How Does Car Financing Work?

Car Financing Explained

car financing explainedIf you can’t pay cash when you buy your new or used car, you will need a loan, commonly known as “financing.”

Auto financing can come from a number of sources — banks, credit unions, online loan companies, finance companies associated with car manufacturers, or even from certain types of used-car dealers.

f you are buying a brand new car from a new-car dealer, he arranges your loan for you (if you haven’t already arranged one for yourself) with his “captive” finance company. A “captive” finance company is one that is owned by a car manufacturer and used by dealers who sell that manufacturer’s vehicles. Examples would be Ford Credit, Honda Financial Services, and Porsche Financial Services.

If you car buying a used car from a dealer, he may have a number of finance sources that he works with to arrange customer car loans. These may include local banks, large national banks, or national finance companies.

You can also arrange your own financing for a new car or used car. Go to a bank or credit union, or to a reputable online auto loan company such as CarsDirect or Auto Credit Express.

Most used-car dealers (and all new-car dealers) do not directly finance car loans themselves. It’s nearly always done with an outside finance company. The only exception is “buy-here-pay-here” used-car dealers who provide financing to customers directly.

How it works

Let’s say you are buying a new car and need a loan. Your dealer will have you complete a sales agreement and loan application for the amount of you need to buy the car. You may be asked to make a down payment, which will reduce the amount you’ll need to borrow. Your dealer might check your credit score as a preliminary step but you should understand that a dealer’s “approval” doesn’t necessarily mean that your loan application will be approved and accepted by the finance company used by the dealer. Many car buyers misunderstand this important fact.

The interest rate (finance charges) you’ll pay will depend on your credit score, which is a number that represents you credit worthiness. The lower your score, the higher the risk to the finance company, and the higher the rate you’ll pay. You should know your credit score before you apply for a car loan. Get your Experian Credit Report FREE at   Make sure you don’t have mistakes in your report, which will lower your score.

Your dealer will let you drive your new car home, even though your loan has not yet been approved by his finance company. This can take a number of days, sometimes as much as a couple of weeks. Until the finance company approves the loan, the dealer has not been paid for his car, and the car doesn’t yet belong to the customer. In fact, the small-print in your sales agreement states that unless the dealer can find acceptable financing for you, you will either be required to return the car, possibly sign a new contract with different terms, or find your own financing.

If a customer has credit problems and the dealer can’t find acceptable financing, the dealer may ask for his car to be returned. Because many customers believe the car belongs to them after they’ve signed a contract, they may think this is some kind of illegal maneuver or scam by the dealer. It is not. If the dealer hasn’t been paid for his car, there is no way a customer will get a free car out of the deal. You can get your own loan with a reputable online car loan company such as Auto Credit Express who specializes in providing car loans to people with poor credit, no credit, bankruptcies, or repossessions.

Assuming no problems, the finance company will accept the customer’s loan application, write a check to the dealer for the amount of the loan, and begin sending the customer monthly statements to pay off the loan. Meanwhile, the finance company (in most states) will hold the car’s title (because the car essentially belongs to them), and will send it to the customer after the loan has been paid off.

If the customer begins making late payments or misses payments, the finance company will begin repossession procedures to either get the money they are owed, or get their car back. If the car is repossessed, it will be sold at auction and any difference between the sale amount and loan balance will be billed back to the customer. A repossession damages the customer’s credit and lowers his credit score, making it more difficult to get a new loan in the future.

For more information, see Car Loans and Financing.