Understanding Vehicle Financing

By Joshua Levinstone

Much like the information about extended warranties in my previous post, there is a lot of conflicting and confusing information about automotive finance.  And just like so many aspects of car industry, that lack of good information is how people get, well… screwed over.

Let me start by giving you a little background about myself.  I have worked in finance for several years while selling cars, and for the past year I worked doing refinancing.  I have looked at some 10,000 credit files over the years and think I have a pretty good grasp on things.

Credit Scores

This is the best place to start.  Many people are under the impression that this number is what determines everything about a loan.  While your credit score is important, it is not the only factor that determines your auto loan. Your credit score is what determines your interest rate, and to a lesser extent–for those with very strong credit–can fast track the approval process.

But your score alone is not what gets your loan approved.  That comes down to several factors. The most important of which is your credit history.  This is what lets lenders know if you can afford your loan. I have seen on many occasions people, typically young adults, who have near-800 credit scores, but are unable to get approved on a car loan because, while they’ve never had a late payment, they have also never had a large loan.

Another factor is your debt-to-income ratio.  Just because you make $4K/mo doesn’t mean a bank or credit union will approve you for a $4K/mo payment… for obvious reasons.  There are other factors too. Having high amounts of revolving debt (credit cards) not only hurts your score–even if you are making all your payments on time–, it is also is a red flag for lenders.

Banks and credit unions take into consideration the ‘what-if’ scenarios, like the possibility of losing your job down the road, and use things like your payment history, the amount of loans you’ve successfully paid off, and your current debt obligations to determine whether they will approve a new loan.  If the largest debt you’ve ever had was $1,000, even if you make excellent income and never had a missed payment, the likelihood of getting approved on a $40K loan is pretty slim.

How to get the best rates

As if this wasn’t complicated enough, this is where things get really confusing, but hang in here with me.  Every bank and credit union has set rates based on your credit score which they divide into different tiers.  This is to prevent discrimination under Fair Lending laws. On average a 740-760 score will land you in the highest tier, with the lowest rate.  And the rates go up the lower your score.

Now, some people have great relationships with their bank or credit union and can get a great deal on their own.  But for the vast majority of us, the best rates are typically obtained through the dealership. I know that sounds strange. You’re probably thinking to yourself, Ok, this is just a sales pitch to get me to finance through your dealership, because you make more money that way.

It is true that dealerships make a profit by setting up financing–this is important to all those “What’s your best cash price?” buyers.  But just like any other goods or services, quantity lowers prices. This same principle applies to lenders. Dealerships will typically work with a select few lenders in order to build a relationship with them.

I mentioned many of the factors lenders consider before approving a loan, and one of those factors is the trust coming from the dealership.  By building a strong relationship with lenders, dealerships often have access to better rates than those offered to the public. The catch here is that because every lender has different rates (and different profit margins), a dealership can use their access to information to hit you with a high rate because it make them the most money.

How are we any different?

Well, part of our success over the years has been a consistent focus on the future.  Sure, smooth-talking a customer into a high rate might make some good money today, but if in two years time you owe thousands more on your car than it’s worth, we are probably not going to be able trade you out of that car and sell you another–and you probably wouldn’t want to buy another from us anyways.

We want customers for life.  A quarter of our customers buy more than one vehicle from us or refer a friend or relative our way.  We love cars and we want to give everyone the ability to own that special vehicle they want. We want to be the last place you ever shop, and we can only do that by setting you up for success.  Knowing which lender has the best rate based on your credit, rather than simply what makes us the most profit in the moment, is not only the right thing to do, it is actually beneficial for us.

It must sound strange, coming from an industry known for doing the wrong thing, to hear that doing the morally right thing actually yields the best results.  It’s too bad so many dealerships are focused on month-to-month profit rather than retaining long-term customers, but their myopic business practices are something we are happy to exploit.