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Financing a Used Car

Buying a used or pre-owned vehicle instead of a new one is a great way to save money. New cars lose value as soon as they’re driven off the lot, and when you buy used, the previous owner takes that loss.

Still, when it comes to financing, don’t expect impressive offers seen on many new models. Your chances of seeing a used car advertised with zero-percent down or cash back incentives are slim to none. Since used cars are already less expensive, one of the best ways to save money is to shop auto loans from banks and credit unions. Negotiating on price is one way to save money, but a getting a good deal on your loan is just as important.

How Credit Impacts Used Car Financing

Your credit score is the first hurdle when shopping for auto loans with competitive rates. Lenders use your credit score to determine whether or not to give you credit, as well as how much they’ll charge you for it. Generally speaking, the better your credit is, the more competitive the rates that you qualify for will be. The Federal Trade Commission provides valuable information on their website, including a link for free annual credit reports and resources to help you build better credit.

Lending institutions look over a number of factors to decide what sort of loan you qualify for, and how risky it will be to loan you money. Here are the big three that impact their decisions:

1. Your Payment History

Banks want to know if you can make payments in a timely manner and if those payments meet the amount due on your monthly bill. Conspiracy theorists might say that creditors are watching you more closely than the FBI, but the fact of the matter is, creditors need to know if you can keep up with monthly payments. That means they’re going to check your credit card and home mortgage statements and personal and student loans.

If you stay on top of your payments, your credit score should look good. However, if you’re frequently late, or don’t pay as much as you’re supposed to, you’ll be a risky investment.

2. Your Current Debt

Credit watchdogs aren’t only interested in how timely your payments are, but also how much debt you’re currently carrying. They’ll analyze any balances that you carry to determine if you’re a risk.

If a new monthly auto payment looks like it could be the financial straw that breaks the camel’s back, the terms of your auto loan may not be as competitive. However, if it appears that you will not be over-extending yourself with a new auto loan, the gods will likely smile upon you with lower interest rates – especially since they can assume that a used car note will not negatively impact your ability to make consistent, timely payments.

3. The Length of Your Credit History

Would you be more comfortable loaning money to a trustworthy friend or a complete stranger? Obviously, you’d be more comfortable loaning funds to someone you know you can trust, and banks and other lenders feel the exact same way. If you’ve been using credit for a long time, lenders can more accurately predict your behavior. Because of this, someone who’s just started building their credit may be regarded as more of a risk. Technically, banks are profiling clients, a process that negatively affects young buyers, but it’s also a safeguard for lenders. 

If you’re trying to get a loan, and find that you’re running into some roadblocks because you don’t have much credit, ask a family member to co-sign on your car loan to get a more competitive rate.

Used Car Financing Options

There are three ways to finance your next car: at the dealership, at a bank or through a credit union. By and large, the best financing that you’ll find will be through a credit union, though it pays to shop rates at traditional banks as well. Interest rates for used car loans fluctuate, so using a website such as bankrate.com will allow you to compare what’s currently offered by various lenders. After you see what current rates are like, check with your local banks and credit unions to see if they can beat the rates you see online.

Financing at the dealership seems easier, but be aware that car dealers make money not only by selling cars, but also by providing financing options for consumers. As a general rule, dealer financing will be higher than what you’ll find at a bank or a credit union, but if you come in with your own pre-approved financing, the dealership may try to beat it. Do the legwork and get approved for financing at a bank or credit union before you sit down to negotiate. That way, you’ll know you’re getting a good deal on your used car loan.

Finding the Best Car Loan

The best car loan for you depends mainly on how much can you afford to spend. The interest rates that you qualify for and the length of your loan will both affect your monthly payments. Used car loans are generally available for a term of up to 60 months, and lengthening the term of your loan will likely result in lower monthly payments. Keep in mind, however, that you’re being charged an annual percentage rate on the balance of your loan, so if you can make more aggressive (higher) payments, shortening the term of your loan will ultimately save you money.

For example, let’s assume you borrowed $20,000 at 3.9-percent APR from your credit union for a used car, and you have the option of either a 36 or 60 month loan. With the 60 month loan, you’re monthly payments will be lower at $367 per month, but you’ll also pay $2,046 in interest over the course of the loan. Shortening the loan to 36 months makes your monthly payments much higher at $590, but you’ll end up with more money in your pocket since you’ll only pay $1,225 in interest -- $821 less than you’ll pay by extending the loan two extra years.

When you finance your next car, remember these tips to keep your costs low. Stick to your budget, and know how factors such as the length of your loan and interest rates affect what you pay. Then, head to the dealership armed with pre-approved, competitive financing that you know is within your budget. Ultimately, it will simplify the negotiation process, and help you get the best price.