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TEMPORARY CORRECTION TO VIDEO CONTENT: Due to the impact of COVID-19, interest rates have returned to historically low rates.
Script for the "Financing A Car" video is here:
While it would be amazing to be able to stroke a check for $25,000, it just isn’t in the cards for most people. That’s why it’s so important to understand about how to finance a vehicle purchase.
When financing a car, you’re going to be taking out a loan where the car is used as collateral to pay it back.
With this purchase method, you don’t own the vehicle until you make all of the payments. If, for some reason, you miss more than three consecutive payments, you can expect that the bank will send someone to repossess the vehicle from you.
When financing a car, it is critical that you understand your credit situation first. If you aren’t the type of person looking at your score every week, just head on over to CreditKarma.com and open an account. It’s totally free, and they’ll give you two of your three credit bureau scores and full reports. Don’t worry, it doesn’t hurt your credit for you to look at it, and I’m providing a link below.
They use a Vantage Score model where most lenders use a FICO score. The difference in the numbers isn’t as important as the category under which you fall. Let’s look at the numbers as a baseline for you to determine loan eligibility.
From 300 to 560 on that model means it will be very difficult to qualify for anything without a significant down payment. 560 to 650 there will usually get approved, but likely with a high rate and a down payment requirement. When you move up over 650 there, things will get a lot easier with anything above 750 being a Prime Borrower meaning that zero to prime rates are on the table, even with zero down payment.
Now just to clarify, you will only ever get 0% financing from a manufacturer’s finance company as an incentive on specific models, like Ford Motor Company lends with Ford Motor Credit. They will only lend on a brand new or certified pre-owned Ford car. Nearly every manufacturer has their own lending company to facilitate incentivized financing.
They lend through a Tiered structure. Every deal is different where it falls into the tier, and there are ways to change which tier you fall into because it’s not just dependent on credit score.
The factors are:
- Your credit score
- The car
- The amount of your down payment.
A buyer with a 700 credit score earning $60,000 per year buying a $25,000 car with $3,000 down looks great to a lender and will tier well. If that same exact buyer switches to a $90,000 dollar car, though it will not tier as well. They will need to increase their down payment or suffer a much higher interest rate even if it’s approved.
It is by understanding this tiered system that those with credit challenges can get into the right car. If this is you, then set your expectations lower. You can own a brand new car, but it will likely be under $20,000 total, including tax, title, and license. The lowest possible vehicle price that meets your needs, the better.
You will also need a down payment. The higher, the better. You can have horrible credit, but if you can put $5,000 down on a $15,000 car, then you will probably get approved.
One thing I noticed at the dealership was that some people always thought we were pushing for more down payment just to put it in our pockets. That is not the case at all. We needed a higher down payment to get a customer approved! We were trying to improve their tier to get a lower rate or even just to get a bank to say yes.
Now there are many ways to approach financing a car. Most people have a payment target in mind, and this is one of the things that the Sales Associate will ask you about. They love to get you thinking about payments instead of price because it’s easier to manipulate you that way. A dealership can move many different numbers around in a way favorable to them to hit a specific payment target.
The good thing is that it’s all just math, and if you’re terrible at math, I’ve included a calculator above. To be on the safe side, always add 10% to the purchase price to cover tax, title, and other fees just to make sure you aren’t surprised.
Also, be realistic about interest rates. You may have bought one between 2008 and 2017 at 4% or less, but that was a historic low for rates. The Prime Rate was at 3 1/4% for seven years! Those days are gone. Check the Prime Rate right here while you’re shopping and be realistic about what you want to accomplish financially based on what you learned about tier-based lending.
There are innumerable lenders that will finance a car for you as well. You can go to your own bank, you can apply online at a bunch of different places, or the dealership can handle your financing. If you go through your own bank, then you’ll essentially be treated the same way as a cash buyer from the previous section. The same goes for applying online. From the dealership’s perspective, they’re just getting a check or a wire from a place that will pay for the car.
The only one I won’t recommend here is a credit union, even if they have a great rate. Why? Because most are too small to report to all three bureaus and if they don’t report your history of good payments, they’re the only ones who know so you’re kind of forced to always go back to them.
The other reason, though, is a clause in credit union member agreements that permits them to seize any assets you have under their control, like your checking account, if you fall behind on payments. Even banks can’t do that. When I went to Auto Finance School, the instructor said for these two reasons; credit unions are like the mafia.
You may also have the dealership arrange your financing. Because of their relationships with dozens of lenders, they can likely beat any rate that you can get. However, you will pay a fee for the convenience. As an example, there is a buy rate from the lender, which say is 5%. The dealer will show you a sell rate and tell you that you’re approved for 6.5%. As the middleman, and essentially by providing a brokerage service, They keep the spread, which makes financing a lucrative profit center for them.
That being said, though, even with that markup, referred to as a finance reserve, if they can still beat the rate you’ll get from your bank, then who cares. Best practice may be to have one or two approvals from outside lenders and take that to the dealership, giving them a chance to beat your rate. Additionally, if you want any backend products like an extended warranty or service plan, then dealer financing will likely have more room to finance them than your own bank.
You will have several hard inquiries on your credit report while you’re rate shopping. It’s ok, though. According to FICO, the Fair Isaac Corporation, all inquiries made for an auto loan within a 30-day timespan will only count as one.
Finally, the “No Credit No Problem” types of dealership business models will usually approach financing a car as the lender themselves. Meaning that you’ll go in and make a down payment, likely close to what they paid for the car, then you’ll be making payments directly to the dealership. If you fail to keep up with payments, it’s not the biggest deal to them because they can just repossess the car and do the same thing over again with it. They will most definitely not report your good payment history to credit bureaus so that you always have to come back to them for your next car.