What Are Car Finance Companies?

What Are Car Finance Companies?
••• nuttiwut rodbangpong/iStock/GettyImages

At one time, if you wanted to take a loan to buy a car, you had two choices: use the dealership’s financing or go to a bank or credit union. But the internet has opened up more options, including online lenders that let you complete the paperwork online. A car finance company is a lender that offers loans for your vehicle purchase, but it can also refer to the financing arm of various dealerships.

What Is a Finance Company?

If you’re in the market for a car but don’t have thousands of dollars on hand, an auto loan is likely in order. But if you go through traditional lenders, you’ll likely need a strong credit score. The dealership could be a little more flexible on credit requirements, but you’ll pay a higher interest rate.

Another type of financial institution has emerged in recent years. A car finance company gives you an alternative to brick-and-mortar lenders and large corporate banks. At the very least, you can shop around and compare prices.

But the term “car finance company” can also refer to the lending arm of a car dealership’s financing department. Ford has its own financing division, as do online lenders like CarsDirect. It’s important to compare their interest rates and terms against other lender types to make sure you’re getting a good deal.

What Is Car Financing?

Car financing refers to the process of taking out a loan to purchase a vehicle. Like a personal loan, an auto loan will require that you make monthly payments for a specific term until the loan is paid back in full. You’ll also pay a percentage of the loan amount in interest.

Lenders will look at your credit score to determine the risk you pose. If you have a strong credit score, a lender will probably see you as likely to pay your bill on time each month and compete for your business. But borrowers with lower credit scores may find that they’re denied or offered a much higher interest rate than is being offered to those with very good or excellent credit.

What Finance Companies Offer

A finance company gives you the money you need to buy something now and pay later. You can shop multiple lenders, usually without affecting your credit, as long as the preapproval process only uses a “soft credit check.” You’ll need to choose a repayment term, which is typically ​24 to 72 months​, and you’ll be given an estimated monthly payment and interest rate.

Checking rates with various lender types can significantly reduce the interest you pay each month. Even a fraction of a percentage point will add up, especially if you take a 72-month loan. Check with corporate lenders, small banks, credit unions, online lenders, car finance companies and dealerships. If you’re preapproved before you start shopping for a car, you can compare the lowest rate you can get outside the dealership with what they’re offering.

Peer-to-Peer Auto Lenders

Another lending option is a peer-to-peer lender. This type of lender pairs investors with people who are interested in purchasing a car using a loan. The investor lets you borrow the money in exchange for monthly payments with interest.

As with other types of lenders, these platforms will require an application that will be used to approve you. A strong credit score will be more likely to get you the best rate, even with a peer-to-peer lending setup. These loans are unsecured, so if you don’t pay your loan on time, your car won’t be repossessed.

Car Financing Scams

If you’re shopping around for auto financing, it’s important to note some car financing scams. These aren’t limited to car finance companies. In fact, even a dealership can scam you. Here are some of the most common car financing scams and some tips to avoid them.

  • Spot delivery scams – With spot delivery, you’re given “on-the-spot” financing, letting you drive the car off the lot the same day. The scam comes later, when the dealer calls to tell you that your credit application was declined and you need to come back to the lot to renegotiate, giving you worse terms. Whether it’s a scam or your credit was actually declined, you can avoid this one by knowing your credit score and securing financing before you shop.
  • Loan modification scams – Beware of companies promising to get you out of trouble with your car loan for a fee. The scam is simply that they take your funds, then do nothing in return.
  • Guaranteed approval ­­– You’ve seen the ads promising “bad credit, no problem” car deals. Be aware that you can likely always secure a loan for a car purchase, but it will come with a price. You’ll be slammed with extremely high interest.

Buy Here Pay Here Dealerships

It can sound like a good deal at first. A “buy here, pay here dealership” promises that you can get financing now, without good credit. A BHPH dealership goes by your income rather than your credit score, although you’ll often be asked to provide a down payment before they’ll approve you.

The problem with BHPH dealerships is that the interest rate you’ll pay is typically much higher than you’d get with other dealerships. This means a large chunk of your monthly payment is going toward interest. You also may be limited in the types of vehicles you can drive, since BHPH dealerships often capitalize on buyers who will accept any car just to be approved somewhere.

Alternatives to Car Finance Companies

If you’re having a tough time securing a car loan due to your credit, there are a few other options. If you don’t like the loan terms and interest rate you’re being offered, these car finance company alternatives are worth considering.

  • Use a cosigner ­– You can secure a car loan by getting someone else to act as a cosigner. A cosigner agrees to take over loan payments if for some reason you default. Some lenders will let you remove the cosigner after you’ve made a certain number of consecutive on-time payments.
  • Buy now, refinance later – If you can’t get a low interest rate now, refinancing later is always an option. Simply make your payments on time every month to strengthen your credit score, then refinance when you can demonstrate you aren’t a risk.
  • Use rideshare services – For those who have bad credit, rideshare services like Uber and Lyft can give you a temporary ride while you set money aside to buy a car.
  • Use public transportation – If you live in an area where public transportation is readily available, it could be a great way to satisfy your need to get around while also saving for a car.

Alternatives to Financing

Financing a car means you’ll pay interest on the amount. No matter which route you go, you’re still giving a portion of your hard-earned money to a lender. There are some alternatives to an auto loan that could save you significant money over the years.

  • Buy an older used car – No matter what auto loan rates are at the present time, you’re still paying a portion of your loan amount in interest. If you have a few thousand dollars, you can shop around for an older used car and drive it while saving to pay cash for a newer car. Instead of paying hundreds or thousands of dollars in interest, that’s money that will go toward a newer car you will own.
  • Improve your credit history – If your credit score leads you to deal with rejection after rejection, taking some time to improve it could help. Not only will a very good or excellent credit score help you get a loan in the first place, but you’ll be also eligible for more competitive interest rates.
  • Refinance your mortgage ­– Homeowners have an option called a cash-out refinance, which gives you money in hand based on the equity in your home. Another option is a home equity line of credit, which issues you a line of credit that you can draw on whenever you need money. Another benefit is that you can refinance your home, possibly for a lower interest rate, while also getting the money you can put toward a car.
  • Lease – Leasing is often not the best financial option, but if you’re set on a new car, it can be more affordable. Compare prices on financing a purchase and leasing the same vehicle. If you find there’s a cost savings, make a commitment to put the extra aside to save for a purchase when your lease is up.
  • Use a credit card – This shouldn’t be your first choice. But if you qualify for a high-limit credit card, you might be able to purchase a car and even earn some reward points. However, the processing fees often lead auto dealerships to decline credit cards as a payment method.

Types of Car Loans

Before you start shopping lenders, it can help to familiarize yourself with the different types of car loans they’ll offer. This will help you speak the language, showing the lender you know your stuff.

  • Secured auto loans – When you go through a dealership or car finance company, you’re probably getting a secured auto loan. A secured loan is one that uses something as collateral as “security” in case you default on the loan. With an auto loan, your car is the collateral.
  • Unsecured auto loans – For those with stronger credit, an unsecured loan may be an option. This type of loan uses your own credit score to qualify you rather than relying on using the car as collateral. This type of loan is typically issued through a bank or credit union.
  • Precomputed interest loans – With this type of loan, the interest and principal are agreed upon before you even sign the paperwork.
  • Simple interest loan – If you have a car loan, chances are it’s a simple interest loan. With this type of loan, the interest you pay each month is calculated based on the amount you owe on the principal.

Car Loan Rates

The interest rate you pay over the course of your loan will vary based on your own credit. It’s typically calculated as an annual percentage rate, which is the percentage of the principal you pay each year in interest. APRs for car loans typically start at three percent but can go into double digits for those with low credit scores.

You can ensure you’re getting the most competitive car loan rate by shopping with a variety of lenders. Online lenders will often provide the most competitive rates because they want your business. Since car loans are typically for only a couple of years, it’s important to get a good rate the first time around, since you’re less likely to refinance as you would with a long-term loan like a mortgage.

Car Financing & Loan Terms

If you’re in the market for an auto loan, you’ll be faced not only with interest rates, but loan terms. In fact, sometimes auto loan rates can be based on the term you choose. Car loans typically range from ​24 to 72 months​, with a longer term resulting in lower monthly payments.

However, as appealing as it can be to stretch your loan out as long as possible, that means you’ll pay more interest over the term of your loan. Even if you’re getting lower interest rates, this extra amount each month will add up over time.

Whether you’re in the market for a used car or a new car, a car loan can help you get the set of wheels you want. You’ll need good credit and, in some cases, proof of income, but if you shop around, you can get a competitive rate. If your credit score still needs work, make sure you pay your payment on time each month to ensure that the next time you buy a car, you get a lower interest rate.