The First-Time Car Buyer’s Complete Guide To Auto Financing

Buying a car for the first time should feel exciting and empowering! From researching which type of vehicle you should get to the moment you fire up the ignition and drive off, buying a car should make you feel great.

That said, we know you have an overwhelming number of decisions to make along the way that can add a fair amount of stress. Be aware you might feel the need to decide quickly. You don't. We’ll help you get through it just like every other first-time car buyer has: one step at a time.

You need to be prepared for vehicle ownership costs, even the expenses that go beyond your monthly auto payment. As you look at your budget, consider other common monthly expenses, including car insurance payments, fuel costs, maintenance costs, any additional parking considerations and more. Make sure you add in those additional costs to get a better picture of how much owning a car will cost you every month.

Getting to that amount takes a little figuring, but it’s worth it. Let’s work together to see how much you can afford.

Estimate Your Monthly Auto Operating Costs

First, figure out the price range you can afford. If you don't have enough cash on hand to buy a vehicle outright, you most likely will be taking out a first-time car buyer loan. Take a moment to assess your monthly budget. How much can you reasonably carve out for a monthly auto loan payment? 

Another big monthly expense will be auto insurance. As you begin to ballpark your monthly auto budget, be sure to consider that the average cost of car insurance is $139.50 per month, but can vary widely. This can differ dramatically based on where you live, what car you drive, your age and your driving history, so make sure to do your homework. You can get an insurance estimate from major providers with your driver’s license number and the VIN of the vehicle you’re planning to buy.

Consider how many miles you plan to drive each month and try to predict your fuel costs. For reference, Americans drove an average of 14,263 miles per year in 2019. Plan for how you’ll park and store your car safely. For example, include recurring parking fees if you will drive to work and need to pay for a parking spot.

Once you add up all of these additional costs, you should be able to work backwards to determine what monthly auto loan payment you can afford. At this point, the final variables will be based on your credit profile, your loan term and interest rate.

Consider All-In Price

Your out-the-door cost will also include the lender or dealership fees, interest and sales tax. That means that, while presumably the largest portion of your payment will go toward paying for the sticker price of the car, you’ll also be paying interest, registration fees and sales tax..

Compare Financing Options

It’s important to balance considerations like monthly payments with the total cost of the loan, which can vary significantly based on financing terms. It’s far better to look at the bigger picture of your loan offers. Two offers could have the same monthly payment but one could cost thousands of dollars more because of a higher interest rate spread out over a longer loan term.

Take a look at the example below that shows similarly priced vehicles at various loan term lengths and interest rates. The longer term loan at a higher interest rate will cost over $5,000 more to finance than the lower term loan at a low interest rate.

We recommend using an auto loan payment calculator to help you find a total sticker price range that you can afford to pay for a new or used car.

With a price range in mind, compare what types of vehicles you’d be able to afford if you were to lease or to buy new vs. used.

An important concept to understand here is depreciation. The moment someone drives a new car off the lot, its value drops by thousands of dollars. Meaning, if you were to buy a $30,000 new vehicle and wanted to sell it the next day, it’s resale value would be significantly lower. That’s where used car shoppers save and can get a great deal on a nearly new car.

Leasing allows you to drive a brand-new car at a fairly low monthly cost. That’s because you’re simply paying off the depreciation value of the vehicle over the first few years of its lifecycle. The concept overall is akin to paying rent to a landlord when you could be paying a mortgage and building equity for yourself.

In the leasing scenario, however, you often have the option to buy your vehicle at the end of the lease. Usually, your lease terms will include a buyout price for the end of your lease if you choose to purchase the car. If you plan to sell the car eventually, this option helps retain the vehicle value since you would be the only owner and can offer maintenance and use transparency to the potential buyer.

The most economical option is buying a nearly new car. That option allows someone else to pay off the bulk of that depreciation, saving you money. Even buying a used car that is just one year old can save you 20% of its original cost. If you were to buy a car that was leased for three years, you’re likely to pay less than half of its original value for a car that could have ten more years of driving ahead of it.

When it comes to buying a new or used car, you’ll find that you can make your dollar stretch further on the used car market than on the new car market, but ultimately it is up to you and what your budget allows.

The best way to pay for a car is in cash. The upside: You’ll avoid paying interest, lender fees, and mitigate the risk of defaulting on payments and losing your car. The not-so-upside: Not all of us can afford to do that. In fact, over a third of used vehicles were bought with auto loans in 2020.

Do some preliminary research and get prequalified by a few different lenders such as a credit union, bank or online lender. A prequalification will help you understand which vehicles you can actually afford without impacting your credit. Then it’s important to go the extra mile and get pre-approved for an auto loan.

The best time to get preapproved is when you’re ready to make your purchase, as it requires a hard inquiry on your credit and can drop your score in the short term. If you choose to get pre-approved by multiple lenders, make sure you apply within a short time frame. Most credit reporting models will treat multiple hard inquiries as a single inquiry when done within a certain window. Be sure to clarify that window before applying for multiple preapprovals.

Be aware that it’s possible to get approved for more loans than you can actually afford. Make sure you consider those additional ownership costs and choose to stay within your budget, even if the bank would allow you to borrow more. By choosing restraint, you’ll avoid a big first-time buyer mistake of taking on too much debt. As a bonus, you’ll enjoy the freedom of both physical and financial mobility.

First-Time Car Buyer Credit Requirements

If this is the first time you’re financing a car, check your credit score before applying for a loan. Your credit score can affect the interest rate a lender will assign a loan and that can affect your monthly payment.

In order to qualify for an auto loan, you don’t need the most stellar credit score. But the better your credit score, the lower your interest rate is likely to be, which could lower your monthly payment.

For example, borrowers with credit scores between 501 and 600 had the highest interest rate for used car loans, according to 2020 data. In contrast, borrowers with scores of 720 or higher enjoyed far lower interest rates on their loans. The price of the car or the amount of down payment can change the loan amount, but interest rates can make a big difference in the amount you pay over the life of the loan.

Worried about student loan debt keeping you from a loan? Don’t be. If you’re a first-time car buyer with student loan debt that you pay consistently on time, you may have a better shot at a good interest rate than a college student with no credit history. Lenders want to see that you pay your credit card debts and loans on time.

If you know you don’t have a good credit score, consider saving for a larger down payment or asking a trusted family member to sign on as a co-borrower to help you lower your interest rate.

This is the fun part. You already have an idea of what type of car to buy and what price you are looking for. Now, it’s time to start the hunt for your next car. Consider using online databases of cars for sale. Filter the search for a car in your budget, mileage range, fuel type, drivetrain and features you want in the car. You can dream here – color, audio systems, interior, sports package – go for it! See what happens. You can always scale back if you need to.

Be sure to look up the vehicle history report to learn more about its accident, maintenance and ownership history. If you’re worried about maintenance costs, look for preowned vehicles that are still under the manufacturer’s extended warranty. Certified pre-owned (CPO) vehicles have been thoroughly inspected by the manufacturer and come with additional warranties to ease your worries.

Some manufacturers even offer first time car buyer programs that include special deals and rebates to ease the financial burden and earn your loyalty to the brand. With so many makes and models out there, it’s important to narrow down what kind of car will meet your needs.

So, imagine yourself at the dealership and you are looking at your dream car. Do you know what to look for on the car itself, such as evidence of rusting, accidents and wear and tear that weren’t noticeable in online photos? We have some suggestions to help you avoid some of the traps first-time buyers can fall into – especially if you’re not buying through one of our trusted dealers.

First, before you buy the car, we recommend getting a pre-purchase inspection from an outside party rather than have the dealership do the inspection. It’s also important that you test drive the vehicle if possible. If you’re buying online, some marketplaces will deliver the car to your door and give you a trial window to help you decide if it’s right for you.

Be sure to understand what current warranties exist from the manufacturer, dealer or online marketplace. And if there are any guarantees made about the quality of the vehicle, make sure to take note. These can give you peace of mind knowing the car has been inspected and meets the seller’s quality standards.

To get the best deal on a used car, do your research on dealership warranties. These can cost thousands of dollars, and they can also save you a headache. For example, you’re more likely to need new wheels and tires long before you need any paint and fabric work done. Compare the cost of the warranties with the potential out-of-pocket cost. Ask yourself if you could afford the lump sum payment of a new set of tires or if you’d prefer to roll it into your loan and make small monthly payments that would reduce the stress of needing all new wheels.

Don’t be afraid to negotiate. Because you already got preapproved for a loan, you may be able to leverage your existing loan offers with any in-house financing the dealership is offering.

Review your vehicle purchase agreement thoroughly. Be sure to look out for any prepayment penalties or additional fees that might get tacked on. If you have bad credit, you’ll want to make sure that you won’t be saddled with prepayment penalty fees if you refinance the loan after a year of making on-time payments.

With the right research into both your own financial health and the car you want to buy, you can be as competent a car buyer as the more experienced person. Prioritize setting a budget and determining a price range that won’t break the bank. As you compare loan offers, look beyond the monthly payment and consider the total cost of the loan.

Your next car is out there. Keep learning more about the process to avoid any surprises. Now that you’ve filtered out vehicles out of your price range, know that you can expand your options beyond your local inventory by buying a car online.