The best way to buy a car is with cash. It can stop you from overspending. It also avoids paying interest on a loan for years. Of course, paying cash isn’t always an option.

Sometimes you just have to have a new ride, especially if you have to drive to get to work. But when you find yourself in this situation, what you don’t want to do is simply pick a car from the dealer and accept whatever financing terms they offer.

Instead, use these steps to make sure you’re financing your car in the smartest way possible.

How to Finance a Car

1. Get your credit score in order first

Before shopping for a vehicle, check your credit score. Chances are you can check it for free. However, some free options are actually based on estimates. So they may not actually show the score lenders will see. Because of this, you might want to spring for your official FICO score from at least one, if not two or all three, credit bureaus.

(Remember, though, there are many different FICO and VantageScore models. Your lender may not pull the exact model you purchased. So your score could still vary, though usually not by more than a few points.)

Is your credit score in the low-to-average range? If possible, take some time to bring your score up before you apply for auto financing. You’d be amazed at how much interest you can save just by boosting your credit score.

Not sure where to start? Check out these articles:

11 Simple Ways to Improve Your Credit Score Today

Podcast: How to Improve Your FICO Score with Credit Expert Tom Quinn

How to Build Credit When You Are Just Starting Out (the Smart Way)

Yes, improving your credit score can take time. But if there’s any way you can take public transportation, rideshare, or stretch your current vehicle’s life for a few months, it’ll be worth your while.

2. Save up for a down payment or trade-in

Again, this is a step you’ll need to start a few months before it’s time to purchase your next vehicle. It’s possible to qualify for financing for a vehicle with no money down. But this isn’t the ideal way to finance a vehicle.

For one thing, 100 percent financing will get you a much larger loan and a larger payment. Plus, putting no money down generally means you’ll have a higher interest rate. And since cars depreciate quickly, you may owe more on the car than its worth as soon as you drive off the lot.

Your best bet is to put at least ten to 20 percent towards a down payment. However, since used cars depreciate more slowly, you can get away with a smaller down payment on an older car. However, if you have a low credit score, be ready to offset it with a larger down payment. This can get you into a much better financing arrangement.

As you’re calculating your down payment, be sure to account for the value of your trade-in. Even an older vehicle can bring some extra money to the table when you’re buying a new vehicle. Use tools like Kelley Blue Book to figure out what your trade-in vehicle will be worth.

3. Get an idea of what you need to spend

Once you have your credit score and down payment sorted, it’s time to start shopping around. This is where you need to make your list of minimal must-haves for your vehicle. The shorter this list, the more options you’ll have to choose from.

Your must-have list might include several features. For example, the amount of seating or ability to haul extra stuff, a certain level of gas efficiency, or a certain rating for used vehicles may be important to you. Once you have a must-have list, start looking around on sites like Edmunds. This will give you an idea of what you’ll need to spend.

Your spending level will depend on the type of vehicle you purchase. Larger vehicles are more expensive, as are newer and lower mileage options. Your goal is to get what you really need out of a vehicle without spending more than you absolutely must.

4. Understand taxes and fees

Before you can shop for financing, figure out exactly how much you’re likely to pay in additional fees and taxes. This can include dealer and licensing fees, for one.

You’ll want to pay these additional fees in cash. So this can eat into the cash you have available for your down payment. It’s important to know this before you shop for financing.

You can get an estimate of additional taxes and fees with this car payment calculator from CarMax. This is just an estimate, but it’ll give you a starting place. If you want a more specific estimate, check your local DMV/BMV site or call a local dealership.

Subtract your taxes and fees from the cash you have on hand to buy a new car, and that’s your total down payment amount.

5. Shop around for financing first

Now that you have all this done, you might think you’re ready to walk into a dealer. Not so fast!

Dealerships don’t often offer the best financing terms, especially for those with less-than-perfect credit or those buying used vehicles.

You should check at least two or three potential options for financing. Rate shopping won’t harm your credit score, so long as you do your shopping within a two-week period. And shopping around can help you find the best possible financing terms.

Where should you shop around? You can look online for auto financing, and you can even compare potential rates with some interfaces. But you should definitely check out one or two local credit unions, too. They often offer lower rates and better terms, particularly for those with less-than-perfect credit.

6. Opt for a shorter term when possible

Lenders typically give you a few financing options to choose from. You’ll likely notice that a lower term gets you a lower interest rate, as well. Plus, financing for shorter terms means you’re taking a bigger bite of the loan principal with every payment. This means that you’re less likely to owe more on the vehicle than it’s worth at any point in the life of the loan.

Of course, you don’t want to choose a shorter term than you can’t actually afford. If you jack your monthly payment up too high, you risk missing payments or having to make them late. And that can tank your credit score and lead to additional fees.

7. Show up with financing in hand

One of the advantages of shopping around for financing before you go to the dealership is that you can use this financing to negotiate with the dealer. Having secured financing gives you leverage to negotiate for a lower purchase price on a vehicle. But you can also challenge the dealer to come up with a better financing option for you, if possible.

You won’t always be able to get a better deal, but sometimes you can.

8. Consider gap insurance, if necessary

When you buy car insurance, chances are that it will only cover the car’s current value. So if you owe $5,000 but total your car when it’s valued at $4,500, you’ll be on the hook for the extra $500.

With those low dollar amounts, that’s not a huge deal. But what if you were on the hook for a few thousand bucks? This is an expense many of us can’t handle.

That’s where gap insurance comes in. It essentially pays the difference between your car’s actual value and what you owe to the lender. If you’re able to follow all these smart financing steps, you shouldn’t need gap insurance because you’ll have a good down payment.

But if that’s just not possible, gap insurance can protect you from going even further in the hole if you total your car while you’re upside down on the loan.

9. Look towards refinancing in the future

Finally, what do you do if you can’t follow all these smart financing steps? For example, what if you have to buy a car before you have time to improve your credit score?

In this case, start off by doing the best you can. Buy an older, cheaper car, for one. But then keep an eye on your credit score and auto loan rates. You may be able to refinance in the future. And if you can trim your interest rate by a few points, that could be well worth your while!

So there you have it. These are the steps you should take to finance your car the smart way.


  • Abby Hayes

    Abby is a freelance journalist who writes on everything from personal finance to health and wellness. She spends her spare time bargain hunting and meal planning for her family of three. She has a B.A. in English Literature from Indiana University Purdue University Indianapolis, and lives with her husband and children in Indianapolis.