How Does a Car Loan Work?

There are essentially two ways to buy a car. You can pay cash, or if you don’t have the necessary cash, you can get a loan. Actually there’s another way — leasing — that we won’t discuss here, but is discussed in a number of other articles on this web site.

When you get a loan, you are borrowing money from a bank, credit union, or finance company and promising to repay that money, with interest, over a specified period of time. You use that money to pay the dealer for your car. Although car buyers can arrange their own car loans with local banks or credit unions, many choose to let their car dealer arrange the loan for them.  Dealers don’t provide loans themselves but work with banks or finance companies on customers’ behalf.

So if you buy a brand new Ford, and need a loan, the Ford dealer will send our loan application to Ford Credit Corporation, who will provide the loan (assuming you are approved). Ford Credit pays the dealer for the car and begins sending you bills for each monthly payment. From now on, until the loan has been paid off, you will be dealing with Ford Credit, not the car dealer. It often takes a few days for the approval to come through.

As a courtesy, dealers frequently let customers drive the car home even before getting word of approval from the finance company. This can be a problem if a customer has bad credit. If the finance company does not approve the loan, the dealer will want his car back. This often causes anger and confusion because the customer may have assumed he was already approved for the loan by the dealer. The fact is that dealers can’t approve car loans. Only banks and finance companies approve car loans.

In order to be approved for a car loan, you must be at least 18 years old, have a good steady job, no excessive debt and have a good credit score. You should know your most recent credit score and have seen your credit report before you so see a car dealer or bank about a car loan. What’s your FICO score? Find out now when you check your credit report for $1 at Experian.com!

The interest rate you pay for your loan will depend on your credit score. Higher scores get the best (lowest) rates. High scores can also qualify applicants for 0% APR loans frequently offered by car manufacturers.  A lower score may require that you pay a higher interest rate, or not be approved at all.

If your credit is so bad that you can’t get approved, you can have someone co-sign with you.  A co-signer is not a co-owner but someone who agrees to make payments for you should you fail to do so. For more details, see Do I Need a Co-Signer?

Most loan agreements state the conditions under which the loan is considered to be in default. This situation occurs when payments are late or missed during a specified time period. When it occurs, the bank or finance company can, and will, repossess the car, which means they can take the car without warning. The car will then be sold at a wholesale auto auction and the borrower will be sued for the remaining loan balance after auction sale amount has been deducted. The borrower may also be billed for repossession and storage fees. Furthermore, the borrower’s credit will be seriously damaged for seven years. It’s best to do everything possible to avoid repossession.

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