How to Finance a Car: A Guide to the Auto Loan Process

Next to a home, a vehicle is the largest purchase many of us make, and they can cost in the tens of thousands. For this reason, car financing is a common way Americans buy vehicles. 

In this article, we explain how car financing works to help you better understand automotive loans and make strong financial decisions. 

What is Car Financing?

Car financing is when money is borrowed from a lending company to purchase a vehicle. The car, truck or SUV being purchased is collateral for the loan. 

The borrower repays the loan by making regular payments over a specified amount of time. These payments include paying back the car loan itself and the loan interest. Interest rates vary widely among finance companies and are tied to the current base interest rate set by the Federal Reserve.

Once the final payment has been made, the vehicle is free and clear in your name. Many loans require a small deposit, but zero-down car loans are sometimes an option. Your finance company may require you to have a full coverage auto insurance policy on your car to protect their asset.

Key Terms You Should Know

Every car loan contract comes with jargon that's important to understand.

Downpayment: A downpayment is the amount of money you put down on the vehicle at the time of purchase. For example, if you buy a vehicle for a total cost of $20,000 and put $2,000 toward it at the time of purchase, your downpayment is $2,000 and you only have to finance $18,000. 

Principal: Principal is the sum of the amount you financed. It may include the cost of the vehicle, any taxes and on-road fees and any other add-ons to your car such as winter mats or tires, minus any downpayment. This is the amount that the dealership receives once the bank funds your loan. 

Interest: Interest is the amount you pay to the bank for extending the loan

Interest Rate: This is the rate of interest you pay as a percentage of your loan. For example, 4.9% annual interest means you pay 4.9% of the value of the loan each year, or $490 on a $10,000 loan each year. However, there are other fees that apply to your loan above and beyond the interest rate. 

Annual Percentage Rate (APR): This is the actual cost of your loan each year as a percentage of the loan. It includes the interest rate, plus any fees associated with the loan. The APR is usually slightly higher than your actual interest rate. For example, if you have a $10,000 loan with a 4.9% interest rate you'll pay $490 a year in interest. If you also pay $120 a year in fees, you end up paying $610 per year in interest. That is 6.1% of your $10,000 principal, so you're paying a 6.1% APR. 

Simple vs Compound Interest: Almost every car loan is calculated by simple interest. That means your payment is calculated once, at the beginning of the loan, and stays the same for the life of the loan. 

Loan Term: This is the amount of time it takes to pay off your loan, usually expressed in months. For example, a four-year loan term is 48 months. 

Monthly Payment: Your monthly payment is the amount you need to pay each month to repay the loan. 

What do You Need to Finance a Car? 

Many lenders may require the following items before they approve, or even pre-approve your car finance application: 

  • Identification 
  • Proof of income 
  • Emergency contacts 

The lender will often ask for your permission to perform a credit check. They may also need a few additional pieces of information before financing your loan, including: 

  • Proof of insurance
  • Proof of address 
  • Vehicle information including year, make, model and Vehicle Identification Number (VIN) 

Lenders need your VIN to make sure the vehicle has no liens on it, no prior record and that it's in the name of the seller. A lien can be recorded against the VIN until the loan is paid in full. 

What is a Lien? 

Your lender can apply a note against your VIN in the registration system that explains the owed money on the vehicle. This prevents people from selling their car before it has been paid off, which protects the lender's interest in the car. 

How Your Credit Score Impacts Financing

Your credit score is a measure of your risk profile for a lender. A high credit score indicates low risk for a lender. They see a high credit score as a sign of responsible credit use. A low credit score means you might be a greater risk for a lender. Many things can affect a person's credit score, and though not everyone with a poor credit score is irresponsible, your score may still be used by lenders to assess your eligibility for certain interest rates. 

Credit scores are often grouped as Excellent (750 or higher), Good (700-749), Fair (650-699) or Poor (450-649). The interest rate available to you could vary depending on your credit score. 

Types of Auto Financing

There are two main ways to finance your car: dealership financing and direct lending. Each method has potential pros and cons. 

How to Finance a Car with Dealership Financing

Dealership financing is common and often considered a convenient option. Many dealerships may let you apply for a loan on a vehicle on-site and, if you qualify, could provide an answer quickly. Dealerships may emphasize their own financing because it gives them extra revenue and also helps them have more control over the deal. 

A typical dealership financing experience looks like this for you as a buyer: 

  1. Visit a dealership to look at a car
  2. Work with the salesperson to negotiate a price
  3. Meet with a finance agent who initiates the loan application process
  4. Get a loan offer if you meet the required qualifications
  5. Decide whether to accept the offer 
  6. Sign required paperwork and leave with your new vehicle

However, this process doesn't leave much opportunity for the buyer to shop around for interest rates and find the best loan. 

How to Finance a Car with Direct Lending 

It's possible to take more control of your auto loan by going direct. Direct lending is when you take out a finance arrangement directly with a lender. It might be your own bank or credit union, or another finance company. This allows the buyer time to cross-shop different loans and bundles, and even make sure the loan term suits their needs. 

Because direct lending can be more flexible, you can finance a car purchased at a dealership or even finance a vehicle from a private party

Here's how to finance a car with direct lending in typical cases for you as a buyer: 

  1. Conduct research for the best loan rates and terms 
  2. Submit an application directly with the lender or finance company
  3. Get approved for a certain loan amount if you meet the required qualifications
  4. Shop for a vehicle
  5. Find a car and negotiate a price 
  6. Submit the vehicle's information to a chosen lender who will disburse the funds to the dealership or current owner 
  7. Sign required paperwork and take possession of the car

Alternatives to Car Financing

A car loan isn't the only way to pay for a vehicle without using cash. Leasing is another option to explore. 


Leasing a car usually means paying a monthly payment for a set period of time, and then choosing from two options: 

  • Pay the balloon payment, which is the amount left over on your leased vehicle after the car lease term is finished, or finance the amount of the balloon payment and buy the car 
  • Return the car to the leasing company 

In this scenario, you never own the vehicle unless you finance your car lease buyout or pay out the balloon payment once the leasing period ends. 

Ready To Take A Drive? 

Are you looking for an auto loan that is easy and quick to apply for? PNC auto loans offer competitive rates, easy applications and fast approval. Explore your car loan options with PNC today.