What's the Best Way to Pay for a New Car?

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In the market for a new car? Here's what you need to know about making that purchase.

If you're in the market for a new car, chances are you've excitedly researched the perfect make, model, and options package. It's easy to get carried away test driving fun new cars, but don't forget to do your homework about how you can pay for your new car.

A common mistake many first-time car-buyers make is to simply accept the dealer's offer of financing without comparing their other auto loan options. While the dealer's loan could have great terms, just a bit of research ahead of time can ensure you don't accept an offer that's going to cost you more in the long run. 

Here's what you need to know about the different ways to pay for a new car.

Paying with cash

According to Experian, 85% of all new cars and 55% of used cars are paid for with financing. Considering the average new car costs over $32,000, it makes sense that most people need to take out a loan to pay for it. But if you have the savings, you might wonder if it's better to just pay for the car with cash. By paying cash, you'll avoid paying any interest, so you'll pay less over the cost of the loan.

On the other hand, if you have great credit and can make a large down payment, you may actually qualify for such a low interest rate that you'd be better off investing the rest of your savings instead of putting all that equity into your car. You also don't want to pay cash if it will wipe out your savings, leaving you with no emergency fund for the first time you need new tires or some other car repair.

The good and the bad of dealer financing

Most car dealerships partner with a bank to offer you financing directly. To stay competitive, dealerships often offer shockingly low interest rates. They also sometimes offer other incentives, like cash back or special 0% interest introductory periods. Another benefit of financing through a dealer is that they tend to work with borrowers of all credit levels, so you might have a better chance of being approved if you don't have great credit. 

But it's important to make sure you're clear on the terms of the loan for the entire time you'll be paying it back. Those 0% introductory periods might spare you interest for a short time, but they often have higher-than-average interest rates once the initial period ends. And make sure you focus on the total amount of the loan, rather than negotiating over monthly payments. Historically, car loans have had repayment terms of 48 or 60 months, but longer repayment terms like 72 months are becoming more common. While these longer loan periods will lower your monthly payment, you'll pay more interest in the end.

When you're negotiating with the dealer in person, there can be a lot of pressure to sign on the dotted line immediately, but take your time to read the fine print and make sure there aren't any hidden drawbacks to the deal.

Why you should get pre-approved from an outside lender

Even if you end up taking the financing offer from the dealer, chances are you'll be able to negotiate the lowest possible interest rate by shopping around before you actually go in to buy your car. Many banks, credit unions, and online lenders offer a variety of auto loans, and it's not a bad idea to apply for pre-approval from more than one of these lenders to compare their rates. Don't worry about multiple hard inquiries on your credit report: The credit bureaus tend to recognize multiple applications for the same type of credit within two weeks as just one hard credit pull.

To get pre-approved for an auto loan, you'll need to provide the lender with some basic info, like your income, Social Security number, and other information about your debt. For those with good credit, interest rates are still near all-time lows. Here are the average auto loan APRs as of July 2019, according to U.S. News and World Report:

Credit Score                                           New Car Loan                        Used Car Loan

750+ 3.99% 4.24%
700-749 3.99% 4.24%
650-699 6.2% 6.45%
450-649 7.5% 7.75%
449 or less 12% 12.25%

Those with average to bad credit may not qualify for better terms than they'd get directly from the dealer, but it's still a good idea to compare multiple options. In addition to the APR, be sure to compare the loan terms and required down payment to make sure you can afford the monthly payment. Having a few offers in hand will give you the confidence to walk into the dealership with significant negotiating power.

Should you consider a personal loan?

It's also possible to finance a car purchase with a personal loan. If you're seriously interested in this, you can read our explainer comparing the two options. In short, you will almost always get a lower interest rate on an auto loan than on a different sort of personal loan. However, some auto loans require you to buy only from a dealer, so if you're looking to purchase a car directly from another owner, you may need the flexibility of a personal loan.

Whether you go with an outside loan or finance through a dealer, you should shop around to make sure you choose the best option for purchasing your new car. Doing the research in advance will help you to avoid buyer's regret down the road.

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