Unless you’re independently wealthy or have a rich relative, chances are you'll need a loan to buy a car. There are a couple of options to consider. The first is to secure financing from a bank or credit union. Secondly, most dealerships have a finance and insurance (F&I in industry jargon) office that can help arrange financing for your purchase. Both approaches have their advantages.
In the direct lending approach you go to a bank or credit union and try to pre-qualify for a loan. The lender will look at factors including your credit score and the amount of your down payment as the basis for its decision. If you meet their lending criteria you’ll receive a letter of intent that spells out how much you can borrow and your interest rate. Direct lending opens up opportunities for buying from private sellers -- including relatives -- which can lead to great deals.
F&I departments offer the convenience of one-stop shopping. In this scenario, the F&I manager negotiates with a lender on your behalf. This can result in a better financing deal than you could get on your own. In contrast to direct lending, however, the dealer doesn’t normally approach a lender until you’ve settled on a vehicle. The dealer then facilitates the paperwork and sells or assigns the loan back to the lender. One advantage of dealer-arranged financing is that the F&I manager often has a rapport with lenders. As a result she’ll often have a good idea of which ones offer the best terms.
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There are also drawbacks to each method. If you decide to go the direct financing route, don’t apply for financing at every bank in the phone book. Having a flurry of inquiries on your credit report can hurt your chances of getting approved and can lower your overall score. The same can be said of shopping at multiple dealers if you decide to use dealer financing. Dealer reserve is another potential pitfall to watch for. Suppose the dealer negotiates a loan for you with a 3% interest rate. The dealer can then bump that rate to, say, 5%, and pocket the difference. While that practice is completely legal, it doesn’t mean you have to accept it.
Banks and credit unions might be reluctant to work with you if you have credit problems, leaving you no choice but dealer-arranged financing. However, a number of companies specialize in helping credit-challenged customers. With this type of financing lenders issue what's known as a “payment call” based on your credit, with final approval based on the specific structure of your deal. Some dealers offer "buy here, pay here" financing, which can come with high interest rates. That might be your last resort if another lender won't work with you.
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