Financing a car purchase – a guide to buying a car the smart way

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Very few people are blessed with living in an area where public transportation is both reliable and sufficient to make commuting easy. For the rest of us, a reliable car is the only thing we can count on to take us to work or run errands.

However, cars are amongst our most expensive possessions, so purchasing one takes quite a bit of financial planning. You need a vehicle that suits your needs and fits within the budget.

We are no car experts, so we won’t tell you which model suits a family with two kids best, or which model is the most economical for long commuting. What this guide will teach you is how to work out the finances to buy a new car and what the entire process means.

So, without further ado, here are the steps you need to take if you are considering investing in a new vehicle.

man driving a car wearing wrist watch

Decide on a budget

The first thing you need to do before you even start looking for a car is establishing a budget. This will help limit your search and keep you focus on cars you actually afford to purchase. There is no point in looking at the latest sports car if they go way above your budget.

If this is your first car, take a look at your monthly budget and figure out how much you are going to be able to pay. Keep in mind that your monthly payments will likely include interests and several other fees, so make sure you consider those when working your budget.

You also need to consider additional payments such as insurance, fuel, and maintenance when choosing a car as well. You may think you found a good deal when an expensive car is on sale, but maintenance and insurance can get pretty pricey on high-end cars, so make sure it won’t ruin your finances on the long term.

Check your credit score

After deciding on a budget, it’s time to get into the more technical part of the process. As you probably know, the better your credit score is, the higher the chances of finding a good financing option.

Banks and financial companies will be looking at your credit score before deciding to give you a loan, so you will want to know where you are standing.

The FICO score is the most widely used model by banks and credit grantors alike, and even though the exact formulas for calculating your score are kept secret, we know they are taking into consideration the following:

  • Your payment history accounts for 35% of the score
  • Debt burden accounts for 30%
  • Time in file, which means the length of your credit history, represents 15%
  • The type of credits you had or still have accounts for 10%
  • Recent credit searches add up another 10%

If you are wondering what does an excellent credit score mean, the FICO model sets up the following ranges:

  • 300-579 points – very poor credit score; applicants may not be approved for credit
  • 50-669 points – fair score; applicants may be required to pay a certain fee or deposit
  • 670-739 – good credit score; applicants are not considered to represent high-risk by banks
  • 740-799 – very good credit score; applicants are likely to receive above-average rates
  • 800-850 – exceptional score; applicants will receive the best rates from lenders

Get familiar with the terms

If what we mentioned above seems to confuse you, that’s because you need to get familiar with some financial terms first. This way, you will understand what lenders are talking about when they show you the list of options, and you won’t risk getting fooled just because you didn’t understand what was written on the contract.

The interest, for example, represents the cost of borrowing money from a lender. This will be added to your monthly loan.

The loan term is the number of moths you will be paying off your loan. Keep in mind that, the longer you loan term is, the more interest you’ll pay.

Some lenders also require a down payment, which is the initial sum of cash you need to have on hand when taking out a loan. This sum will then be subtracted from the initial loan, before calculating your monthly payment.

Research your financing options

There is a multitude of financing options available, but this does not mean all of them will be suite for your needs.

Logbook loans, which are a type of loan that uses your vehicle for security, were very popular for a while, but they are a high-risk option that provides little protection for borrowers.

A logbook loan alternative that is much more secure and allows for longer repayment terms is a car equity loan. Similar to home equity loans, car equity loans are a type of secured loans that use the vehicle as collateral. When applying for one, the lender will take into consideration several aspects such as your credit score, the market value of your car, and your income to verify your eligibility.

Make sure you do your research and weigh the options well before deciding on one. Remember that what works for some may not work for you, so take into consideration your needs, not fends; recommendations when making your decision.

Don’t base your decision on monthly payments alone

As we mentioned before, your monthly car expenses are made out of much more than just the monthly payments. Take a look at all the numbers when comparing options and choose the one that aligns with your financial goals.

How much interest are you going to be paying over the years? What is the term length of your loan? Are there any other additional fees? Get an answer to all of these questions and compare them. Just because you will be paying £50 less each month, it does not make it your best option if the term is longer. In general, the shorter the term length, the less money you are going to spend on interest in the long run.