What Is a Car Loan?
A car loan is a form of personal loan used to buy a vehicle. A lender, in more precise terms, lends the borrower (you) the funds required to purchase a car.
In exchange, you promise to repay the lender the loan sum plus interest, normally in monthly installments, until the debt is fully paid off.
A large portion of personal loans are unsecured. That is, the loan is made solely on the basis of the borrower’s creditworthiness and is not backed by collateral.
Note: Collateral is property or assets that the lender may repossess and sell if you fail to repay the loan.
Car loans are distinct in that they are almost always secured loans, with the vehicle itself serving as collateral. If you do not make the payments, your car will be repossessed and sold to pay off the loan debt.
How a Car Loan Works
Other than a mortgage, a car loan is one of the most significant financial agreements one can enter into, so it’s important to carefully weigh your options and understand what you’re getting yourself into before signing on the dotted line.
A car loan (and most loans in general) have four components that you should think about before signing on the dotted line: loan rates, interest rate, down payment, and conditions.
The cost of a car loan is divided into two parts: the principal and the interest.
The principal is the agreed-upon price of the car. The term “interest” relates to the costs incurred over the loan’s existence depending on the principal amount and the given interest rate.
Fees can be included in the loan costs. Some of these expenses, such as taxes and title fees, are non-negotiable. Some fees, such as shipping and origination fees, are negotiable.
An interest rate is the basic rate paid to the borrower for the loaned funds. Your car loan can display two rates: the annual percentage rate (APR) and the interest rate.
The loan payments are included in the APR. When loan shopping, compare APR to APR and interest rate to interest rate to ensure you’re comparing apples to apples.
Terms and Conditions
These are all of the other components of a car loan, such as the loan term, which is typically specified in months or years.
There are also insurance and registration requirements, loan payoff and resale terms, maintenance requirements, theft or injury conditions, and loan default and repossession conditions.
Other terms and conditions can apply, and it’s critical to read them carefully and understand what they mean before signing on.
The down payment is an initial payment made at the time of vehicle purchase. A trade-in car may also be used as a down payment.
Your down payment is usually calculated as a percentage of the overall purchase price. The greater your down payment, the less you would need to borrow.
Direct Lending Options
With direct lending, you get a personalized loan directly from a finance company, bank, or credit union. You agree to pay the amount financed for the vehicle purchase, along with interest and any other finance charges over an agreed-upon period of time.
You’ll generally receive a financing check or a wire transfer to your bank to pay for the vehicle and any other items you may have purchased, like a service contract, options, or extended warranty.
- Shop around to find the best auto financing rate
- Allows you to find a lender that suits your payment terms
- You generally receive funds directly into your bank account
One of the benefits of direct lending is that you can shop around and compare several lenders to ensure you get the best auto loan rates before you purchase a vehicle.
You are also able to review credit terms before choosing a loan and buying a vehicle, so you’ll know the interest rate/car loan rates upfront during the loan process.
Finally, because you received the funds directly from the bank, you basically become a cash buyer at the dealership, giving you the upper hand in the negotiation process.
Comparing a variety of online car loans ensures you get the best possible deal, as the costs of vehicle loans may vary by thousands of dollars.
Dealership financing is typically the path most buyers take because it’s generally the most convenient at the time.
Just think about it, you go to the dealership, choose the vehicle you like, negotiate a price, then the dealership handles all the financing for you.
While it may seem like the dealership is providing the financing, it’s not. The dealership simply shops your credit around to various banks who then offer loans to pay for the vehicle.
The dealer then chooses the loan that they feel is best and by this, we mean the best loan for the dealership. When you enter the contract, you’re entering it with the bank, not the dealership they are simply the middle man for auto financing.
While this may seem great because it’s so simple, there are a few downsides to dealership financing:
- The dealer may present only loans that offer kickbacks
- You’re separated from the rate-negotiation process
- There may be better options that you never hear about
- Car dealers can creatively package loans to make a bad deal seem good
Put simply this strategy is not optimal for you as the consumer. This simply just doesn’t guarantee the best-fixed rates/ low rates, best terms and conditions, annual percentage rates (APRs), etc because it incentivizes the car dealership to use a third-party lender that will also share a profit with the dealership.
The Car Loan Process
Here are five steps you can follow to ensure your car loan process go smoothly:
Determine what you can afford
Take out a piece of paper and create a practical budget that shows you how much you can spend in terms of monthly payments. Keep in mind recurring expenses such as insurance, repairs, and electricity. Next, calculate the cost of your down payment or the value of the car you want to trade in.
Check your credit score
Before speaking with lenders, it’s a good idea to know where you stand in terms of your credit score. Some websites have free credit scores. You may also pay to get your credit ratings directly from the credit bureaus. Lenders base loan interest rates and terms on credit reports and ratings. The higher your credit score, the better your chances of securing a lower interest rate.
Shop around for the best loan terms
Rates and terms differ, often significantly, between lenders. To obtain a quote, contact many lenders, including your bank or credit union. Your dealer can also have financing, but if you shop for the best loan rate before going car shopping, you’ll be in a better place to negotiate.
Getting pre-approved for a loan ensures you’ve defined your financial boundaries before ever setting foot in a dealer’s showroom. Pre-approval does not imply that you have made a decision, but it does provide you with an idea of what you can afford.
Shop for your car
It’s now time to visit your favorite car dealerships. Find the exact vehicle you want, and then provide your lender with the year, make, model, and VIN. You can also get auto insurance as soon as possible. Most dealerships will not let you drive away until you provide evidence of auto insurance.
Applying for Car Loan Financing
When applying for car financing, it’s also important to understand the type of information you will need to provide.
If you opt for dealership financing, you will usually submit your application through the finance-and-insurance office at the dealership.
This will involve completing an application, which will require such information as:
- Social Security number
- Date of birth
- Length of employment
- Income sources
- Gross monthly income
- Income to debt ratio
The dealership will also obtain a copy of your credit report, which contains information about your past and current credit obligations, credit history, including payment history, existing auto loans, balances, credit limits and interest, any relevant data from public records.
Each account’s status will also be included on your credit report, including any overdue amounts and if the account is open or closed.
If a creditor has taken any legal steps to collect on a debt, this information will also be included.
Note: Most dealerships will submit your application to multiple possible lenders, including finance companies, banks, and credit unions, to find an assignee who’s willing to finance your purchase.
Your credit application will be evaluated using various techniques to determine whether you will be approved for a loan with the proper terms and conditions that make car payments or lease buyouts manageable given your current financial situation.
When you finance through a dealer, you will not deal directly with prospective lenders.
The decision to offer you financing will be based on an evaluation of your credit score, credit report, your completed application and terms of the sale, including your down payment amount.
- Buy rate: Interest rate that a potential lender quotes the dealer
- Contract rate: The rate which the dealer offers you
If a lender agrees to finance your purchase, it will notify the dealership and give a buy rate, which is the APR the lender is willing to offer.
The dealer then comes to you with a contract rate which is the interest rate you will pay, which may or may not be higher than the buy rate.
Tip: Read more bout the difference between interest rate and APR.
This is where you want to start negotiating that interest rate to push the rate you are paying closer to the buy rate the dealership received.
Improve Your Chances of Getting Approved
What if you don’t have good enough credit to get a car loan on your own? Here are a few strategies for can your chances.
Get a Co-Signer
Is your credit score too poor (or non-existent) to apply for a good auto loan? This can change if you have a co-signer.
A co-signer guarantees your order by putting their name and credit score on the line. If you don’t pay, their credit would suffer the same consequences as if the loan were entirely in their name.
A co-signer is usually a very close relative, such as a parent. It’s an excellent way for you to develop credit and improve your credit score.
Warning: Avoid conditional or contingent loans, which require you to sign a loan agreement with a dealer and drive away with your new car before the loan terms have been finalized. Important factors such as the interest rate, loan term, down payment, and monthly payment sum can be altered, resulting in you paying much more than you expected.
Peer-to-Peer Auto Loans
You can’t find a co-signer to help you? There are peer-to-peer car loan websites that can help link lenders and borrowers.
Instead of applying for a loan from a big company, you pursue a loan from individual investors through peer-to-peer lending.
Following the development of a profile describing why you need the loan, your credit score will be checked, and if you have a poor or nonexistent score, you will be classified as high risk.
Individuals will look over your profile and determine whether to finance the loan or not. If there is enough interest, the loan will be funded, and you will be able to use the proceeds to purchase a vehicle.
You repay the loan through the peer-to-peer site, and the interest you pay benefits the investors.
The higher the interest rate, the riskier the loan is for borrowers. Whether your credit is good or poor, it’s another lending option to consider.
Financer.com has taken the burden away from you as a consumer by showing you a network of lenders you can do business with right now.
In addition to that, you can compare auto loans instantly online and be well on your way to finding the funds you need for the car you want.
Alternatively, there are always other lenders but you’re most likely going to have to sift website by website to find a deal. So skip the noise and instantly compare online right now!
Car Loan FAQs
Is it better to get a car loan or a personal loan?
When purchasing a vehicle, an auto loan is preferable to a personal loan in most cases. This is due to a few basic reasons: auto loans are easier to apply for. Your interest rate would almost certainly be lower. Other loan payments are less likely to be incurred.
How do auto loans work?
Auto loans are simple-interest loans, which require the borrower to repay the lender in monthly installments for the amount borrowed (the principal) plus interest (the cost of borrowing from the lender, expressed as a percentage of the principal balance).
Where should I get my car loan?
When it comes to car finance, it’s a good idea to do some comparison shopping to find the best deal for you. You should compare terms from various lenders, such as banks, credit unions, and other financial institutions, to see if their rates are better than your dealer’s.
With Financer.com it’s easy to compare car loans from multiple lenders.
If something goes wrong, can someone else take over a car loan?
The short answer is: most likely not in an official capacity, but it’s worth checking with your lender. If your lender allows it, the individual assuming the loan would most likely have to go through the loan application process, including a credit check. That means they’ll probably end up with a new loan rather than taking over the old one.