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How Does Car Financing Work?

September 15, 2017 • Steve Cyr • Tags:


Alright, you’re finally ready for that new car. You block out a Saturday, head to the dealership, and prepare for an all-day affair that ends in you driving away on a set of sweet new wheels. You’ve got all the confidence in the world to make a deal (partly because you read our blog and feel like a pro), and are ready to go.

After a few test drives, you’ve narrowed it down to the vehicle you want. Now the hardest decision left is to pick the red one or the white one (pro tip: white looks cleaner longer). You’ve got everything lined up and you’re feeling great, but as just as you move that snazzy pen the salesperson gave you to sign, you realize something…

You don’t really know how car financing works.

Obviously you know the whole concept behind monthly payments and the contract being for a certain period of time, but how are all of these numbers calculated? The more you think about it, the more you swear that you pay what they said the “cost” of the car was long before your payments are through, but how would that work? You start to get cold feet – ABORT! ABORT! You back out and drive home empty-handed in your old car with nothing to show for the day except wasted time and a sore back (sitting in those desk chairs gets uncomfortable!)

Okay, nightmare over. Let’s give you the inside look at car financing and how it works so you can save your Saturdays and never have to go through something like this.


The Basics

When looking at how car financing works, there are three key components you should focus on: the term, the amount, and the rate. Let’s take a look at each of these in a little more detail.

The Term: This is basically the life of your contract. 60 months (5 years) is a pretty common length for the term of a contract, but you can go shorter and sometimes, even longer! Remember though that in general, the longer the loan, the smaller the payment but the more interest you may end up paying. It may seem like some voodoo magic with lots of moving parts, so let’s make it easier with a visual. Check out the graphic to see the comparison between making all the payments on time for a 4-year and 5-year term.

 Car Loan Terms

The Amount: And by this we mean the amount financed. As the second part of a loan that you will want to learn about, the amount has significant power in determining how much money you will actually spend on your vehicle. After all, your payments are determined by the interest rate, the total amount financed, and the term of the contract. That’s why a down payment can save you money in the long run, but don’t just take our word for it, check out the graphic below!

Loan Amount Comparison

The Annual Percentage Rate: Usually you’ll see this listed as the APR or Annual Percentage Rate. This is the cost of credit as a yearly rate. You can think of this interest as the “slice of cake” the financer receives in return for providing you with the money to purchase your car. Your rate is determined by a lot of things, but some of them include your credit history, the current going rate, and what your financial institution is willing to provide. All other considerations equal, the lower the rate, the less money you’ll pay towards interest.


Your Monthly Payment

Every situation is different, so there is no “one size fits all” when it comes to financing (we’re dealing with cars, not spandex!) Based on your situation, you need to figure out what would be the best fit for you and your automotive needs. Can you afford a higher monthly payment? Do you want a new car but also a lower monthly payment in order for it to fit into your budget? These are just a few of the things to consider when deciding what financing features are right for you.

 Monthly Car Payment Slider

Moving Forward

Now that you have a basic understanding of how car financing works, you’re better equipped to set out and get that new car that you’ve been wanting to buy. Being aware of each of these components and what they mean for you in both the short and long term will go a long way in helping you feel comfortable with the numbers that are presented to you when purchasing your new vehicle.

So congratulations! You can now escape the nightmare of confusing car purchases. Go clear a Saturday on your calendar and head to the dealership full of confidence that you know what’s going on because you came here first!

If you have any more questions or want to talk more on this topic, shout us out on Facebook, Twitter, or Instagram and let us know! We love to hear from our readers and customers!