Categories

Personal Finance

What Is the Best Way to Pay for a Car?

While the thought of hitting the road with a new car can be exciting, many of us approach the car-buying process with dread. On top of finding a car that meets all your criteria and possibly having to haggle with a dealer or seller, you have to figure out how you'll pay for it.

Many car buyers rely on financing, but don't assume you have to—there are plenty of other tactics. Here are some of the common car payment options to consider, and what you need to know about each one.

Use Your Personal Savings to Pay for a Car

While it might be unrealistic to save enough cash to buy a brand-new car outright, it's a wise strategy to pay with cash if you're able to buy an inexpensive used car. By paying with cash savings instead of taking out a loan, you save money by not paying interest.

Try to plan far enough ahead that you're able to build up a healthy savings account. Think about how much you'd be paying every month to finance a new car and set aside an equivalent amount every few weeks. In two or three years, you'll have a significant sum of money built up that could totally cover the cost of a vehicle (or at least significantly reduce the amount you'll need to finance). If you find someone to buy your existing car, proceeds from the sale can go toward funding the purchase.

If you already have a savings account in the form of an emergency fund, it's usually best to avoid using it to pay for a car unless you're in a really tight spot—your car died and you don't have another way to get to work, for example. It's best to keep that money there for true emergencies, and instead use general savings intended for big purchases.

Find a Low-Interest Auto Loan

Consumers often turn to auto loans to finance car purchases when they can't pay for it with cash. These are secured installment loans, meaning you repay in fixed monthly installments, and if you can't keep up, you risk the car being repossessed.

When financing a car, do everything you can to get the lowest possible interest rate on your loan. Due to the size of an auto loan, interest can add significantly to the total cost of the vehicle. For example, a $12,000 auto loan with a 7% interest rate and a 60-month term will end up costing you $14,257 by the time you've paid it off. That's $2,257 that could have otherwise gone toward a down payment on a home or other financial goals. Getting that interest rate down to 4% could save you roughly $1,000 on your loan.

You have several lender options when financing a car:

  • A bank or credit union: Check the borrowing options your bank or credit union can offer you before you start shopping for a vehicle. They may be able to preapprove you for a loan with a lower interest rate than you'd get elsewhere. Once you have the loan documents in hand, you can bring them with you to a dealer to show you're qualified to buy a car up to a certain price. Be aware that financial institutions often charge different interest rates depending on whether the car is new or used, in addition to the age and mileage on the car. However, going through a lender typically means lower loan interest rates than going through a dealer.
  • An online lender: If you'd rather not go through your own bank or credit union, or if you're not able to get approved, many online-only lenders now offer auto purchase loans. These lenders typically offer quick approval and may be more lenient on approval and rates if your credit isn't in tip-top shape.
  • The car dealer: If you don't get preapproved by a lender before you go car-shopping, you can apply for financing at the car dealership once you've selected a vehicle. It may be easier to get approved through the dealership financing office than with a traditional lender. They'll typically shop your application with several lenders they partner with and provide you with a few options to compare. The vehicle manufacturer also may offer financing themselves, which is called captive financing.The rates you'll get from a dealership may be higher than what you'd get from a bank since the dealership may bump up your rate slightly in order to collect a cut. Some dealerships offer 0% APR promotions or other offers on new cars, so it could be worth going through a dealer if the savings are worth it. Some dealers even offer financing directly (buy here, pay here), but it's usually geared toward those with bad credit and comes with steep fees.

Explore Other Borrowing Methods

There are a few other, less common ways to finance a car. These typically aren't recommended, but here's what you should know.

  • Credit cards: Wondering if you can buy a car with a credit card? Dealerships often have limits on how much can be put on plastic; but you may be able to use a card to cover some or all of your down payment. You may even be able to pay the entire purchase amount with a card depending on dealership policies and your credit limit. If you plan to put some of all of the car on your credit card, you may need to contact your card issuer first to make sure the large transaction will be approved.
    Before moving forward, understand that this payment method could be unwise for several reasons, not the least of which is the fact that credit card interest rates are usually much higher than auto loans. Furthermore, carrying a large balance can hurt your credit since it'll drive up your credit utilization ratio. If you can't pay it off right away, opt for an auto loan instead.
  • Personal loans: Just like auto loans, personal loans are installment loans that are repaid monthly with interest. They differ in that they are usually unsecured loans, so if you buy a car or anything else with a personal loan, it can't be repossessed if you don't pay (but your credit will take a big hit). While personal loans may be easier for car buying if you're purchasing a vehicle from an individual rather than a dealership, their interest rates are usually higher than what you'd get from a comparable auto loan. So if you're looking to spend the least amount of money, an auto loan is usually your best bet.
  • Borrow from a loved one: If you have a friend or family member willing to give you an interest-free loan, asking for their help could get you behind the wheel of a new car and save you a lot of cash in the process. You don't have to borrow the entire amount either; this could be an option to make up the difference if you don't have quite enough to complete the transaction. This method isn't one you should count on, though, since it can be hard to find and persuade someone to go through with this. Additionally, failure to repay can irreparably damage your relationship with whomever you borrow from. If you do choose this option, draw up a promissory note that outlines the terms so your lender can be confident you'll repay.

Steps to Take Before You Take Out an Auto Loan

If you decide to take out an auto loan to pay for your car, do plenty of research before you sign on the dotted line.

Getting preapproved before visiting a dealership can help you understand how much you can afford to spend, which can help you narrow down which car to buy. To find the best rate, get preapproved with more than one lender. Your credit score can impact whether you're approved and what interest rate you receive; the better your credit, the more favorable the loan terms will be.

When looking at quotes, you'll want to look at the loan's interest rate, term (amount of time over which you pay off the loan), any taxes and fees, and the total monthly payment amount. This can help give you a sense of the overall cost of the loan and ensure the car payment will fit within your monthly budget.

If you do take out a loan, you'll also most likely need to put some money upfront as a down payment. The more you put down, the lower the loan balance will be and the less you'll pay in interest fees over the life of the loan.

Improve Your Credit First

If your credit isn't in great shape right now and you need a loan to purchase a car, it's best to work on improving your credit before you buy. While this isn't always possible if you're in a time crunch, if you can wait several months, it would be prudent to use that time to increase your credit score first. To do this, keep your credit card balances low, pay down as much debt as possible and pay every bill on time. It's also smart to monitor your credit so you can make sure your hard work is paying off. Experian Boost can also give your credit a bump by adding on-time cellphone, utility and other payments to your credit report.

Resources