life of the loan. If you’re buying a new car, a good rule of thumb is to pay 10 to 20 percent of the final price as a down payment. This will help keep you from being “underwater” on the loan (in other words, owing more than the car is actually worth).

Do your homework well ahead of time. Examine your credit report for inaccuracies and have them removed. This might be old debts you’ve paid off or accounts that aren’t yours.

Look for any debts you can pay down or pay off completely to reduce your total debt load. The way a lender looks at it, the less debt you have overall, the better chances are that if you fall on hard times later, you’ll still be able to make your car payment.

Once your credit report is in good shape, start gathering your documentation. Generally, you can expect to show a recent W-2 or the last two to three months’ paystubs to verify your income. You’ll also need current identification.

Just as you shouldn’t buy the first car you see, you don’t have to settle for the first loan offer that comes your way, either. Shop around for the best terms and interest rates. Banks sometimes offer premium rates to long-term members, so consider applying at your regular bank first. Credit unions are also worth checking into, as they often have lower rates than larger banks simply because credit unions are smaller and have to compete for business.

Don’t be afraid of applying at a dealership either, especially for a new car. Dealerships usually have extensive networks of partner banks, and sometimes they can beat your bank’s finance rate.

When considering a car loan, keep in mind how long you plan to own the car and how long you want to make payments. Shorter loans mean higher monthly payments, but you’ll pay less overall in interest and pay off the car more quickly. Longer loans mean lower monthly payments, but you’ll pay more in interest by the time the car is fully paid off. The car will also be older and resell for less, if you do plan to sell it.

One of the most well-known car loan scams involves “yo-yo” financing, in which a salesperson leads you to believe your financing application has gone through, accepts your down payment or trade-in, and sends you home with your new car. You think everything is fine until days or weeks later when the dealer calls and says the financing fell through and you need to come back in to sign additional paperwork, which usually features less favorable terms. This type of scam is especially targeted toward buyers whose financing options are limited by low income or by poor or no credit history.

To avoid this mishap, be as honest as possible when disclosing your income and ability to pay. If you want to be extra careful, insist on not taking the car home until all financing and related paperwork is finalized.

If you’re applying for a loan online and aren’t certain about the site’s authenticity, look up the company on the Better Business Bureau’s website to make sure the company is legitimate and you aren’t giving your sensitive information to scammers.

Read the fine print, paying special attention to the interest rate and loan length outlined in the contract. Make certain that what is written in the contract matches what you have discussed with the salesperson. Look out for any add-ons you didn’t agree to, such as extra warranties, gap insurance, or trim packages.

Buying a new car takes time, patience and a lot of research. But if you know how to navigate the world of car loans, you’ll be in a much better position to get the car you want and save a lot of money at the same time.