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What Does Financing a Car Mean?

More than 8 out of every 10 new cars purchased these days is either leased or financed. Despite this, there is an astonishing lack of clarity about just what financing a car means. Since we’re the experts in this particular industry, we thought we’d lay it all out for you in layman’s terms.

Financing a Car = Monthly Payments

As its most basic, financing a car means that you did not have all of the money for an outright purchase, so you turned to a lender of some kind to fund the balance. In most cases, that means you got a loan, also known as a car, auto, or vehicle loan. It can also mean you got a vehicle lease, though financing typically refers to a loan rather than a lease. In either case, this leaves you with a monthly payment and a requirement to carry full-coverage insurance.

Who Finances Cars?

Most accurately, the lender (provider of the loan) “finances” the vehicle purchase, as they are the ones putting up the money. However, in everyday talk, buyers who use an auto loan to purchase their vehicles are said to “finance” them as well.

The lender that finances your purchases can be a traditional bank, a credit union, a finance company, or a specialty lender. The loans made by these types of lenders are reported to all of the major credit reporting agencies and will improve your credit score if used wisely. The loans can also destroy your credit score if you make late payments or stop paying altogether.

Is Buy Here Pay Here a Type of Financing?

Buy-here-pay-here (BHPH) dealerships technically finance cars, but the process is different. The main difference is that the loan is not held by a traditional lender and is usually not reported to the major agencies, so does not help your credit profile. If you default on a BHPH contract, the repossession will be reported, though. The repossession will damage your credit for several years.

How Financing Differs from Leasing

Financing is different from leasing in that you will own the vehicle at the end of the term. With a lease, at the end of the term you must return the vehicle to the dealership you got it from. You will have a monthly payment through the lease term and may owe additional money if you exceeded the mileage limits stated in your lease agreement. For the same car, leasing is generally more affordable in terms of monthly payment, but less financially sound in the long run because your payments are not buying you equity in the vehicle. Basically, leasing is like renting a home, and financing is like buying it. For this reason, whether it’s ever smart to lease a car is a question of some debate. Leasing is generally best for people with higher incomes and credit scores who prefer the convenience and luxury of having a new car every 2-3 years, and who are okay with not owning the vehicle they drive.