Buying a new car is one of the most exciting things you can experience. It’s like taking a big plunge toward a more prosperous life. Well, at least that’s what most people say.
Understanding car loans can seem like a daunting task. But with the right information, you can make an informed decision when it comes to financing your new wheels! We’ve got everything you need to know about car loans: from understanding interest rates and loan terms to shopping around for the best deals. Get ready to hit the road in style and find the perfect loan for your next set of wheels!
Luckily, getting a car loan is very easy and convenient nowadays. You can even do it in the comfort of your home. If you want to know what a car loan is and how it works, we suggest you read on.
What is a Car/Auto Loan?
An auto or car loan is a type of financing where you can borrow money from a lender to secure money to buy a new car. Of course, this comes with terms where you must pay the lenders back the principal amount and interest through fixed installments over a set period. If you have a good enough credit score, you can opt for a car loan with a lower interest rate and better repayment terms.
Also, your credit score will determine the initial loan amount you can borrow and its required down payment. And of course, with a higher initial amount, the kind of car you can buy will also be flexible.
However, if you’re new to all of this, you should know some of the terminologies you might encounter during this endeavor. Doing this helps you fully understand the terms and policies of the loan, which allows you to find the best deal possible for your circumstance. These terms are very common in finance, and it will be helpful if you familiarize yourself with them.
Interest Rate: This is the annual fee your lender will charge you when you borrow funds to finance a vehicle. Your credit score will determine how high or low your interest rate will be. This is also how the lender earns money through financing.
Annual Percentage Rate or APR: The APR is the overall total of the borrowing cost of the loan. It includes your interest rate, fees, etc.
Loan Term: The loan term, sometimes called the repayment period, is the window of time that determines how long you’ll be paying off the entirety of the loan.
Down Payment: This is the amount you must pay before the lender can give you the loan. It’s like a fee, except that the bigger your down payment is, the lower your monthly fee will be.
Principal: The principal means the total amount you’re borrowing for the loan without the interest rate and other fees. It, along with the down payment, usually equals the cost of the car.
Qualifying for a Car Loan
Now that you know how a car loan generally works, we need to discuss how to qualify for a car loan in the first place.
Save Up for a Down Payment
If you want to get approved fast, one way to do so is to save up for a down payment. The lenders will only take your application seriously if you’re willing to invest a lot of money. One way to show that you’re serious is by showing that you can give the lenders a huge amount for the initial payment.
Usually, it’s recommended that you should be able to pay for at least a 20% down payment for the loan. It’s also important to know that the bigger your down payment is, the lower your monthly payments will be.
Avoid New Debt
If you want a better chance of getting approved for a car loan, you should avoid incurring new debt. This is because it will create another hard inquiry in your credit report, which your lender will occasionally check throughout the application process.
If you take up new debt, this will significantly lower your creditworthiness, which will reduce your chances of getting approved for a car loan.
Have a Stable Income
One thing that lenders check before they approve you for a loan is your ability to repay the loan. That said, to increase your chances, you should have a stable income, or more specifically, be at least two years in your current job. By showing them that you can pay off your loans, you’ll have a greater chance of being qualified for a loan.
Be Truthful About Your Financial Details
It’d help if you remained honest about your financial details. Inflating your income or lying about your financial status will make your lenders outright drop your application because of fraudulent behavior.
Lying is useless, though, as they can always check your credit report, employment status, and even your credit history. Not to mention that there’s also a chance of you getting reported to credit bureaus, hurting your chances of getting a loan now and in the future.
Get Expert Help
Suppose you need help getting approved for loans. In that case, you can ask for professionals who can help you manage and overview your financial details and even introduce you to their network of professionals, which can help you be qualified for a loan.
Not only that, but they can also help you find lenders with the best rates and dealerships and even recommend cars if you’re flexible with that aspect. With their expertise, you can easily breeze through the application process from start to finish, and they can even help things speed up significantly.
How to Get a Car Loan
You’re ready to get a car loan with all that in mind. But how exactly do you purchase a car with a loan? Here are some easy steps.
Check Your Credit
Your credit score and income are some of the pivotal factors when getting into a car loan. This is because they can determine how much money you can borrow and how much interest you’ll have to pay for the duration of the loan term. That said, check your credit first before you immediately apply for a car loan, especially your credit report.
Errors in credit reports are quite common, so you must constantly check for spelling errors, fraudulent activities, hard inquiries, and so on. Remember, your credit report is usually the first thing a lender would check when determining your creditworthiness, so sorting it out first should be at the top of your priority list.
With that in mind, you can get a copy of your credit report every 12 months from the major credit bureaus: Equifax, TransUnion, and Experian. It’s also important to note that credit reports are the raw materials that they use to compute your credit score, which, as we all know, affects your loans. You might want to check your credit reports if your credit score is poor.
Do not be discouraged if you have bad credit, you may still be eligible for a car loan.
Apply for Auto Loans From Different Lenders
Once you’ve sorted out your credit score and report, now it’s time for you to find an auto loan. You can get auto loans from different sources, which can be categorized into four:
1 Local community banks or credit unions
2 Online lenders that offer auto loans
3 Large national banks like Capital One or Bank of America
4 Or Dealership financing.
Usually, people prefer to go for dealership financing because they are cheaper and faster. However, that’s not necessarily the case all the time. What you want to do, though, is to compare the prices from the other three sources before you go to dealerships since the other sources also run a lot of promotions regarding auto loans.
Get Preapproved for an Auto Loan
Once you’ve narrowed your search for lenders into two or three, it’s time to request quotes and compare the offer they’ll give you. Most of the time, when a borrower is interested in getting a loan, lenders will not let that borrower go, especially to their competition. You can use this to your advantage. Getting lenders to compete for your business is a great way to get the best deals.
One way to do this is to get preapproved for an auto loan. However, before we delve further into that, we want to discuss first the difference between preapproved and prequalified. These are different words with different meanings, and they’re used a lot in the financing, so knowing what they mean first is crucial.
So, for prequalification, the lender will provide you an estimate of the rate and the loan amount that you can expect based on the little knowledge your lender has about your credit history. Prequalification requires a soft inquiry on your credit report so it wouldn’t affect your credit score too much. However, expect the loan amount and the interest rate to be changed once they finish a full credit check on you.
On the other hand, pre-approval is a step up from prequalification. It’s pretty much the same thing, but this time, your interest rate and loan amount can change dramatically since, at this stage, they’ve already done a full credit check on you. The interest rate and loan amount are closer to the final numbers you’ll get once you go with the lender. One thing to note, though, is that a pre-approval requires a hard inquiry, which will affect your credit score negatively temporarily.
With all that said, if you’re ready to buy a car, getting pre-approval from a lender offers a few advantages, like giving you more negotiating power regarding the loan’s details. It can also protect you from marked-up rates that some lenders do.
Use Your Loan Offer to Set Your Budget
Now that you have your pre-approval, we should discuss the finer details of the loan. Your pre-approval offer will state the maximum amount you can get for the loan. However, you should not think that it will be the cost of the car you’ll buy since you still have to pay at least 10% of your loan to taxes and fees. There are a lot of loan calculators online, so you might want to check on that.
Put down your down payment and trade-in value of the car you’re planning to buy, and the lending terms and the calculator will then tell you how much you’ll be paying monthly.
If you think your monthly payment is too much, remember that you’re still in the pre-approval stage. You can still negotiate with the lender on several details about the loans, especially your monthly payment. The key here is to compromise, but you have more negotiating power if you have an excellent credit score. However, don’t set things in stone just yet.
Remember that being aware of how much you can pay off every month is essential. If you’re gunning for a secured loan, the car itself can be used as collateral. Failure to pay can lead to repossession of the car. Learning how to get car out of repo is an entirely new process you would rather not deal with, so make sure you can pay off the loan monthly before agreeing.
Find Your Car
Now here comes the exciting part; picking a car. Of course, this one is easy since you might already have something in mind. However, you still have to remember some things before you pick one.
Excluded Brands: Some lenders don’t include certain car manufacturers or specific brand cars that you can pick. Most of the time, they exclude expensive brands or electric cars. They might not be too limiting, but they’re still worth remembering.
Dealership Requirements: Some lenders, such as Capital One, have a list of dealers you can visit. Any car outside that list of dealers is a no-go.
Time Restrictions: Most lenders have a time limit on when you can use the loan. Usually, it’s about 30 days. Failing to use the loan at that time means a penalty, cancellation, etc. You can call your lender to extend the time if you can’t make it.
Lender Requirements: This is only applicable if you plan to buy a car from an individual.
Review the Dealer’s Loan
This might sound too late, but do you remember when we said not to set things in stone yet? Here’s why.
When you go to a dealership with a preapproved loan, they will sometimes offer an even better loan than the one you’re preapproved with. Carmakers usually set their banks for auto purchases through dealerships. Most of the time, they offer way below market prices, which is why we mentioned earlier that most people opt for dealerships.
Once the finance manager gets wind that you have a preapproved loan for a car, they will come to you and offer to beat those prices in an attempt to get you to go for their financing instead.
Of course, there’s no harm in applying to see the numbers they offer. But if you don’t want to play that game, you can opt to tell the person that you’re a cash buyer, which means you can still haggle for the price of the car. It’s still a win since they know you can also get your car from another dealership.
Choose and Finalize Your Loan
If the dealership beats your preapproved loan, you get a great deal. But if you still opt for the preapproved loan, then that’s totally alright. That means that you still got yourself a great deal. No matter which one you picked, you secured yourself financing. You can now take that loan and disregard the other offers, but that doesn’t mean that you’re done; oh no.
Before you sign anything, make sure to read the contract first. Some lenders put some sneaky details in contracts since no one is patient enough to read those. Nevertheless, it’s very important to read them. Here are some things you need to look out for.
Hidden Fees: It’s normal to pay for sales tax, registration costs, and documentation fees. Any other fees other than that should be questioned.
Longer Loan Term: Depending on the APR, adding at least 12 months to the loan terms means you’ll be paying more interest. But usually, you can see some dealerships offering lower monthly payments at the expense that you’ll be paying for it for a longer term. Always watch out for that kind of deal.
Add-on you didn’t ask for: Sometimes, contracts include add-ons you don’t want, like insurance, especially gap insurance. You don’t want this since you can usually get much cheaper gap insurance from a third party.
Early Pay-off Penalty: This one can be found in some auto dealerships, banks, and online lenders. But for the most part, it’s not that common. But still, watch out for these.
Now that you’ve signed your contract, you only need to do some things. If you decide to go through with the preapproved loan, you must follow the lender’s instructions to complete your application and finalize the loan.
In some cases, the dealer representative will contact the dealer to initiate the funding, and from then on, you can let them finish the whole transaction. But in most cases, you have to finalize the loan by going through important documentation.
You don’t have to do much for dealership loans since it’s in-house financing. You just have to sign some forms, and you can go home with the car at the end of the day or the next day at most.
If you’re buying from a private seller, most of the time, they’re most likely to request cash or a check. After the purchase, the usual transaction will happen, which will be instructed by the lender. Just some paperwork, and you’re done.
Mistakes to Avoid When Getting a Car Loan
Now that you know how to qualify for a car loan and get a car loan step-by-step, here are some mistakes you must avoid during the process. Always keep them in mind since not only will they hurt your chances of getting approved, but creating these habits could also hurt your chances of getting a car loan.
Not Making a Down Payment
Financing the full amount of the car without so much as shaving off at least 20% of the whole amount is a common mistake that many people make.
Financing more than you need means that you’ll be paying a lot longer than expected, which can result in you only shaving off a small amount on the principal amount every month. This also means you’ll be paying much more interest in the long run.
If you can comfortably take out a significant amount from the loan, either through a trade-in or a down payment, you’ll significantly save a lot of money. This is especially true with down payments since the larger your down payment is, the lower your interest rate will be, which means most of your monthly payments will be paid for the principal amount of the loan.
Tunnel-Visioning on a Lower Monthly Payment
Many people make the mistake of solely aiming for a lower monthly payment. This is because they think they will save a lot more with it, which is just wrong on many levels. When taking out a loan that spans, let’s say, 5 to 7 years, you should consider the entire cost of the loan, which should include what you’ll pay with the APR.
You need to see the whole picture. For example, if you have a good enough credit score between 500-600 and take out a car loan that spans five years for a $30,000 car, your average APR will be 11.3%. With this proposed rate, you’ll be paying a total interest of $9,163. So while you think you’re saving a lot with a lower monthly payment, your total loan amount would be $39,163.
And this is assuming that you’ll always pay on time with the right amount for the whole duration of the loan. We’re not saying you shouldn’t opt for a lower monthly rate here. We’re saying that if you can afford a slightly higher monthly payment comfortably, then you should do so since it considerably lowers the interest you’ll have to pay for the whole duration of the loan.
Not Accounting for the Future of Your Financial Life
Before you get a car loan that spans a few years, you should consider the changes your financial life will experience in the immediate future. For example, if you’re marrying soon or planning to have kids in the next few years, or if you recently had a car repossessed, you might want to hold off on getting a car loan yet.
In these situations, things will get hectic, and you’ll be paying a lot more bills, which can affect your monthly payments significantly. You should also consider the expenses for car maintenance or if you’ve bought a used car and are looking for a loan for car repair.
Missing even just a single monthly payment can affect your credit score pretty severely. It could also be reported to credit bureaus, which can translate into your credit report. In short, if you think your financial life will change significantly soon, it might be better to purchase a car loan later.
Not Considering Early Pay-Off Penalties
When taking out a car loan, it’s important to read the fine print thoroughly before signing anything. This is because, as mentioned earlier, some lenders have an early pay-off penalty if you pay the full loan earlier than the loan term. Lenders make money through the interest that you’ll pay throughout the loan’s duration.
So if you agree to pay for the loan for six years, and you decide to pay your loan in full after four years, that means that they’ll only collect the interest on the loan for four years, which is a significant loss in profit. They recoup these losses through early pay-off penalties.
One of the biggest mistakes people make when taking out a car loan is rushing through the process. Rushing means you won’t be shopping around for the best deals, taking the first loan offer, not reading the fine print, etc. It’s important to take your time through the process, especially if you’re looking for the best deals in the market.
Read the fine print, ask questions, and see other options if you have the time. Not doing so might put you in danger in the future.
This is practically everything you need to know when taking out a car loan. It might be a lot, but taking out a car loan is one of the most important purchases of your financial life, so of course, you’d want to be thorough about it. Remember, be patient with the whole thing and always ask questions.
Also, do remember that if you want better terms and interest rates for your car loan, it would be wise to improve your credit score and sort out your credit report first. Pay off any debt and make sure that you won’t be incurring any more debts during the process. Good luck out there!