Buying a new or used car may be one of the biggest purchases you make in your lifetime. With all the moving parts that come with a car loan, figuring out how to pay for your ride can send you for a spin.
According to Kelley Blue Book, the average cost of a new car in April 2023 will be more than $48,000, so it’s likely that you’ll need to get a car loan.
But it’s a good idea to research auto financing a little before choosing your next set of wheels. This post will go over the most popular kinds of auto loans, lenders that offer them, essential vocabulary to understand, and how to get ready to apply.
What is a car loan?
Whether the car is new or used, a car loan can help you purchase it if you don’t have the cash on hand. Upon receiving an auto loan, you take out a loan from a lender to purchase a vehicle. You consent to repaying the money plus any associated fees and interest over a predetermined time frame.
Key terms to know
Let’s take a moment to become familiar with some of the most common terms you might encounter when researching loan options before we go into detail about how auto loans operate.
- The amount you will pay to borrow the money, including interest and fees, is expressed as an annual percentage rate, or APR. You will owe more for the loan if the APR is higher.
- A down payment is an amount you pay in advance to cover the cost of the vehicle. Cash, the trade-in value of a car, or both may be accepted. A smaller total amount that you need to finance, which could result in smaller monthly payments, is helped by the down payment.
- Loan term: Often referred to as loan duration, this is how long you will have to repay your loan. Remember that you will probably pay more in interest the longer your loan term is.
- Monthly payment: The amount you owe on a monthly basis is your monthly payment. It consists of principal, interest, and any additional fees that may be incurred.
- Principal: The amount you are borrowing less any applicable fees, penalties, interest, and other expenses
- Total cost: The total amount of principal and interest you will pay for the duration of your auto loan is referred to as the “total cost.”
How do car loans work?
Loan payments are the monthly installments that are used to repay a car loan to the lender. The loan amount, the loan term, and the total amount of interest you must pay over the loan’s duration will all affect your monthly payment.
The principal and interest on your loan, along with any optional add-ons, are detailed in your loan contract.
Loans with longer terms, such as 60- or 72-month loans, may have lower monthly payments. However, bear in mind that when you factor in interest, a longer loan term may result in higher overall loan payments. You might even find yourself upside down on your loan if you end up owing more than the car is worth.
Let’s compare a $20,000 loan at a 3. 75% interest rate across two different loan terms. Remember that any applicable sales tax is not included in this calculation.
| Loan term | Monthly payment | Total interest paid |
|---|---|---|
|
3 years (36 months) |
$588 |
$1,177 |
|
5 years (60 months) |
$366 |
$1,965 |
Even though the longer loan term reduces your monthly out-of-pocket expenses, you will pay an extra $788 in interest over the course of the loan if you choose to repay the loan in five years as opposed to three.
Most common types of loans
A car loan can be used to buy a new or used car. Additionally, you can apply for a loan to refinance an existing loan or to buy out a lease. It’s possible that loans for new cars have cheaper interest rates than those for used cars, and they occasionally have extra benefits.
Where should I get my car loan?
It’s a good idea to take your time looking around for the best deal on vehicle financing. To determine whether an offer from a different lender can outperform your dealer’s, you can compare terms from banks, credit unions, and other financial institutions.
Who issues car loans?
In general, there are two ways to obtain financing for the purchase of an automobile: dealer financing or direct lending.
- Banks, credit unions, and other financial institutions, such as online lenders, are examples of direct lenders. By taking out a loan from one of these lenders, you can compare loans to find the best terms for yourself and even have the option to be preapproved for a particular loan before you shop around. And you’ll use this loan to cover the car’s cost when the time comes to make the purchase.
- Dealership financing – This option allows you to shop for your car and auto loan in one convenient location. It is handled by your dealer’s finance department. Because dealers typically work with several lenders, you might be able to compare terms and even be eligible for incentive or low-rate programs sponsored by the manufacturer. However, watch out for “buy here, pay here” dealers who give consumers with bad credit high-interest internal auto loans.
Consider asking a family member for assistance if you don’t want to take out a traditional auto loan or if you don’t qualify for one, or wait until you have enough money saved up. Another loan choice you might consider is a personal loan from a peer-to-peer lender.
Requirements for applying for a car loan
Usually, in order to be eligible for a car loan, you must fill out a loan application with details about your financial status. The following details should be on hand to ensure a seamless process:
- Social Security number
- Current and past addresses
- Current and past employment information
- Total income and income sources
- Information on any other debt you may have
Typically, the approval procedure begins with a prequalification and involves reviewing your credit scores. Your credit may be soft pulled as a result, so it won’t have an impact on your credit scores.
The lender will usually run a hard inquiry on your credit if you proceed with a full application after being preapproved, which may lower your credit scores. Additionally, even if you were prequalified, submitting a complete application could result in different loan terms and approval.
However, there won’t be much of an adverse effect on your credit if you complete all of your loan comparison shopping within a brief period of time.
If something goes wrong, can someone else take over a car loan?
The quick response is probably not in an official position, but it might still be worthwhile to contact your lender. The person taking out the loan will probably have to go through the application process, complete with a credit check, if your lender permits it. This implies that rather than actually taking over your loan, they’ll probably wind up with a new one.
The lender wants to make sure that whoever takes on the loan will be able to pay it back, so why all the extra paperwork? Additionally, bear in mind that the car no longer belongs to you if your lender permits you to do this.
Maybe you could talk a generous relative or friend into taking up the payments for you until you recover and are able to repay them. But keep in mind that failing to make payments might lead to the repossession of your vehicle. Crucially, you would still be the owner of the default since the loan would still be in your name.
Before you default if you’ve fallen behind, you might want to think about these other options.
- Talk to your lender. You might be able to ask for a payment deferral or extension, or you could ask for an extension on your due date.
- See if you can work out a repayment plan.
- Try to refinance the loan at a lower interest rate.
It’s a good idea to look at your credit score and monthly budget before applying for an auto loan to make sure you can afford to make the payments. If your credit isn’t too good, you might want to look into co-signing an application or finding lenders who accept applicants with bad credit.
Consider your potential down payment amount and whether you would like to trade in a car to reduce the overall cost of the loan. Additionally, find out how optional extras like extended warranties, credit insurance, or service contracts will impact the overall cost of your loan if you think you might be interested in them.
If you choose to take out a loan, make sure you sign all the documents correctly before you leave in your new vehicle, and always make your loan payments on time.
Calculate your sales tax
To determine the sales tax rate in your area and the amount that sales tax adds to the cost of purchases, use our sales tax calculator.
FAQ
How does getting an auto loan from a bank work?
When you borrow money from a financial institution for a car, you get it all at once and have to pay it back over time with interest. The amount of your monthly payment depends on a number of factors, including how much you borrow, how long it takes to pay it back, and your interest rate.
Is it a good idea to get a car loan?
Compared to a cash purchase, an auto loan is much more accessible because it spreads out your upfront costs. Additionally, you still have money in the bank for other uses. Depleting your savings means you won’t have an emergency fund, which could cost you later.
How does a loan against a car work?
With an auto equity loan, you can borrow money deducted from the amount you still owe on your vehicle, leaving you with equity. This loan won’t impact your original car loan. You can borrow against $5,000 in equity if your car is worth $15,000 but you still owe $10,000 on it.
Read More :
https://www.bankofamerica.com/auto-loans/how-car-loans-work/