For most of us, a car is the second biggest purchase we’ll make. And, owning a car isn’t cheap. In fact, the average price of a new car in January 2021 was $40,857, according to Kelley Bluebook®.
Actually buying a car isn’t the only cost that comes with purchasing the vehicle. There’s also depreciation, insurance, maintenance, and gas to consider—it can add up. Depreciation is one of the largest costs of owning a new car. Therefore, the longer you have a car, the more your investment pays off. Not-so-fun fact: A new car typically loses 20% of its value in the first year of ownership.
Assessing a car’s value, and how that value changes over time, is the first step when considering financing a car. Once you know what car you want and how much you should pay, it’s time to consider your financing options and how to get a car loan.
How to Assess the Value of a Car
What do you need in a new car? What kind of gas mileage, capacity, and features? And, most importantly, what can you afford to spend? Before heading to a dealership, decide what you’re looking for, and extensively research the car you want.
Once you have an idea of the car you’re interested in buying, there are a number of services that can offer a baseline estimate for the car’s worth. Edmunds’ offers a True Market Value (TMV®) guide; Kelley Blue Book® provides suggested price ranges based on things like year, model, condition, and mileage (particularly useful for used cars); the National Automobile Dealers Association’s guide focuses on dealer’s sticker prices; and Consumer Reports provides detailed reviews and reports about specific cars.
None of these resources will necessarily tell you the exact price you’ll get, but they can give you some necessary context. It may also be helpful to look at the listed prices for similar cars in your area.
You can even call around to other dealerships and/or sellers ahead of time for price quotes, so you’re better-equipped by the time you walk onto the car lot.
How the Value of Your Car Changes Over Time
While a car is a big asset, its value changes over time. Generally, when measuring the value of a car, the cost of depreciation is spread over a five-year period. A new car can lose, on average, 60% of its value in the first five years. It depreciates about 15% each year.
Also factor in maintenance costs over time. Consumer Reports surveyed customers to create detailed accounts of different cars’ maintenance costs over time, so you can factor those averages into your calculations.
Car Financing Options
The biggest cost of a car is often the car loan itself. Once you make all the monthly payments (plus interest), you’ll eventually own the car outright. But until then, the car loan is an ongoing cost that has to be factored into your budget.
There are a few car purchase finance options: car loans (either direct from a traditional bank or through the dealership) or personal loans from banks, credit unions, or online lenders. In general, it’s not advisable to use an unsecured personal loan to buy a car. The rates are typically higher than on car loans and the qualification process can be difficult.
There are very rare circumstances where it may make sense to use a personal loan to buy a car, such as if you plan on restoring an old car as a passion project. Cars in need of repair can be difficult to finance with a traditional auto loan.
Car loans can be offered directly from a bank, or online lenders, or can be arranged through the car dealer. The average five-year (60-month) car loan had a 4.19% interest rate in February 2021, and the average loan amount was $32,797.
Alternatively, it is possible to borrow an unsecured personal loan to finance a car, but this is generally not advisable. Personal loans generally have a higher interest rate than an auto loan, which is backed by the car. It’s also generally more difficult to qualify for a personal loan than it is to qualify for a car loan, again, because the car loan is backed by collateral. Another factor to consider is the repayment term. In general, car loans extend over seven years whereas a personal loan is repaid in three to five years.
When getting a loan directly through the dealer, they generally collect your information and then take that information to prospective lenders to find you a financing offer.
Car dealerships are typically designed to help get you a car loan quickly, sometimes even if you don’t have great credit. You can sometimes even sign a car loan and drive off in your new car the same day.
Auto Loan from a Private Lender
Banks, on the other hand, may offer more competitive interest rates or more favorable terms when applying with them directly, but the application process can be more involved and take longer. Generally, borrowers using financing from a bank or credit union, will get pre-approved for a car loan prior to heading to the dealer.
Another option for financing a car is not to get an auto loan at all, but rather to take out an unsecured personal loan. A personal loan can be taken out to pay for any number of personal expenses—home repairs, debt consolidation, or a new car. On the flip side, a car loan can only be used to pay for a car.
In general, buying a car with a personal loan is not the best course of action. There may be some circumstances where this makes sense, but on the whole, personal loans are a more expensive option than traditional auto financing.
Car loans are secured by the car, which means that the car is the asset that secures the loan (also known as “collateral”). Until it’s paid off in full, you don’t own the car, and if you default, the lender could seize your car.
However, because a car loan is a secured loan, you’d typically qualify for a lower interest rate than you would with an unsecured personal loan. A strong credit score, along with a solid financial history, could also help a borrower qualify for a competitive interest rate on a personal loan.
You also can get pre-qualified for a personal loan before going into the dealership, so you will have an idea of how much buying power you have. (Though keep in mind that pre-qualifications aren’t a done deal, so the loan offer is still subject to change.)
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Strategies for Getting a Car Loan
Here are some strategies that could help as you look for a car loan that matches your needs.
Do Some Research
Before heading to the dealer, consider shopping around for loans to see the types of rates and terms you may qualify for. Part of doing this research is understanding your credit score. Lenders review factors like a borrower’s credit score and financial history to inform their borrowing decisions.
Recommended: What Credit Score Do You Need to Buy a Car in 2022?
Prepare a Down Payment
In general, having a larger down payment can help reduce the amount that is borrowed. Reducing the amount borrowed can also help reduce the amount of money spent in interest over the life of the loan.
Consider Getting Prequalified for a Loan
Getting prequalified for a car loan can help the borrower understand what kind of car payment they can afford. Prequalification could also be used as a tool in negotiations with the dealer. In some cases, the dealer may be willing to offer a more competitive financing option.
For many people, buying a car outright with cash isn’t an option. That’s where financing comes in. Auto loans are intended to help borrowers finance their car purchase. With an auto loan, the car acts as collateral to secure the loan. It is also possible to use an unsecured personal loan to purchase a car. In most cases, this isn’t advisable. Unlike a car loan, an unsecured personal loan isn’t backed by collateral and usually has higher interest rates.
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