You're sitting in the dealership when the salesperson asks, "So, how are you going to finance your new car?"
The question leaves you a little confused. What is he really asking?
In the car business, the term financing is loosely used to mean that the dealership will either provide you with an auto loan to buy the car or lease the car to you. The opposite of "financing a car" would be buying it outright with one cash payment.
Although you can take out a bank loan to finance your car, many people like the convenience of getting a loan through the dealership. They can walk in, choose a car, fill out a credit application and drive away in a new car. They can do this at night or on the weekends when banks and credit unions are closed.
In exchange for this service, the dealer will often charge you more for your auto loan. How much more? That depends. If you have sterling credit, you might get a competitive interest rate and be eligible for special programs that lower your cost. However, if you have bad credit, or no credit, the dealer might charge a much higher interest rate for taking what is perceived as a risk on loaning you money.
So, going back to the salesperson's question, "How are you going to finance your new car?" your answer could be one of three things:
Let's look in more detail at each of these financing options so you can know what to expect at the dealership:
"I want to buy the car."
If you decide to buy the car and you want the dealership to help you finance it, you will be asked to fill out a credit application. Based on your credit score, an auto loan will be arranged through the dealership's lending institution based on the negotiated price of the car and related expenses (sales tax, title and licensing fees). Loaning money is big business, and most auto manufacturers have their own companies to arrange car loans. For example, Nissan cars are often financed through Nissan Motor Acceptance Corp.
You will probably be asked how quickly you want to pay off your new car. Most auto loans are from three to five years -- 36 to 60 monthly payments. Different lengths of time can be arranged, if desired. Obviously, the longer you take to pay off the loan, the lower the payments will be. In addition, the amount of your monthly payment will depend on the interest rate, the length of the loan and the amount of your down payment. Keep in mind that the dealership will urge you to make a large down payment.
While you are paying off the balance you owe on your car, the lending institution will hold the car's title. Once all the payments are made, the car's title is sent to you and you finally own the car.
"I want to lease the car."
If you decide to lease the car, you will also be asked to fill out a credit application. Based on your credit score, and the length of the auto lease you want, the dealer will shop for a lease for you. Using a sophisticated computer program, numerous banks will be contacted. Each bank will have different terms and conditions.
You will need to decide how long you want to lease for (we strongly recommend three years). Also, you need to decide how much you want to pay upfront (we recommend you pay as little as possible to start the lease -- tell the dealer you want to pay "drive-off fees only").
Most auto lease contracts allow you to drive the car 12,000 miles a year. If you typically drive more than this, ask that the car lease be written for 15,000 miles or even 18,500 miles. This will raise your monthly payments but save you money in the long run.
Your contract will contain a residual price for the car you are leasing. When you have made all the lease payments, you can then buy the car for this residual price (or you can sometimes negotiate an even lower price to buy the car for). If you decide to return the car to the leasing company, they may charge you for excessive wear and tear to the vehicle. If the car is in great shape, you can get your security deposit back or use it to start the lease of another new car.
"I will be paying cash for the car."
Paying cash for a new car makes the transaction very simple -- all you need to do is negotiate the price of the car and then write the dealer a check for this amount. This removes several variables from the negotiation process: the down payment, the interest rate and the monthly payment. Negotiating in this manner means the dealership can't disguise the true cost of the car.
Wait a second, you say, who has the dough sitting around to buy a new car outright? What we're really saying is to borrow the cash from an outside source so you can be a "cash buyer" at the dealership.
There are many lending institutions that make loans for new cars. Up2Drive.com will even arrange a loan over the Internet. Again, the process begins with filling out a credit application. If approved, you will be given a credit limit and issued a check (sometimes called a draft or bank draft) that can be made out to a dealership. The lending institution will hold the car's title while you make all the agreed-upon payments. When the balance is paid off, you will get the car's title.
Summary
That is an overview of the credit process you are likely to encounter at the dealership. There are several different strategies for buyers to reduce their costs at the dealership. For more information on these subjects, review the other finance and credit stories available on Edmunds.com.
