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• May 9, 2022

A new car costs more than $45,000 on average. For many people, it's not practical to pay that sum all at once; instead, it makes more sense to take out a loan and pay for the vehicle over a few years.

If you're thinking about financing a car, here's what you need to know.

Get preapproved

It's a good idea to get preapproved before you start visiting dealerships. Applying for preapproval involves going to a bank and sharing some information about your finances and the type of vehicle you'd like to buy. The bank then gives you an estimate of how much it might lend to you and what interest rate it might charge. This estimate can help you decide how much it's realistic for you to borrow.

The bank will look at your credit history when it makes its decision, so consider checking your credit report to ensure there aren't any errors.

Compare trade-in offers

If you have equity in the car you're driving now, trading it in can lower the amount you need to borrow when you buy your new car. Say a dealer offers you $6,000 to trade in your old car, and you still owe $2,000 on it. Then your equity is $6,000 - $2,000 = $4,000. That means trading this car in would give you $4,000 toward the cost of your new car.

To get the best value for a trade in, do some research online at auto pricing sites like Kelley Blue Book to get an idea of what your vehicle is worth. You'll also want to get quotes from several dealerships so you can choose the best offer.

Compare the costs of an electric, hybrid or gas-powered car

To decide which type of car to buy, look at the purchase price of each kind of car and the costs of fueling and maintaining it long-term.

Electric and hybrid cars often have higher sticker prices than gas-powered cars, although state and federal credits can bring down the cost somewhat. And in the long term, it typically costs less to power electric or hybrid vehicles thanks to their higher efficiency.

Plus, overall repair costs for electric or hybrid cars are usually lower because these vehicles are less likely to break down. Consumer Reports found that battery electric cars and plug-in hybrid cars cost on average half as much to maintain per mile as gas-powered cars.

It can be helpful to find out how much more an electric or hybrid car will cost upfront, then see how much you can expect to save on fuel and upkeep over the life of the vehicle. A higher upfront price may be worth it if you can generate significant savings over time.

In addition, you may want to consider other pros and cons of different types of cars. For example, an advantage of gas-powered vehicles is that gas stations are everywhere. Depending on where you’re driving, charging stations for electric cars may not be as numerous. On the other hand, the reduced pollution and better environmental impacts of electric and hybrid cars might tip the scales in their favor.

Watch for add-ons

Dealerships often try to sell add-ons like extended warranties, accessories and niche insurance products. Oftentimes, add-ons can be financed so that you pay for them with your auto loan.

A downside of financing add-ons is that you pay interest on them, which can significantly push up the total cost of these extra purchases. Plus, borrowing to cover a lot of expensive add-ons could cause your loan amount to be larger than what the car is worth, which could make your loan harder to pay off later if you decide to sell the car.

Before agreeing to any add-ons, ask some questions:

  • How much will you pay in total for each add-on, including interest?
  • How likely are you to use these products?
  • Could you buy these products from another company at a lower price?

Understand your loan

When you've chosen a vehicle, you're ready to apply for an auto loan. If you're approved, you'll receive an offer that gives the details of your loan. Read it carefully, and talk to your lender if you have any questions.

You'll likely make a down payment, either by paying in cash or trading in a vehicle. This covers a portion of the cost of your new car, and the loan covers the rest.

The amount you're borrowing is called the principal of the loan. You'll also be charged interest and fees. You can compare the cost of different loans by looking at their APRs, which show the percentage you owe in interest and fees on a yearly basis.

The term of your loan is the length of time you'll make payments on it. For example, if you're taking out a loan for five years, the term is 60 months.

Your lender will place a lien on your vehicle while you're paying back the loan. This is a legal claim to the property. If you decide to sell the car before the loan term is up, you'll need to pay off the loan to remove the lien.

Budget for your monthly payment

Choose a loan with a monthly payment you can afford. It’s generally recommended that your debt payments don’t take up more than 36 percent of your monthly income. So if you’re spending 20 percent of your income on your mortgage and 6 percent on student loans, for example, it would make sense to aim for a car payment that’s no more than 10 percent of your monthly earnings.

If you're considering a loan with a monthly payment that's higher than you want, keep in mind you might be able to get a lower payment with a longer loan term. However, a longer term means making more interest payments and probably paying more interest in total. Compare the total cost of the loan with a lower payment versus the total cost with a higher payment to decide if a longer term is worth it.

For more on personal finance topics

If you have more questions about other personal finance topics that matter to you, visit the Learning Center on TD Bank's website.

We hope you found this helpful. This article is based on information available in May 2022 and is subject to change. It is for general information purposes only. Our content is not intended to provide legal, tax, investment, or financial advice or to indicate that a particular TD Bank product or service is available or right for you. For specific advice about your unique circumstances, consider talking with a qualified professional.

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