Car Loans – How Auto Loans Work
How to borrow money for a car loan. Where to find the best rates and terms.
Although this web site is primarily about car leasing, many of our readers tell us that they have decided that leasing is not right for them and that they will buy a car with a loan. They want to know if we have tips and advice that might help them. Hence, this article — just for them.
Car loan financing is generally better understood than leasing, but there’s much room for information and advice, particularly for inexperienced car buyers.
A car buyer’s first encounter with loan payments typically comes from car salespeople who ask, “What kind of monthly payment are you looking for?”
This is certainly a legitimate question but if you don’t know how payments relate to vehicle price, interest rates, and loan terms, you are subject to paying too much, or even getting cheated. You may want to read our article, Don’t be A Payment Buyer.
Why do you need a car loan?
There are really only two reasons for needing a car loan:
- You don’t have the cash needed to purchase the car you want
- You have the cash, but you have better uses for it, such as for investments, paying off bills, or saving for emergencies
If you are in the first category – don’t have the cash – make sure you’ve taken a serious look at your finances to understand what you can afford.
Many car buyers, particularly new ones, overestimate their ability to pay — and buy more car than they can afford. They often overlook the other expenses of owning and driving an automobile: insurance, gas, oil, routine maintenance, taxes, tags, tires, and repairs. These costs can easily exceed monthly car loan costs.
How is your credit?
Your credit history is the most important determinant of what you’ll pay for a loan, or even if you can get approved. It also affects what you pay for car insurance (see Cheap Auto Insurance).
When you apply for a loan or lease, your car dealer and finance company will request a credit history report and credit score from one or more of the three major credit reporting agencies: Equifax , Experian, and TransUnion .
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The credit report details your past and present credit card accounts, loans, mortgages, car loans, and leases. It shows whether or not you’ve missed payments, made late payments, to whom, how often, and by how much. Bankruptcies and repossessions also show up. It details balances on all outstanding accounts, credit limits, and shows how many inquiries have been made recently by lenders.
Since car dealers and finance companies may not have time to read through credit histories, they also ask for your credit score , which is a single number that summarizes your entire credit history. Your credit score is a measure of your credit worthiness and can range from 300 to 850. The median for consumers in the U.S. is about 720. A score above 700 is considered “prime” and will get you the best rates. If you’re below about 640, you’re considered “sub-prime” and you may have problems.
It’s necessary that you know your credit history and credit score, especially if you have poor or borderline credit. Often, the problem may be a simple mistake or a couple of missed payments that can be easily explained. A bad credit report can be repaired.
What if you have bad credit?
Dealers and their associated finance companies don’t typically approve customers who have serious credit problems. Most conventional lenders such as CapitalOne, Chase, Wells Fargo, and manufacturer’s finance companies refer bad-credit loan requests to a “sub-prime” lender. One such lender is Auto Credit Express, who offers direct loans to credit-challenged borrowers. They have a great track record, are in excellent standing with the BBB, and have helped thousands of people who have no credit, poor credit, bankruptcies, and even repossessions.
Another reputable online auto loan provider is InstantCarLoan.com. Get a loan deal offer from them, even if you’ve credit problems, and compare to the other offers you’ve received — and go with the best deal.
Another solution is to buy your car from a buy-here-pay-here car dealer who handles his own loans and does not check credit. However, take a lot of caution when buying from such a dealer. Not only might you find that his cars are not the best, but you can also expect to pay a very high loan interest rate. But if it is the only way you can get a loan, it might be the right solution under the circumstances.
Where to get your loan?
Most car buyers accept loans offered through the dealer from whom they buy. However, that may not be the best deal.
Dealers don’t directly provide loans (except buy-here-pay-here dealers mentioned above). They have relationships with banks, credit unions, and carmaker’s finance companies (Honda Financial Services, Ford Credit, etc.) who provide customers’ loans. All loan requests through dealers must be approved by the associated finance company. Even though dealers often run a credit report, it’s only preliminary and is not a final approval.
It’s not necessary to finance your car through your dealer. Dealer loan rates are not always the best. You can shop for your own loans, and get pre-approved so that you’re ready with a check when you decide to buy. Banks and credit unions are good sources. One of the fastest and easiest ways to get pre-approved at good rates is online, on the Internet.
Auto Credit Express is a good company for online loans. The application process is free, easy, and fast. There is no obligation to accept their loan if you don’t like it. They work with people with credit problems or no credit. You’ll learn how much you can borrow and at what rate right online.
How much loan?
People who are “payment buyers” often don’t consider what makes a low monthly car payment. Certainly, the price of the car affects payment amount but interest rate and loan term (length of loan) are other major factors. Dealers can offer low monthly payments by spreading payments over a long period of time, as much as 84 months (7 years).
Such long-term loans generally are not good. First, interest rates are higher on long-term oans, meaning that total finance cost can be as much as the cost of the automobile. Second, long-term loans almost always mean that you’ll be upside down on your loan nearly to the end. What is the problem?
Being upside down means you owe more on a car loan than the vehicle is worth. If you tire of the car and decide to sell or trade, you’ll owe extra cash to pay off your loan. Furthermore, if your car is totaled in an accident or stolen, your insurance only pays what the car is worth, not what you owe on your loan. You would have to come up with cash to pay off the loan. Buying GAP insurance would help this situation.
Summary
Look at alternatives to dealer-provided car loans. You may find better deals at banks or online financing companies such as CarsDirect and Auto Credit Express (see links above). Know your credit score so that you won’t be surprised by being turned down or getting high rates, and get the shortest term loan you can afford. Finally, know your current credit score and make your payments on time to protect your credit history. Find your FICO score now when you check your credit report for $1 at Experian.com!