Many of the fundamentals and best practices for financing pre-owned vehicles also apply to new vehicles.

1. Know your Credit Score Before Applying

Regardless of whether you have good credit or bad credit, borrowers should obtain a recent copy of their credit report. Each major credit bureau will provide you with a credit history each year at no charge.

Car shoppers should review their credit reports to assess what lenders will see when considering your application for auto financing. Closely review the credit report to potentially identify any errors associated with other loans, credit cards, or other financings.

What is a good credit score to buy a car with an auto loan? The following chart illustrates the different credit tiers and how your credit score dictates whether your car loan has a lower or higher interest rate. 

How Credit Scores Impact Interest Rates in Auto Financing

Credit Score Range	Average Interest Rate	Average APR (New Car)	Average APR (Used Car)
Excellent Credit Score (781 – 850)	3.89%	2.99%	4.29%
Good Credit Score (661 – 780)	4.98%	4.12%	6.29%
Average Credit Score (601 – 660)	8.19%	7.01%	11.29%
Poor Credit Score (501 – 600)	12.45%	11.92%	18.03%
Very Poor Credit Score (300 – 500)	15.99%	16.49%	23.50%

Source: Estimates based on current market trends and economic factors as of Q2, 2024.

As the chart indicates, the lower interest rate financing options are reserved for those with good credit. Some borrowers may consider delaying their car financing efforts until they have improved their credit score.

One effective tool for boosting a credit score is to obtain a credit builder loan option available from Credit Strong. 

Instead of receiving the loan funds, the amount is deposited into a bank savings account and remains there throughout the loan term. You will then make fixed monthly payments to repay the loan and the financial institution reports your payment history to all three credit bureaus.

After completing the payments for the chosen financing term, the lender releases the bank account funds. Borrowers will have established a solid monthly payment history that should improve your credit score and enable you to qualify for auto financing at lower rates.

2. Calculate How Much You Can Afford

Determining the affordability of an auto loan requires thinking beyond only the monthly payment. A common rule of thumb is that the car loan payment should not exceed 10% of your monthly income.

One consideration or “guidepost” when assessing an auto loan is your current debt-to-income (DTI) ratio, which is calculated as follows:

DTI= Your Total Gross Monthly Earnings / Total Monthly Debt Payments

The Consumer Financial Protection Bureau explains that borrowers should not have a DTI that exceeds 43%.  Data shows that those who exceed 43% are much more likely to have significant financial problems.

As the purchase prices for vehicles continue to surge, more borrowers are motivated to opt for auto loans with longer terms. More car loans today have extended terms that reach 72 or 84-months, which can create problems with potential negative equity.

Another concern relates to affordability, particularly when financing for longer terms, where you owe more to a lender than the vehicle is worth. This is a negative equity situation often referred to as being “underwater” on an auto loan.

Finance teams often sell borrowers “gap insurance” to cover negative equity situations. For example, if you totaled the car and the insurance coverage was insufficient to pay the car loan balance owed.

Can you lease a car with bad credit? Rather than buying a car with a vehicle loan, some consider leasing a vehicle instead, which is basically a long-term rental where the borrower makes monthly payments.

Check with the dealership’s finance department who might check with multiple lenders on your leasing options. According to Experian, unlike with auto loans, most applicants with a credit score below 670 will struggle to qualify for a lease.

3. Explore Different Lending Options

What are some of the most common sources of car loans?

Prospective buyers shopping for a vehicle at an automobile dealer may consider dealership financing options. Captive financing is most common through new car dealers affiliated with manufacturers including Toyota Financial Services, Ford Credit, or GM Finance.

“Buy-here pay-here” refers to financing typically offered by used car dealers and caters to those with poor credit. Generally, they also feature very high interest rates.

The other segment is loosely referred to as direct lenders. Common examples include banks, credit unions, online lenders, and various consumer finance organizations.

If you have an existing relationship with a bank or credit union, they may be willing to provide you with favorable financing. The online lending industry is large today, and most offer consumers a quick online finance application process.

4. Apply for Your Used Car Loan

Lenders will require you to formally apply for a loan to assess your creditworthiness. Be prepared to provide information including your income, expenses, social security number, and bank account details.

Your social security number is necessary for the prospective lender to access your credit report, which reveals the data that will likely impact the maximum amount they will lend you and the interest rate of the loan.

Your credit report will have a “hard inquiry” or “hard pull” entry documenting the credit check, which may have a slightly negative impact on your credit score. Try to complete multiple applications with different lenders in a short time so they are combined into one inquiry.

5. Compare Different Financing Options Available

You are encouraged to shop around to find the best deal. Keep in mind that merely comparing monthly payments is not an accurate means of comparison; rather, you should assess the total, including upfront payments and fees.

Using a used car loan calculator allows for a simple means of properly analyzing the options with the taxes, interest rate, and term factored in.

Different Financing Options for Used Cars

Borrowers obtain used car financing from various sources including those either facilitated by or financed through a dealership or third-party financing directly from banks, credit unions, and online lenders and finance companies.

Dealership Financing

Automotive dealerships are differentiated into franchise or independent locations. Both categories sell used vehicles, but franchise dealers are part of a manufacturer’s network of new vehicles dealers i.e., XYZ Honda or ABC Ford.

Both franchise and independent dealers have roughly half of the market share, as franchise dealers financed 48.79% in 2020 and 52% in the first half of 2021 of overall used car sales.

Dealerships facilitate used vehicle financing through a mix of lenders. Including the aforementioned captive financing provided by vehicle manufacturers in addition to banks, credit unions, finance companies, and direct “buy here pay here” financing arrangements.

Bank & Credit Union Financing

Banks and credit unions will lend directly to individuals seeking to finance a vehicle and are also an option for obtaining pre-approval. Consider using resources such as Kelley Blue Book to familiarize yourself with the current price range of vehicles you want.

Both banks and credit unions will provide you with a pre-approval that helps determine the amount that you can borrow and a good idea of the interest rates that you qualify for. Which is a good idea before visiting an auto dealership. 

Although credit unions may be more likely to extend financing than banks to those with fair or poor credit, you will likely have to become a member of the credit union to qualify as a prospective borrower.  

Online Lender

Various types of online banks and finance companies operate exclusively online. Many of these lenders operate in certain niche areas of the car loan market. Such as offering to finance those with poor credit (subprime borrowers), and they will likely also offer online pre-approvals.

In theory, online lenders might have significantly lower overhead costs and operating expenses compared to traditional brick and mortar banks and credit unions that could allow them to offer auto loans with lower interest rates.  

Shopping online lenders for vehicle financing may allow you to quickly compare loan options from several competing institutions.

Things to Look for When Comparing Used Car Loans

You should have a firm understanding of the key variables that exist in the realm of vehicle financing so that you comprehend the terminology and can confidently make “apples-to-apples” comparisons.

APR

The loan’s annual percentage rate, or APR, is an expression of the annual (yearly) cost of the credit that includes the interest rate and any fees that are imposed. The APR a borrower obtains is most heavily based on your credit score along with other factors.

When considering dealership financing, you may have some success negotiating your APR. Dealerships often inflate the APR on loans they facilitate to compensate for their efforts but also often as a commission or a source of profit.

The APR is one of the best means of comparing loan offers.

Down Payment

Many lenders require a down payment in the form of cash and/or a trade-in vehicle to qualify. Even a modest 10% down payment should reduce your monthly payments, amount of debt, interest expenses, and might even allow you to qualify for lower rates.

Monthly Payment

While the amount of your monthly auto loan payment is critical for ongoing affordability, a comfortable payment may come at the expense of longer-term loans and increased interest rates.

Term Length

According to Bankrate, the majority of used car loans involve making fixed monthly payments for a term that ranges from 24 to 60 months. The longer 72 and 84-month vehicle loan terms are primarily applicable to new vehicles.

The average APR based on terms for used vehicle loans are: 

• 36-month: 4.31%
• 48-month: 4.50%
• 60-month: 6.12%

FAQs

Is it smart to finance a used car?

It might be tempting to visit a car dealer to purchase a new car rather than a pre-owned vehicle. Even if the new car loan financing has an attractive annual percentage rate (APR) and affordable monthly payments, buying a used model is smart.

According to the National Auto Dealers Association (NADA), purchasing a three-year-old pre-owned vehicle will provide massive savings compared to driving away from the dealership in a new car.

NADA estimates suggest that new cars lose 20% of their value (depreciation) after you buy them and leave the dealership. The table below shows how depreciation makes purchasing a pre-owned vehicle a smart buy.

Measuring Depreciation

Vehicle Type	Purchase Price	Sales Price in 3 Years	Depreciation
New Vehicle	$30,000	$18,000	$12,000
Used Vehicle	$15,000	$10,500	$4,500

Source: Estimates based on current market trends as of 2024.

Another benefit of purchasing a used vehicle is that your auto insurance premiums for collision and comprehensive coverage are lower. 

What credit score do you need for a used car loan?

In most cases, people with stable income usually will find someone willing to offer them an auto loan. No universal or accepted minimum credit score exists for auto loan financing, as some banks, credit unions, or online lenders usually will extend you a car loan.

Part of the reason why auto loans are available to those with poor credit is that car loans represent a type of secured loan.

Unlike unsecured loans such as personal loans, student loans, and credit cards, lenders know that an auto loan is secured by the value of the vehicle. If you fail to make the monthly payments on the auto loan, the borrower can repossess the vehicle to recoup their losses.

Keep in mind that those with a sub-600 credit score will face auto loans that have an exorbitant interest rate, fees, and payments.

Is it easier to get approved for a used car?

Yes. The average new car prices today exceed $40,000, meaning that those with below-average income and/or credit will struggle to qualify for financing the purchase.

The interest rates on used vehicle loans are usually higher; however, financing a used vehicle will likely have affordable monthly payments and car insurance premiums.  

Borrowers seeking to finance the purchase of a used vehicle should remember that the likelihood of approval and the favorability of interest rates are potentially influenced by many factors including the region where you reside, credit history, income, employment, and more.

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