Auto Loan: New & Used Car Loan Options
Most people today need a loan when they buy a new or used car and the high cost of many vehicles often means that consumers spend years paying off the auto loan. The average length of a car loan at the start of 2015 was 67 months, about five months longer than it was in 2010.
The trend is going even longer with 30% of car loans now stretched between 72 and 84 months. The average amount financed in 2015 was $28,711 with average monthly payments of $485, a record high for both length of loan and amount financed.
The most common places to secure auto loans are:
- Banks. Getting financed through a bank is typically the easiest route because commercial and private banks have large pools of capital. A bank could be your best bet if you are looking for the lowest interest rate. Banks can also be a quicker and more convenient source for car loans because they are structured to make a large number of transactions in a short period of time.
- Credit Unions. These nonprofit organizations can offer competitive interest rates, but you need to be a member to utilize their services. Criteria for membership varies, but credit unions may focus on people who work in specific industries, live in a certain area or belong to a particular group.
- Car Dealerships. Car dealerships offer financing to help sell cars. They often have established relationships with lenders, which can help you get a loan quickly and without a lot of legwork on your part. Keep in mind, however, that dealers typically make a considerable profit on loans, so it pays to understand the interest rate and other terms being offered.
How Does Car Loan Interest Work?
The typical automobile loan is calculated using simple interest, meaning you pay interest only on the principal owed.
This is similar to the method used in repaying mortgages and student loans, but vastly different from the method used with credit cards, where compound interest creates a much larger bill for the borrower.
For example, a simple interest automobile loan of $18,000 at an interest rate of 9.9 percent (typical in 2015 for someone with credit score of 640) would mean monthly payments of $332.55 and cost $23,944 when the loan is paid off.
Compare that to the same loan, using compound interest. The $18,000 loan would end up costing $32,522. Interest payments alone would be $14,523. That is why credit card debt builds so rapidly and why you should insist on a simple interest loan when buying a car.
Car Loan Rate Tied To Credit Score
Your credit score determines how much of the car a lender is willing to finance. You probably have heard advertisements for “zero percent interest” from dealers. They do exist, but you must have a credit score of 750 or higher to get them.
If you have bad credit (such as a credit score under 550), the best you can hope for is they will finance 80% of the car’s value and you will have to make up the remaining 20% with a down payment.
Credit scores and interest rates operate in a see-saw fashion on auto loans. As your credit score rises, the interest rate you pay drops. If your credit score drops, the interest rate goes up.
For example, in 2015, a credit score of 740 would get you a 72-month loan at 2.9%. A credit score 100 points lower (640) and you’ll be paying 9.9%. Drop another 20 points to 620 and the rate goes up to 12.49%.
To put that in dollar terms, if you finance $18,000 for the car, the difference between a very good credit score (740) and an average score (640) is $4,311 over the life of the loan. The difference between the very good and poor score (620) is $6,035 over the course of six years.
How to Get a Car Loan
June 3, 2013 • 10 min read by Gerri Detweiler
I bought my first car from my parents. It had lots of miles and no frills — not even air conditioning — but the price was right and they sold it to me cheaply enough that I could pay cash. My second car, though, was a gray Mustang convertible I found in the classifieds (no Craigslist back then). For that one, I had to get a car loan, so I turned to my local bank. I didn’t really have a clue what I was doing, but they walked me through the process.
If you are thinking about getting your first vehicle loan, you may feel a bit overwhelmed as well. Here’s how the process of getting a car loan works.
Step One: Check Your Credit
Your credit score will play a key role in the rate you’ll pay for your loan. While that may sound obvious to someone who has applied for one of these loans before, if you are a first-time car buyer, you may not realize how important your credit score is when it comes to getting a loan. A high credit score can help you get a low car loan rate, which in turn saves you money on interest.
Your credit score is based on the information in your credit reports, so to make sure that your credit score is accurate it’s a good idea to also get your credit reports. You can check them for free once a year.
It’s also a good idea to get your free credit score to see where you stand (and you can do that using Credit.com’s Free Credit Report Card). Just understand that you probably won’t see the same credit score the auto lender will see. There are many different credit scores available, and auto lenders typically use scores customized for auto lenders.
Step Two: Pick Your Payment
Your job here is to figure out how much you can realistically afford to spend each month on a car payment without straining your budget. Once you know that amount, you can plug it into a car loan calculator to find out the total you can afford to spend.
Car loans typically come in 3-, 4-, 5- and 6-year terms. The longer the term of the loan, the lower the monthly payment. But a longer car loan also means you are likely to be “upside down” for a longer period of time. To be upside down (or “underwater”) on a loan means you owe more than the vehicle is worth.
Don’t forget to factor in insurance and maintenance costs. While those won’t be included in your monthly payment, you’ll have to come up with those funds as well. If you have trouble paying them, you may find it hard to keep up with your car payment, so you want to make sure you are prepared for the total cost. An insurance agent can help you estimate the cost of insuring the types of vehicles you are considering buying.
Step Three: Get Pre-Approved
You can shop for an auto loan online, as well as through a local credit union or bank. You don’t have to limit yourself to the financial institution where you do your banking, and it’s fine to check with a few different sources. You want to see what kind of loan, and for what amount, they can offer. Whichever one offers you the best deal, that’s the one you can get financing through.
If you qualify for a loan, you’ll get a “pre-approval” that will be good for a certain period of time and up to a certain amount of money. It’s sort of like having a blank check to buy your vehicle. You can always spend less than the amount for which you are pre-approved, but you can’t spend more, unless you want to make up the difference in cash or by trading in your current vehicle. If you do buy a vehicle for less than the amount for which you have been pre-approved you won’t get the difference back in cash; you’ll just get a smaller loan.
Don’t have great credit? You may still be able to get pre-approved for a car loan with bad credit, but your interest rate will be higher. If you have no credit history, you can either ask someone to co-sign or consider a lender that will work with borrowers with no credit.
Try to do all your car loan shopping within a 14-day period. That’s because some credit scoring models will penalize you if there are too many inquiries into your credit history. But none of them will do so if those inquiries are within a two-week window.
Step Four: Choose Your Vehicle
Once you are pre-approved, you can get serious about shopping for your vehicle. One of the good things about being pre-approved is that you can focus your efforts on negotiating the best deal for the car or truck you want to buy, rather than having to negotiate financing as well.
If the dealer can beat the terms you’ve been offered for a loan, you may want to take it. Just be careful: the dealer may try to talk you into a longer loan that will reduce your monthly payment, but will cost you more in the long run.
If you are going to buy a used car from a private party, make sure the loan you apply for covers that option. Also make sure you understand the restrictions on used car loans. You may not be able to buy a vehicle older than five years or with more than 75,000 miles, for example. And keep in mind the interest rate for these vehicle loans may be a little higher.
Step Five: Finalize the Paperwork
Once you’ve chosen your vehicle and negotiated the price, the auto dealer’s financing department will coordinate with the lender to finalize the sale. They will very likely try to get you to buy add-ons, such as an extended warranty, VIN etching, paint or fabric protection etc. Be sure to research these ahead of time so you don’t feel pressured into making an uninformed decision.
If you buy a used car from a private party, your lender should walk you through the process of finalizing the sale.
Step Six: Start Paying Your Car Loan
After the sale is finalized, you will get information about the payment schedule for your loan. Most lenders will send a coupon book you can use for mailing in your payments, along with information on how to access your account online. Even if you plan to pay your loan by mail or at a local branch of your financial institution, it’s a good idea to sign up for the online service so you can check your balance and payments if you need to, and so you’ll be able to make payments online if you are traveling, for example.
Almost every car loan allows you to prepay without a penalty, so if you decide to pay off your loan faster you can do that. Just be sure to check with your lender to make sure your additional payments are processed correctly.
Name ______Date______Block______
Price Tax (6.35%) Interest RateTotal Finance #Months Monthly payments
x.063Add price+tax+interest
$5,000 2.9% (x.029) divide by 60
9.9% (x.099)
12.49% (x.1249)
$10,0002.9% (x.029) divide by 60
9.9% (x.099)
12.49% (x.1249)
$15,0002.9% (x.029) divideby 60
9.9% (x.099)
12.49% (x.1249)
$20,0002.9% (x.029) divideby 60
9.9% (x.099)
12.49% (x.1249)
$30,0002.9% (x.029) divideby 60
9.9% (x.099)
12.49% (x.1249)