A Simple Guide to Auto Loans: Make the most of your vehicle purchase!
A Simple Guide to Auto Loans: Make the most of your vehicle purchase!
Getting an auto loan isn’t as difficult as securing a mortgage. This is because the lending criteria are a bit more flexible. But, it’s a good idea to know what you can afford in advance. This can help you avoid falling for an expensive vehicle and committing to a car loan that dries up your savings.
Approximately 17 million cars and light trucks were sold in 2019 in the United States. 44% of Americans rely on auto loans to finance car purchases.
In this article, we’ll try to help you understand all that you should know about getting a car loan. After going through this article, you’ll know the auto loan process, how to qualify for one, where can you get one, and more such relevant information.
Let’s get into it!
What is an Auto Loan?
Let’s assume you want to purchase a new or used vehicle, but you don’t have the full amount in cash. In such a situation, you can take out an auto loan to get your vehicle. An auto loan is a loan used to purchase a vehicle.
You can use an auto loan to buy the car at a dealership, online, or through a private seller. After purchasing the vehicle using the loan, you have to repay the loan, and any interest accrued to the lender. Online services like GConnectPro can help you choose from a number of lender options when it comes to auto loans.
Types of Auto Loans
A lot of people have to take out a loan in order to buy a car. There are a few different types of auto loans. Based on your financial situation, one type of loan may be a better choice than others. Here are the basic types of auto loans:
1. Secured Loan
In a secured loan, the borrower has to put up collateral until the loan is paid in full. If you fail to repay the loan as per the terms of the agreement, the lender can repossess the collateral without notice. Secured loans usually have lower interest rates, longer repayment options, and higher borrowing limits. These loans are less risky to the lender and so they are easier to get. A secured auto loan is secured by the vehicle that you’ve bought using the loan.
2. Unsecured Loan
An unsecured auto loan needs no collateral. It's just a line of credit issued that is based on your creditworthiness. If you fail to make payments, your debt is sold to a debt collection agency. This type of auto loans are riskier to the lender and hence tend to have higher interest rates.
3. Title Loan
If you own your car then a car title loan can help you quickly get a small amount of cash, albeit at a higher rate. To get a title loan, you transfer the title of your car to the lender and pay a monthly fee to borrow money.
You'll have to repay the loan, including interest, in full in 15-30 days. If you daily to repay, the lender can keep your car. These are often called pink-slip loans or title pawns.
4. Lease Buyout Loan
If you're leasing a car, you generally have the option to buy the car at the end of your lease. A lot of borrowers take out a lease buyout loan to complete this type of buyout.
This type of loan is good for you if you have good credit, good payment history on your current lease agreement, and want to keep the same car.
Key Factors that determine your Auto Loan
There are several factors at work when you’re taking out an auto loan. Let’s take a look at all such major factors.
Credit history and Debt
The Credit score is the primary criteria that lenders consider when deciding whether to extend an auto loan. The better your credit score, the higher the chances of you getting approved. Also, the better your credit score, the lower your interest rate will be.
Lenders will also want to ensure that you aren’t already overburdened with other debt. If you are overburdened with other debt, that implies higher chances of you having trouble paying back your loan. Lenders calculate your debt-to-income ratio, which is simply the proportion of your debts with respect to your income. All lenders are different, but most want this number to be 40% or less.
Down payment refers to the money you are willing to pay upfront for your car. It reduces the principal (the amount you have to borrow) of your auto loan.
When it comes to down payments, bigger is often better. Cars depreciate by as much as 25% in their first year of ownership. So, while buying new, putting down at least 20% of the purchase price is ideal. This is because it helps make sure you don’t start out owing more than your car is worth, post depreciation.
While buying a used car, you should still aim for a down payment of 10% at least. Moreover, if your credit score isn’t good, a bigger down payment gives you more leverage to negotiate a better interest rate.
Term of the Loan
Your loan term is a measure of how much time you get to pay back the lender. For an auto loan, a term of anywhere from 3 to 6 years is common. But, you can also easily find shorter or longer terms.
Spread your loan over a longer-term and you’ll have lower monthly payments. But, with a longer-term, you’ll end up paying more in interest. So, your car will cost you more money in the long term.
For a used vehicle, your loan principal will usually be lower since the vehicle’s price will be lower. For a new vehicle, you can get a better interest rate on the loan.
There are a few reasons behind this. If you default on your loan, It’ll be harder for a lender to resell a used car. This is why many lenders prefer if you buy a pricier new car since they’ll collect more interest. People with lower credit scores are more likely to buy a used car. Lenders charge such people higher interest rates to offset the extra risk.
How to get an Auto Loan (Steps)
1. Decide between a new or used car
It is important to decide whether you want a new or used car. This depends on your finances, family life, and travel needs. New cars last longer but rapidly decrease in value.
You can often get better interest rates on a new car loan. This is because if you default on the loan, the lender can resell the vehicle for a high value. A loan for a used car is usually not as affordable, and the car may require more maintenance. All these expenses can add up in the long run.
2. Determine of Budget
Analyze your finances properly to determine how much you can spend on your vehicle. You have to judge your ability to provide down payment and recurring expenses that come with owning a car.
The longer the term of the loan, the less you'll have to pay each month. But longer-term also means that you'll end up paying more interest. This can eventually lead you to pay much more than the car is actually worth. You must take all these things into consideration when deciding your price range.
It's not just about the monthly payment! It's about the total of those monthly payments and the entire interest expense during a loan.
3. Check your Credit Report
Your credit score will have a huge impact on the type of loan you're approved for. So, check your credit report before applying for an auto loan. The better your credit score, the better the loan terms you’ll get.
4. Loan Application
For a loan application, you'll be asked to provide some or all of the following information:
- Basic info (name, address, birthdate)
- Social Security number
- Credit report
- Your income
- The name of your current employer and the number of years you've been employed
- Bank account numbers
- Whether you rent or own your home
- Typical monthly expenses
Remember that every time you apply for a loan, it shows up on your credit report and hurts your credit score. But, if you apply for more than one loan within a 14-day period, it’ll only count as a single inquiry.
5. Get Pre-approved
Get pre-approved by a lender before you go car shopping. You will get an idea about your maximum budget from the amount for which you're pre-approved.
If you're getting a loan at the dealership, inquire beforehand if you can be pre-approved for a loan. It depends on the dealership but some will allow pre-approval of auto loan before you've selected a specific vehicle.
6. Get a Co-signer
In some situations, lenders will only approve your auto loan if you have a co-signer. In some situations, the lender may require you to have a co-signer on the loan. These situations include low credit score, no credit at all, or not having enough income to cover monthly payments. A co-signer has good credit and agrees to take full responsibility for the loan in case you default. Ensure that your co-signer completely understands the terms because the payment appears on both your credit reports.
7. Choose a Vehicle
Select a car that matches your budget and meets your needs. Negotiate to get the best deal possible on the vehicle and your credit rate. Then, determine the amount you'll need to pay each month. It’s as simple as that!
An auto loan can get you behind the wheel of a new or used car easily. But, it’s important to shop around for rates and understand all the costs associated with car ownership. When you take out an auto loan, make sure that you use this auto loan guide to help you get the most out of your new vehicle. This will also help avoid common financial traps or owing more than you can afford.
Got any questions? Let us know in the comments below or write to us and we’ll get back to you!