With 43 percent of vehicle owners choosing to finance, financing your car is the most popular path toward ownership. For many individuals and families, financing is more accessible than paying the full purchase price upfront.
Despite the popularity of financing, many people are without a clear understanding of how it works. In order to clear up any misconceptions and ease concerns, I’ve answered some of the most basic questions about financing your vehicle purchase.
What does financing a car mean?
If you need a vehicle but don’t have the upfront cash to purchase it outright, financing is a way to bridge that gap. When you finance your car, you’re borrowing the purchase amount from either a creditor or a lending institution and agreeing to pay that amount back with interest.
What does the loan term mean?
“Loan term” refers to the length of time you have to repay the borrowed amount and the corresponding interest. Your loan term is determined during financing, as it affects the required monthly payment. A shorter loan term means larger monthly payments, and a longer loan term means smaller monthly payments.
How are interest rate and term related?
The amount of interest you’ll pay when leasing is directly affected by your loan term. Interest accumulates for as long as you’re paying back the borrowed money, so a longer loan period means more interest charges.
Your loan’s interest rate is also affected by the loan term. Lenders typically require a higher interest rate on longer loan terms because it will take much longer for them to recoup their initial investment. Similarly, a shorter loan term often means a lower interest rate.
To see how loan term and interest rate can have an effect on your payment, use our free car payment calculator.
What affect will your credit have on the interest rate you’re offered?
Your credit score definitely affects what interest rate you’ll be offered for financing. Those with excellent credit scores will likely receive lower interest rates than those with standard or low credit scores. This relates back to the lenders and the risk they assume by lending you the money to purchase a vehicle.
While your credit score does matter when it comes to interest rate, it isn’t the only thing considered. Two additional variables that will lower your interest rate are having a stable income and having a low debt-to-income ratio. If you do have less-than-excellent credit, these two variables may influence your approval and interest rate.
How does down payment figure into financing your car?
Your down payment is the amount of money you initially put toward the vehicle at the time of purchase. A larger down payment means less money needs to be borrowed from a lender and a lesser amount will be charged interest on.