We normally don’t think of sales tax as being a very significant amount, but when you’re buying a car, it can be hundreds, even thousands of dollars.
Fortunately, auto loans do typically include sales tax. When you apply for an auto loan the paperwork that is submitted to lenders shows the total purchase price of the vehicle. That includes the sale price, all taxes and fees, and any maintenance packages you agree to. After all of these are totaled, your down payment and/or trade will be reflected and subtracted from the total purchase price.
Your trade/down payment may completely satisfy the sales tax, but the loan application will not reflect that the monies were applied to the tax per se, just that money has been offered down to lower the total purchase price of the vehicle. This lowers the principal amount of the loan, meaning the amount you have to borrow. As a rule, the lower the principal in relation to the value of the vehicle being financed, the better chances you have at approval.
The Role of Loan-to-Value Ratio
If you plan to buy a car and finance the sales tax and all of the fees, you will need to keep the loan-to-value (LTV) ratio of the vehicle in mind. This is, as touched upon above, the ratio of the amount borrowed (principal) versus the vehicle’s value. Most lenders will not loan more than 115 percent of the value of a car. If the sales tax and fees cause the loan to exceed this percentage, you will most likely be denied a loan. The possibility of a loan denial reinforces the importance of a down payment that is at least equal to the amount of sales tax. This keeps your LTV lower, making for not only easier approval, but a lower interest rate as well. This is particularly important if your credit is less than perfect, as most lenders require lower LTVs (bigger down payments) for people with lower credit scores.
To keep things on the safe side, you want to have a down payment equal to at least 20% of the vehicle’s purchase price for a new vehicle, and 10% for a pre-owned one.