This resource is part of the Innovative Funding Services (IFS) auto finance Library.
Learn how to find a car loan that fits your finances.
Most car shoppers would prefer to avoid searching for auto loans. While the idea of borrowing a large sum of money is unpleasant in itself, many borrowers’ dislike auto finance because of its perceived lack of transparency—a perception it probably deserves. Fortunately, as a car buyer, you have the tools to take charge of the car loan application process and to determine when a loan offer meets your needs.
The key to finding a good auto loan is to directly compare loan offers from multiple lenders. This article will explore the types of auto finance institutions that you can apply with and how to evaluate and compare any offers you receive.
But first, a word of caution: you must always apply for a loan to receive a true loan offer. If you find yourself on a website that quotes auto loan terms like monthly payments and interest rates without an application, know that you would be looking at estimates that in all likelihood will differ from any loan offer you would actually receive.
Searching for Auto Loans
The most common places to apply for auto loans are 1) banks and credit unions, 2) specialized auto finance companies, 3) finance & insurance departments at car dealerships, and 4) auto loan companies.
Before applying for loans, make sure you understand how applying with each type of institution may affect you.
Banks and Credit Unions
Many car buyers start their auto financing search at the banks or credit unions with which they have checking and savings accounts. These institutions regularly offer the lowest interest rates on vehicle loans, making them attractive lenders.
But it is not always easy to get a loan from a bank or credit union. To offer such great rates, these lenders are generally picky about which loan applications they approve, tending to serve those they consider lower risk (i.e. those with higher credit scores and/or incomes).
And even when a bank, credit union, or any other lender serves higher risk borrowers, they will still only approve those applications with risk profiles they understand well, meaning almost no lender is a match for everyone.
So, do not be discouraged if you are denied a loan when you apply with your banking institution. You will just need to find other lenders that serve applicants who are more like yourself.
If you are fortunate enough to get a good offer from your bank or credit union, do not settle for the deal immediately. Remember, the key to finding an auto loan that meets your needs is to get and compare multiple offers.
Auto Finance Companies
Auto finance companies are the other major type of lender in the car world. These financial institutions specialize in making auto loans and offer few if any of the other financial services you would find at a bank or credit union.
In contrast with many banks and credit unions, auto finance companies typically serve customers with fair to poor credit.
While car shoppers have many options for buying cars today, most people still purchase their new and used cars from dealerships. If you are buying from a dealership, see what kind of loan its Finance and Insurance (F&I) department can offer you.
A dealership F&I department will work with multiple lenders, so in many cases they will be able to get you approved for a loan. They will usually make the loan to you themselves and then “sell” the loan to one of their lenders, a deal known as an “indirect loan.”
But to put yourself in the best position for evaluating F&I loan offers, seek approvals from other lenders, like your local credit union, before going into the dealership. Then, you have the option to reject any F&I loan offers are not better than the one you have in your pocket.
If you are looking to buy a new car, a dealership F&I department can typically beat any loan offer you bring to it by working with the vehicle’s captive lender (i.e. a lender owned by the car manufacturer). Since a car manufacturer’s top priority is selling vehicles, they typically will allow their captive lenders to give discounts and incentives when extending loans.
Auto Loan Companies
An alternative to searching for loans yourself is to work with an auto loan company. These companies match applicants with lenders. Many will take your application and submit it to only those lenders that are a match for you, allowing you to get the benefit of applying with multiple lenders without having to go through all the work.
An auto loan company should also handle all of the paperwork involved in getting a loan and manage the title transfer on your vehicle.
The Credit Impact of Applying for Auto Loans
Contrary to popular belief, applying for loans from multiple lenders at the same time will not ruin your credit. Hard credit pulls can cause your credit scores to take a small, temporary dip, but most credit scoring models consolidate similar credit inquiries together when they are made within a few weeks of each other.
So, if you apply with multiple lenders for a car loan in a short period of time, it should only affect your credit as if you submitted one application.
Strategy Tip: Do your research on auto lenders before you begin applying. Then, make a list of 3 to 5 lenders that may be a good fit for you in terms of your credit and income, and apply with them at one time. Or as mentioned above, work with an auto loan company.
Comparing Auto Loans
Auto loans are easier to weigh against one another than other types of loans like mortgages and credit cards. You can understand how much a car loan will cost you by looking at the following contract terms:
- Amount Financed
- Term Length
- Finance Charge
- Annual Percentage Rate
- Interest Rate
- Monthly Payment
You will find all of these terms listed in your “Truth In Lending” disclosure box on your loan documents. By comparing these elements on each of your loan offers, you can quickly determine which will best meet your needs.
So, once you have your loan offers, lay them out and compare these contract terms one by one.
- Amount Financed – the amount you are borrowing.
Start by noting if each of your lenders is offering to finance the same dollar amount. If a lender requires a downpayment on a loan, then they are not willing to finance the entire cost of your car purchase or refinance.
- Term Length – the number of months over which you will pay back your loan with interest. For the same APR (see below), a longer term length produces lower payments, but it can also increase the total cost of your loan in the long run as you pay more months of interest charges.
Tip: Check whether your loan offers are all for the same term length.
- Finance Charge – the total cost of your loan over the life of the loan. This number tells you how much you will be paying your lender and other institutions as compensation for their services. It includes both your interest charges and your prepaid finance charges.
Determine which of your loan offers has the lowest finance charge as that loan will be your least expensive loan in the long run. However, consider all other factors as well. If, for instance, the loan with the lowest Finance Charge also has a lower Amount Financed due to a down payment requirement, you have to consider whether you can afford the down payment.
Additionally, finance charges reflect the cost of your loan if you pay back your entire loan as scheduled. If you pay off your loan early for some reason, perhaps when trading in your vehicle to buy another, then you will not have pay the entire finance charge on the loan.
- Annual Percentage Rate (APR) – your total cost of financing represented as a yearly rate. It will generally be higher than your interest rate as it accounts for both your interest charges and your prepaid finance charges.
When the term lengths are the same, the loan offer with the lowest APR should be the one with the lowest finance charge. Like with finance charges, consider other contract terms in conjunction with the APRs before deciding on which loan to choose.
- Interest Rate – your cost of borrowing per year not including fees or interest accrued to the day of your first payment expressed as a yearly rate. It is usually slightly lower than your APR.
APRs are generally easier to compare than interest rates. Learn more about APRs, interest rates, and how they relate here.
- Monthly Payment – the amount you owe per month to repay your loan with interest. A lender calculates your payment using your term length, amount financed, and APR (learn how to calculate car loan payments here). For a fixed amount financed, a lender can give you a lower payment by either decreasing your APR or increasing your term length. Remember, longer term lengths lead to bigger finance charges for the same APRs.
Compare your loan offers by their payments. You need to weigh the monthly payments against their respective finance charges (and down payments if there are any). Ideally, the loan you will accept will have both the lowest payment and finance charge.
Always consider all auto loan terms when comparing loan offers. But, to put it briefly, look at how much each lender is offering to lend (the amount financed), how much each loan will cost you in the long run (the finance charge), and how much each loan will cost you in the short run (the monthly payment).
Example: Comparing Auto Loans
Let’s imagine you are are looking to purchase a $20,000 car and need an auto loan to cover the full amount. So, you do your research and decide to apply with five lenders that you may be a match for: Big Bank, Small Bank, Local Credit Union, Geographic Credit Union, and FinanceMyCar!, an auto finance company (these are all fictitious lenders).
Big Bank and Geographic Credit Union decline your application, so you only have three loan offers to consider.
Looking at the three offers you quickly notice that FinanceMyCar! offers the lowest monthly payment at $337.53 and Small Bank offers the lowest Finance Charge at $3,059.98.
However, to get a better picture of which loan works for your needs, you look through all of the terms for each loan.
Starting with amount financed for the loan offers, you see that Small Bank is only offering to finance $18,000, which would require you to make a $2,000 down payment. You think that you may be able to get a $2,000 down payment together if you had to but decide this might not be a good move for you. You reason that if you were to pull together $2,000 that it would be best used to pay off some credit cards. So, Small Bank’s offer is out.
Now it’s between Local Credit Union and FinanceMyCar!.
Local Credit Union’s offer has a payment that is $54.73 more per month than FinanceMyCar!’s! But you quickly see why.
FinanceMyCar!’s offer has a longer term length of 72 months versus 60 months with Local Credit Union. This longer loan term increases the number of months you would have to pay towards interest charges, which is the main reason that FinanceMyCar!’s offer comes with a Finance Charge that is $766.77 more than Local Credit Union’s.
While FinanceMyCar!’s lower payment is tempting, you decide that paying $766.77 more over the life of your loan to buy the same car is too much. So, you accept Local Credit Union’s offer and buy your new car!
While in this example, our analysis favored a loan without a down payment that was inexpensive in the long run, you may value other outcomes when you search for loans, such as getting lower payments. You should make decisions that align with your financial needs and goals. But, as we did in this example, always analyze the full impact of every loan offer you receive before accepting one.
Note: in this example, the loans only covered the amount you need to purchase the car. If some of the lenders offered to finance service protection products like extended warranties, then you would have to consider the benefits and drawbacks of taking out a larger loan to get those protection products.
When searching for auto loans, you want to put yourself in a position to get a good deal. A strategy you can use when shopping for a car loan is to Research, Apply, Compare:
- Research multiple lenders to find ones that lend to customers with similar credit scores and incomes to yourself.
- Apply with three to five of those lenders within a short period of time.
- Compare any loan offers you receive by all their terms, considering each loan offer’s short-term costs (i.e. the monthly payment) versus long-term costs (i.e. the APR and finance charge).
Another way to go about finding and comparing car loans is to work with an auto loan company like IFS. A good auto loan company will take your application, send it to only those lenders that may be a good match for you, and handle all the paperwork on any auto loan you accept.
If you would like a lower monthly payment and APR on a current auto loan you have, consider refinancing. Through refinancing, you can replace your current auto loan with a new one of more favorable terms for you. Learn how auto loan refinancing works, calculate how much refinancing could save you, or apply to refinance through IFS now.