How Financing a Car Works

When you go to a dealership to purchase a car, you have two purchasing options; you can pay for the car in full at once or you can finance the car. Because a car is a large purchase, many people choose to finance. Automotive.com says that 70 percent of vehicles are financed. An informed consumer is a wise consumer so you should understand the vehicle financing process prior to financing your new car.

Misconceptions

A common misconception is that the dealership is also the lender. You do not obtain your loan from the dealership. The dealership has a list of lenders (finance companies or banks) that it goes through to obtain car loans for their customers, according to Lease Guide. Another common misconception is that the dealership is owned by the car manufacturer. For example, many people think Bob Bell Ford is owned by Ford. Bob Bell Ford is an authorized, independently owned franchise, reports Lease Guide. A final misconception is that the dealership prefers when a customer pays for a vehicle in full instead of financing. In actuality, the dealership prefers when a customer finances a vehicle as it sometimes receive a "finder's fee" from the lender when a customer finances, according to Lease Guide.

Your Credit Score

Lenders look at your credit score to determine your credit worthiness. Generally, the higher your credit score, the better the interest rate will be on your car loan, according to the American Financial Services Association Education Foundation. If your credit score is too low, the bank or financial institution may not be willing to lend to you at all. According to Consumer Federation of America Fair Isaac Corporation, a score above 700 is very good and is a sign that a consumer is financially stable but, when a lender sees a score under 600, it will charge that consumer a high interest rate or refuse to loan to that consumer.

Your Debt to Income Ratio

Your debt to income ratio also has a factor on the lender's decision. The lender looks at your income and asks questions about your financial obligations to ensure that you can afford the monthly payments. Automotive.com says that your car payment should not exceed 20 percent of your net income.

The Financing Process

Now that you have decided which vehicle you want to purchase and the lender has determined that your credit and income are appropriate for your vehicle, there are a few more steps in the financing process. You must show documentation to prove that the information you gave the bank is accurate and valid. This includes pay stubs or a W2 (to show your earnings), proof of identification and other documents as the lender sees fit. The lender does not always determine your interest rate. According to Lease Guide, sometimes, after the lender approves a loan, the dealership may increase the interest rate to add margin (additional profit for the dealership). You then sign a large packet of paperwork. Make sure you carefully read each section of the paperwork, including the fine print.

Monthly Payments and Total Package

Before you sign any paperwork, examine your monthly payment as a function of the car's worth. If you finance a $15,000 car and your monthly payments are $350 per month for 60 months, you are actually paying $21,000 for a $15,000 car. If you are content with this type of package, be aware that this loan will be "upside down" for the majority of the loan's life. When a loan is upside down, the amount the borrower owes exceeds the value of the property purchased with the loan's funds. You will not be able to trade in a car with an upside down loan without paying the upside down amount (amount owed over the property value) in the form of a down payment.