Understanding Vehicle Financing

With prices averaging more than $20,000 for a new vehicle and $9,500 for a four-year-old vehicle, most consumers need financing or leasing to acquire a vehicle. In some cases, buyers use "direct lending:" they obtain a loan directly from a finance company, bank or credit union. In direct lending, a buyer agrees to pay the amount financed, plus an agreed-upon finance charge, over a period of time. Once a buyer and a vehicle dealership enter into a contract and the buyer agrees to a vehicle price, the buyer uses the loan proceeds from the direct lender to pay the dealership for the vehicle. Consumers also may arrange for a vehicle loan over the Internet.

The most common type of vehicle financing, is "dealership financing.", but the smart car buyer knows it's better to shop for financing before you shop for the car, and the internet is fast becoming the "big dog" in auto financing. In a dealership financing arrangement, a buyer and a dealership enter into a contract where the buyer agrees to pay the amount financed, plus an agreed-upon finance charge, over a period of time. The dealership may retain the contract, but usually sells it to an assignee (such as a bank, finance company or credit union), which services the account and collects the payments.

For a vehicle buyer, internet financing offers:

1. Convenience - Consumers can shop for financing from many different sources (often from one website), from the comfort and privacy of their own home.

2. Multiple financing options - A potential auto buyer now has the power to "shop the nation" for auto financing and get approval within minutes, without ever leaving their den or living room.

3. Special programs - From time to time, online loan entities may offer incentive discounts to buyers who have procured a loan with them previously, or are already doing business with a partnered company.

4. Low overhead - Some financial companies are now "internet only" which allows them to have very low overhead. In turn they tend to pass the savings on to their customers in the form of lower interest rates, and to their employees in the form of better wages. The later usually translates into better customer service.

For the vehicle buyer, dealership financing offers:

1. Convenience - Dealers offer buyers vehicles and financing in one place.

2. Multiple financing relationships - The dealership's relationships with a variety of banks and finance companies mean they can offer buyers a range of financing options.

3. Special programs - From time to time, dealerships may offer manufacturer-sponsored, low-rate programs to buyers.

One downside of waiting to finance through a dealership is that the customer may get "car fever", and step into a financing situation that may be less than optimal, just so they can "drive the car home today". Automobile salesmen are quite aware of this potential, and will sometimes help the customer's emotions get the best of them.

Do your homework:

• Determine how much you can afford to finance and spend on a monthly payment by downloading a copy of our "Monthly Spending Plan" worksheet located here (right click and choose "save target as").

• Get a copy of your credit report so you are aware of what creditors will see. Errors or accurate negative information can impact your ability to get credit and/or your finance rate.

• Identify your transportation needs, and come to terms with your wants - then be realistic about what you need, what you want, and what you can afford.

• Check auto buying guides, the Internet and other sources to find out the price range and other information for the vehicle you want to buy.

• Compare current finance rates being offered by contacting various banks, credit unions or other lenders. Compare bank quotes and dealer quotes; there may be restrictions on the most attractive rates or terms from any credit source.

What Happens When You Apply For Financing

First off you will be required to complete a credit application. Information on this application may include: your name; Social Security number; date of birth; current and previous addresses and length of stay; current and previous employers and length of employment; occupation; sources of income; total gross monthly income; and financial information on existing credit accounts. Be honest, as inaccuracies can come back to haunt you!

The finance company (or dealership, if you've waited until then) will obtain a copy of your credit report, which contains information about current and past credit obligations, your payment record and data from public records (for example, a bankruptcy filing obtained from court documents). For each account, the credit report shows your account number, the type and terms of the account, the credit limit, the most recent balance and the most recent payment. The comments section describes the current status of your account, including the creditor's summary of past due information and any legal steps that may have been taken to collect.

Sometimes dealership may be able to offer manufacturer incentives that an online loan company cannot, such as reduced finance rates or cash back on certain models, per the factory. You may see these specials advertised in your area. Make sure you ask your dealer if the model you are interested in has any special financing offers or rebates. Generally, these discounted rates are not negotiable, may be limited by a consumer's credit history, and are available only for certain models that may be "slow sellers", or year-end makes or models.

When there are no special financing offers available from dealerships or auto makers, you can usually get a better financing deal from online financing company's. The APR that you get from an online company can sometimes be matched buy a dealer, depending on demographics, location, and sales volume, but it pays to be prepared (on all levels) before you enter the dealership.

What Influences Your APR

Your credit history, current finance rates, competition, market conditions and special offers are among the factors that influence your APR. That's why it is important to get a copy of you credit report before you go shopping for any type of financing.

What About A Cosigner

You may be allowed by the creditor to have a co-signer sign the finance contract with you in order to make up for any deficiencies in your credit history. A co-signer assumes equal responsibility for the contract, and the account history will be reflected on the co-signer's credit history as well. For this reason, you should exercise caution if asked to co-sign for someone else. Since many co-signers are eventually asked to repay the obligation, be sure you can afford to do so before agreeing to be someone's co-signer. A cosigner is quite common for a first-time major purchase, and more often than not it is an immediate family member that is the cosigner. All persons concerned need to be aware, alternative, and cautious.

What About Leasing

If you are considering leasing, there are several things to keep in mind. The monthly payments on a lease are usually lower than monthly finance payments on the same vehicle because you are paying for the vehicle's expected depreciation during the lease term, plus a rent charge, taxes, and fees. But at the end of a lease, you must return the vehicle unless the lease lets you buy it and you agree to the purchase costs and terms. To be sure the lease terms fit your situation: Consider the beginning, middle and end of lease costs. Compare different lease offers and terms, including mileage limits, and also consider how long you may want to keep the vehicle.

When you lease a vehicle, you have the right to use it for an agreed number of months and miles. At lease end, you may return the vehicle, pay any end-of-lease fees and charges, and "walk away." You may buy the vehicle for the additional agreed-upon price if you have a purchase option, which is a typical provision in retail lease contracts. Keep in mind that in most cases, you will be responsible for an early termination charge if you end the lease early. That charge could be substantial.

Another important consideration is the mileage limit - most standard leases are calculated based on a specified number of miles you can drive, typically 15,000 or fewer per year. You can negotiate a higher mileage limit, but you will normally have an increased monthly payment since the vehicle's depreciation will be greater during your lease term. If you exceed the mileage limit set in the lease agreement, you'll probably have to pay additional charges when you return the vehicle.

When you lease, you are also responsible for excess wear and damage, and missing equipment. You must also service the vehicle in accordance with the manufacturer's recommendations. Finally, you will have to maintain insurance that meets the leasing company's standards.

Determining How Much You Can Afford

Before financing or leasing a vehicle, make sure you have enough income to cover your current monthly living expenses. Then, finance new purchases only when you can afford to take on a new monthly payment. The "Monthly Spending Plan" is a tool to help determine an affordable payment for you.

The only time to consider taking on additional debt is when you're spending less each month than you take home. The additional debt load should not cut into the amount you've committed to saving for emergencies and other top priorities or life goals. Saving money for a down payment or trading in a vehicle can reduce the amount you need to finance. In some cases, your trade-in vehicle will take care of the down payment on your vehicle.