UNDERSTANDING AUTO LOANS
Everything you need to know about financing a new vehicle
HOW TO BUY A VEHICLE USING AN AUTO LOAN:
Many people choose to use an auto loan when purchasing a vehicle since it allows them to break up the cost of a their new car into small, monthly payments instead of paying the full purchase price upfront.
Car shoppers can apply for auto loans through various lenders or directly through the dealership. Auto loans typically must be paid back in 3-6 years, and once the loan principal and interest is paid, the buyer will own the vehicle in full.
PAYMENT OPTIONS:
#1. Buy with an auto loan
Borrow money to purchase new car, & pay lender back monthly.
Pros: Once loan is paid, buyer has full equity in vehicle
Cons: Must pay interest on loan. Must keep up with payments.
#2. Pay total upfront
Vehicle is fully paid off by buyer on day of purchase
Pros: Immediate full equity. No payments. No interest.
Cons: Requires significant cash on-hand at time of purchase.
#3. Lease your vehicle
Pay to drive vehicle for set time period. Then return it.
Pros: Smaller monthly payments than buying.
Cons: Will not own vehicle at end of lease. Some restrictions apply.
UNDERSTANDING HOW AUTO LOANS WORK:
When a car buyer uses an auto loan, they borrow money from a lender and then pay back the principal (amount borrowed) as well as the interest via monthly payments.
Interest is the price of borrowing money from a lender- expressed as a percentage of the amount borrowed.
When the loan is paid in full, the buyer will have full equity in the vehicle. The owner can continue to drive the vehicle or can sell or trade it for it’s market value.
Payments can typically be mailed to the lender, paid over the phone, internet, or through automatic withdrawals.
Auto loans are “secured loans”, meaning that the vehicle can be used as collateral if a buyer defaults on payment. A secured loan is a smaller risk for lenders, which is why auto loan interest rates are lower than credit card rates.
WHAT IT COSTS TO BORROW MONEY FROM A LENDER: APR vs INTEREST
An APR refers to the annual percentage rate. When shopping for a vehicle, most buyers see that the APR and interest rate are both expressed as percentages, and many people assume that the terms are synonymous. These two terms have some important differences and the APR is typically higher than the interest rate.
Interest Rate- the cost of borrowing money, expressed as a percentage of the amount borrowed
APR- the true cost of borrowing money, which includes not only the interest rate, but also any other fees the lender changes to borrow money, still expressed as a percentage.
Lenders must include both numbers on the paperwork, so be sure to look at the APR as well as the interest rates when comparing auto loan offers offers.
HOW IS MY INTEREST RATE DETERMINED?
The interest rates offered on a vehicle will vary based off the four factors below:
1
DOWN
PAYMENT
Larger downpayments typically lead to lower interest rates for car buyers.
2
LENGTH OF
LOAN
Shorter auto loans have lower interest rates than longer auto loans.
3
NEW CAR
OR USED?
Used car loans aren’t as easy to get approved as new & come with higher rates.
4
FICO CREDIT
SCORE
Higher scores mean less risk for the lender, so they come with lower interest rates.
HOW TO GET APPROVED FOR A LOAN WITHOUT GOOD CREDIT:
-
Excellent
850 - 800
-
Great
799 -750
-
Very Good
749 - 700
-
Good
699 - 650
-
Fair
649 - 600
-
Poor
599 - 300
If you’re credit score isn’t ideal for purchasing a new vehicle, or if you have not built up a credit history yet, there are still ways to get approved for an auto loan:
- By providing a substantial down payment (to show lenders your committment to paying off the purchase)
- By adding a cosigner to your loan. This is generally a family member or close friend who has established credit and a good store.
Learn more about how your FICO credit score is calculated here:
WILL A LENDER APPROVE A LOAN FOR A USED CAR?
Auto loans ARE available for used cars, however they typically come with higher interest rates than new cars and some vehicle age and mileage restrictions may apply.
New vehicles don’t have as much risk to lenders as used cars do since new vehicles have less wear-and-tear. New vehicles are also under factory warranty for a significant portion of the loan term. This means that the buyer isn’t as likely to experience costly out of pocket repairs that may impact their ability to keep up with monthly loan payments.
Used cars no older than 7 model years and with fewer than 80,000 miles are typically eligible for an auto loan.
CAN I PURCHASE A VEHICLE WITHOUT A DOWNPAYMENT?
A downpayment is the amount of money that a car buyer is able to pay up-front from their own cash/savings.
A down payment reduces how much money you will need to borrow, offsets vehicle depreciation, reduces interest owed, lowers interest rates, and makes loan approval easier.
A down payment shows committment to your investment and ability to pay it off, so lenders reward buyers who put money down up-front with easier approvals and lower rates to borrow money. For buyers with a credit score under 600, lenders may require a down payment. Though you can finance a car completely, without a down payment, not putting money down will likely make interest rates higher.
Car dealerships suggest 5-10% down payment for new cars while some financial experts recommend up to a 20% down payment.strong> The amount used as a down payment ultimately is up to personal spending preferences and lender requirements.
Down payments can be in the form of cash, check, or transfer. A trade-in vehicle can also be used as a downpayment.
Interested in trading-in your current vehicle? Read how to get the best value for your trade here.
THE BEST REPAYMENT PERIOD FOR AN AUTO LOAN:
While auto loans of three to five years used to be standard, longer loan lengths have been trending in recent years. In fact in March 2020, the average car loan period reached 70.6 months.
Today, car buyers can choose a loan ranging from 24 to 84 months in length. There are many pros and cons to both short and long-term lease periods.
The length of your loan is completely up to personal preference. Proctors generally advises borrowers to select the shortest term they can afford.
Short Term Auto Loans: Higher monthly payments, but build equity quicker. Lower interest rates.
Long Term Auto Loans: Smaller monthly payment, but takes longer to build equity. Higher interest rates than short term loans.
HOW IS MY MONTHLY PAYMENT CALCULATED?
Learn how to manually calculate your monthly payments by watching the video below. OR simply click the “customize payment” button on any car on our website to estimate and customize monthly payments.
