Auto Financing Guide for First-Time Car Buyers

Buying a car for the first time is one of life's most exciting steps. But as a first-time car buyer, maybe you're unsure about the best way to finance your purchase.

If you need the car right away to start your new job or go to college, it may take too long to save up the money to pay for it. A faster choice is an auto loan for first-time car buyers. This loan allows for the fact you may not have much credit history yet or may have a less than perfect score.

What Is a Credit Score?

Your credit score is based on your financial activity and companies use it to figure out if you're a trustworthy candidate for a loan. 

A low credit score means they'll see you as a riskier borrower. A high score means they'll see you as a safe bet.

Who decides my credit score? 

The Fair Isaac Corporation (known as FICO) gets data from three credit bureaus:  

• Equifax 

• TransUnion 

• Experian 

Each bureau may focus on slightly different parts of your financial history, so your credit score will likely vary between them. 

You're allowed to get one free credit report from each bureau each year.

What determines my credit score?

Financial activity that could affect your credit score includes:

• Your history of paying back your credit cards and loans, including any time you've missed payments or a bill has gone to collections or even court. (Note: Late payments on utility bills won't tend to affect your credit score unless they go to collections.)

• How much total debt you owe, and how much available credit you have (known as credit utilization ratio, or debt to credit ratio).

• How long you've had active loan and credit accounts, and how much time your accounts may have been inactive.

• The types of credit and loan accounts you have, such as credit cards, loans, lines of credit, a mortgage. The more types you have, the better.

• How many times you’ve applied for new credit. Certain applications will lead to a hard credit check, which will lower your credit score until you successfully start paying the money back. 

How Your Credit Score Impacts Loan Interest Rates 

Financial institutions offer people different interest rates based on their credit score. In most cases, the higher your credit score, the lower your interest rate. 

So if you have a low credit score or little financial history, you'll pay more interest. 

How is auto loan interest calculated?

As well as your credit score, there are a few factors that go into deciding how much interest you'll pay each month. 

If you're a first-time car buyer who is thinking of applying for an auto loan, make sure you understand these choices:

• Simple vs. compound interest. Check if your lender charges simple interest, where you pay interest on the loan only. You don't want to pay compound interest, which is interest on the interest! 

• Fixed vs. variable rate. A fixed-rate makes budgeting easier as you know what to pay each month. A variable rate is good if market rates are high and you're hoping they'll go down. 

How Your Credit Score Affects Loan Approval

People with great credit scores are more likely to get approved for any type of loan, mortgage, or credit card. But what happens if you haven't had a chance to build up your financial history? 

As a first-time car buyer, you may still be in school or college, or just starting out in your career. Maybe you've never had a credit card or loan. Or perhaps you forgot to pay a few times and now your credit score isn't so great. 

If that sounds like you, here's what you can do:

• Get a person with great credit to co-sign on the loan. Yes, this means they'll have to pay if you default. The good news is, you won't need them the next time!

• Borrow only a small amount. Lenders may not approve a large loan if you don't have great credit. Find a modest used vehicle and save your dream car for later. 

• Get a secured loan. If you have savings or a certificate of deposit, you can borrow against the funds, keep earning on them, and build credit too. 

Why First-Time Car Buyers Should Get Pre-Approved 

It's a good idea to see if you can get your loan pre-approved before you head to the car dealership because your credit score could affect whether or not your loan is approved. 

There are many ways that getting car loan pre-approval could help you: 

• You'll know your budget for buying the car and what your monthly payment will be, including interest and fees. 

• You'll know you're good to go when you show up at the lot, and you won't run the risk of your loan being denied.

• You'll be in the driver’s seat to negotiate because you already have financing in hand.

• You'll be able to focus purely on buying the car, without worrying about how you're going to pay for it. 

Before you apply for auto loan pre-approval, make sure you shop around for the best interest rates. You should be able to find a credit union to fit your needs -- even if you're at the start of your credit journey.

What Is a Loan Term?

When it comes to loans, the word "term" basically means "time." That is, how long it will take you to pay the loan back in full. 

When choosing your term, consider this:

• A shorter-term will mean higher monthly payments. 

• A longer-term will mean lower monthly payments. 

How does your loan term impact interest rates?

If you have a short loan term, you'll pay it off sooner, therefore paying less interest overall. The longer your loan term, the more interest you'll pay over the life of your loan. 

But there's more to it than that. Different loan terms often come with different interest rates. Most likely, first-time car buyers will find:

• The shorter the term, the lower the interest rate.

• The longer the term, the higher the interest rate. 

This is because market interest rates are likely to rise over a longer loan term. Plus, lenders figure there's a higher risk something could happen that may prevent you from paying the loan back. 

Even so, many students, entry-level workers, and first-time car buyers enjoy the lower monthly payment that comes with a longer-term. So check out the average car loan term and decide what's right for you!

Choosing the Right Lender as a First-Time Car Buyer

Now that you've got to grips with credit scores, interest rates, and loan terms, it's time to pick a financial institution and apply for pre-approval. Remember that it's a great idea to shop around for the best rates and terms to suit your needs and budget. 

You probably have a number of excellent financial institutions in your area. Click below if you need help choosing between your local credit union vs. a big bank!

Is a Credit Union or Bank Best For Car Loans?