Guide to Auto Loans
Most Americans use debt to acquire their vehicles. An auto loan can finance the purchase of a new or used automobile through a series of monthly payments over a number of years. The cost of the loan hinges upon the amount you borrow and the interest you pay. You have some control over both of these factors, and thus you can take steps that affect the total loan cost.
Shopping for a car is a separate, but related, exercise to shopping for a car loan. They two tasks are related by the net cost (i.e., purchase cost minus trade-in credit) of the vehicle. While you’re certainly free to fall in love with a model and trim level, be aware that flexibility might save you money. If you have a final list of three vehicles, you’re in position to take advantage of special deals on the car and the financing. However, you decide which vehicle to buy, you might want to bump up your credit score first.
Managing Your Credit
The combination of your credit and your income will help determine whether you can get a car loan, and if so, how much interest you’ll pay. Lenders look at your credit score, and so should you. The predominant scoring system, FICO, has scores from 300 and 850, and you’ll want to get your score up above 700. The first step is to get copies of your three major credit reports and fix any errors you find. You can take other steps as well, such as paying down some debt, ensuring you pay on time and making more than the minimum payments on your credit cards. Generally, as your credit score rises, your loan costs will drop.
Understanding Loan Lingo
The language of auto loans includes:
Loan contract: a contract between you and the lender specifying the vehicle id, price, loan term, down payment, your interest rate, monthly payments and any other costs. The contract will also reference the lender’s lien on the car, meaning it can repossess the vehicle if you miss payments
Selling price: the price of the car after you factor in all incentives, options, accessories and any other items that affect price
Trade-in value: the amount of money the dealership will credit toward the purchase of the new vehicle when you trade in your current value
Down payment: an upfront payment you make that’s applied toward the car purchase, reducing the amount you need to borrow. You might encounter special $0 down promotions that require no down payment, but remember this means you’ll be financing a larger loan
Principal amount: the amount you borrow, equal to the selling price minus the trade-in value and down payment
Loan term: the length of the loan, in months or years. Typical loan terms range from three to eight years. Longer terms result in smaller monthly payments but higher overall interest cost
Interest rate: the finance charge representing the cost to borrow. The interest rate is expressed as an annual percentage rate (APR) that includes any upfront fees or other costs that are folded into the loan. Car dealers often promote special low interest rates on selected vehicles
Monthly payment: your monthly car loan payment is fixed – it’s the same every month. However, the loan is amortizing, which means you pay mostly interest in the early years and mostly principal in the later years. This allows lenders to collect their income (the interest you pay) early on. You can use an online automobile payment calculator to see each month’s split between principal and interest, and the total interest you’ll pay over the loan term. Usually, the lender sets up an auto payment arrangement that debits your monthly payment directly from your bank account
Sources of Auto Loans
Just as you shop around for the best price on the vehicle you want, it makes sense to comparison shop your auto loan. Here are the different sources of auto loans:
Dealerships: your car dealer works with a captive financing company associated with the car manufacturer. If you buy a new car from the dealer, you’ll almost certainly be offered a loan from the financing arm. The dealership might source loans on used-cars differently, because the financing company might not make a loan offer on a used car. Special deals, like 0% interest rates, are almost exclusively offered by dealership financing arms.
Banks: you can arrange a car loan from a bank. This might be a good idea because you’re free to use the loan on any make and model. If your loan is pre-approved, you know how much you can spend on your car purchase. The bank might be a brick-and-mortar branch or an online-only bank. You can choose among large national banks, regional banks or community banks. Smaller banks offer more hand-holding during the loan process
Credit unions: credit unions are like banks, but they are mutually owned by account holders. They usually charge less than banks for auto loans, because they are non-profit institutions. You must become a member of the credit union before you can get a car loan from it
Financing companies: these companies provide consumer loans, including auto loans. Financing companies are frequently online lenders, and often provide loans to consumers with lower or sub-prime credit scores
Be a Smart Shopper
A smart car shopper wins twice: Grabbing a great deal on the car you want and obtaining great financing. Here are some factors to consider when financing your car purchase:
Consider getting your car loan pre-approved in advance. If you arrange your loan at a bank, credit union or finance company, you’re not tied to any car brand or dealership. However, if you see a special financing deal on the car you want, your dealership might have the best loan for you.
Consider your down payment. The larger the down payment, the less you’ll have to finance and the less interest you’ll have to pay.
Consider your term. A shorter term loan will save you interest charges, so choose the shortest term
Understand what you’re signing. Make sure the loan contract contains only figures you’ve agreed to, and doesn’t contain any surprise costs, such as an unwanted maintenance contract or an extra-cost coating.