What Does Financing a Car Mean?

Next to a house, automobiles are probably the most expensive items a person will purchase. Many consumers do not have the cash to buy a car outright and thus must consider financing. Financing a car means borrowing funds from a creditor or lending institution to complete the purchase. Once you have paid off the loan, the car then belongs to you, not the lender.

Some borrowers who finance a car apply for preapproved loan status through a creditor such as a dealership or bank. A preapproved borrower can purchase any creditor-accepted vehicle with the preapproved loan amount just like using cash. Receiving preapproval makes car buying much easier, so it's wise step to take before going car shopping.

Borrowers can find financing options through banks, car dealerships or loan brokers. The value of the new car will be the loan guarantee (i.e., the lender owns the car until the loan is fully repaid). Borrowers also may choose to self-finance by borrowing against the equity in something they already own, such as a house or retirement savings portfolio, or against the cash value of an insurance policy. In this case, the object borrowed against becomes the loan guarantee in event of payment default.

The best way for a borrower to make financing an automobile cost effective is to pay off the loan in its entirety as quickly as possible. The borrower should accept the loan repayment terms that are most comfortable for his budget but then pay extra each payment to pay less interest over the life of the loan. It's important to make sure at the time of the loan that there is no penalty for early repayment.

Financing companies--as well as loan terms and rates--can vary widely from lender to lender. The best option for a borrower seeking to finance an automobile is to apply to several lenders even if the borrower is approved for financing by the dealership selling the car. When it comes to obtaining car financing, it pays to shop around for the best deal.