Overview

This guide contains a complete education on auto loans, how they work, how you can get qualified, and how to find the most affordable loan possible.


What is an Auto Loan?

An auto loan is a type of loan consumers can borrow from banks, private lenders, and credit unions to use towards purchasing a new or used car. You can use an auto loan to finance a car from a dealership and also a private party (for example, a neighbor down the street).

The bank lends you the money and also charges a set amount of interest on the loan. You repay the loan back in monthly installments for a set number of months (the most common being 5 years or 60 months).


Getting Started - Your Credit and Your Loan

Getting auto financing with a great credit score is easy for most, but if you have less than ideal credit, you may have a harder time finding lenders that will finance you. To ensure that you are getting the best rate possible, check your credit score and reports before you apply for a loan.

By law, may receive your credit report and credit score for free once per year from the government mandated website www.annualcreditreport.com. Review your score and ensure that there are no errors or mistakes in your report that could scare lenders away.

If you have multiple negative marks on your credit report, contact your creditors to see if you can have them removed. You can also try to negotiate your past due balances by contacting your creditors and offering to pay them a fraction of your debt in exchange for the negative item being removed from your credit report.

The lower your credit score, the more of a risk you can pose to lenders who will charge you higher interest rates due to your score. If you do not immediately need a new car, you might want to take some time to fix your credit score. If you want some more in-depth guides to fixing your score, check out some of our articles on ways to boost your score quickly.

Having a high credit score can save you thousands of dollars in expensive interest. With a higher credit score, you can secure an auto loan from a more reputable lender that works with consumers with prime credit. Some subprime auto lenders are known for harsh tactics that can cost you your car and your credit if you’re not careful.


How to Budget an Auto Loan

Buying a new or used car can be an exciting time, but it is also a big decision that will have an impact on your monthly expenses. Before you buy, begin with a budget. Interestingly enough, most people are not aware of what they can actually afford when it comes to financing (AKA getting a loan) for a new or used car.

If you’re in the market for an auto loan, you can use a simple calculation to see what you are able to afford. Remember, when you get an auto loan, the car payment will not be your only expense. You will be required to pay for insurance, registration, and other fees that arise when you own a car.

To figure out what you can afford to pay, find out how much pre-tax income you have on a monthly basis. Most lenders will approve you for an auto loan if the total cost of insurance and car payments are roughly 15-20% of your total monthly pre-tax income. Take your monthly pre-tax income and then multiply it by .20.

For example, if your pre-tax monthly income is $1800 per month, take $1800x.20 to get a total of $360. This $360 is the most you should be paying for your auto loan payment and insurance payments. Also, take note that you will be paying out of pocket for gas as well, so try to find a car that is fuel efficient enough to do the job affordably.


Cosigning

If you need a car but have issues getting a loan due to your credit score, a cosigner may be the best way around this. Essentially, a close friend or family member will “lend” you their credit to get approved.

However, bringing on a cosigner has its own risks, since if you fail to make a payment or fall behind on your loan, their credit will be negatively affected. If you would like to learn more about co-signing, read our article on co-signers here.


Down Payment

A down payment is money you as the buyer put up front towards a car. For instance, most lenders and dealers will require a minimum down payment of 10% or $1,000, whichever is lower. If you are financing a car, the more you put as a down payment, the less money you will pay in the long run towards the loan.

This is because each monthly payment has interest tacked onto it, and having a larger down payment means you have fewer payments to make in total. This can significantly reduce the out of pocket costs of owning the car. You may not be sure of your financial situation in 6 years, so it’s best to ensure that you make a healthy down payment.

For example, if you are financing a $10,000 car and make only a $1,000 down payment, you will have to pay $9,000 back to the lender with interest tacked on. But if you make a $3,000 down payment, you will only need to repay $7,000 back with interest. If you do not have a down payment ready, take the time to save.

Many lenders and some dealers will try to offer consumers a $0 down payment option. However, these options are far more expensive than most auto loans that require a down payment. Down payments show the lender that you have an interest stake in repaying your loan, which can lower the interest amount you pay.

If you are cannot come up with the necessary funding for a down payment, we suggest that you wait and save up.


Ownership Costs

The purchase price of your car is not the only money matter you should consider. There are many expenses that can arise when you own a car, including:

● Purchasing costs (title fees, state taxes, dealership charges and fees)
● Repeating costs that arise from owning the vehicle (insurance expense, gas, repairs and maintenance, and registration)

Some cars cost much more than others to maintain and repair. Before you buy, check online sources for reviews and testimonials regarding the car you are thinking about buying. If you decide to purchase a European car, for instance, you can expect more expensive maintenance procedures and repairs than a mass-produced Japanese car.


Resale Value

Vehicles lose value over time. One important factor that many consumers forget to consider is the resale value of their car. If you decide to sell or trade in the vehicle later on, the value of the vehicle will be important in determining what you can afford next or what the dealership will offer you for a trade-in value.


Your Old Car

If you are looking to exchange your old car for a newer one, you have a few options. First, you could use your older car as a “trade-in”, meaning that the dealership will take possession of your old car and use the funds towards your auto loan. This could potentially offset the down payment most lenders require that you make.

Many consumers will hold off on trading in their old car and simply sell it themselves. You can list your car on numerous free websites such as Craigslist or www.autotrader.com. You could potentially walk away with more money if you decide to sell the car yourself to another private party. Use the cash proceeds from the sale of your car towards your new auto loan.

If you decide to use your car as a trade-in, know the value of your car. You can use resources like www.kbb.com, which will tell you the price range of cars similar to yours. The dealership may try to take advantage of your trade-in by offering a low amount, so come prepared to negotiate the value of your old car.


Getting the Loan

Once you have your budget and down payment ready, you can start shopping for your car loan. Nearly every single lender and dealership offers auto loans. Maybe you could get approved anywhere you go, but that doesn’t mean you should accept the first loan offered to you.

Information Needed

Before you apply for auto loans, there are a few things you should have handy:

● Your social security number
● Date of birth
● All sources of income
● A list of current and past employers
● A list of current and past addresses
● Contact information including a phone number
● A list of references including family members and friends who can vouch for you

Getting Pre-Approved

Before you buy a car, we highly recommend that you get pre-approved from a lender first. Getting pre-approved by a lender means that they have run your credit score and can give you X amount of money to borrow for an auto loan. This can help prevent you from overspending on an auto loan and getting pressured by salesmen to spend more than you can actually afford.

When you get pre-approved for a loan, you also have the higher ground against the dealership. The dealership may try to sway you by offering you a lower interest car loan than the one you got approved for. If get preapproved for an auto loan, the lender will hand you the documentation you can bring to your dealership. The dealership will work out the financing with your lender themselves.


Financing Options

These days, finding a lender for an auto loan is easy. Thanks to technology, shopping for an affordable rate has never been easier. No matter your credit or financial situation, there is a lender out there that can help you get financing.

Dealership Financing

Lenders come in all shapes and sizes. For instance, your local dealership may have a financing branch dedicated to providing loans for their customers. However, walk this line with caution as many dealers work with a network of lenders that originate the loan themselves.

When you apply for financing through a dealership, they will send your application to multiple lending partners to find a lender that can work with you. After they secure a potential line of credit for you, the dealership may try to add a few extra interest percentages to your loan to make some profit off the deal for themselves. Financing through a dealership is usually the more expensive option. If you want to obtain financing from your dealership, do not hesitate to negotiate rates with them.

Buy Here, Pay Here Dealers

Many dealerships also offer “in-house” financing to borrowers who have little or no credit. The catch with “Buy Here Pay Here” dealers is that their interest rates are higher than most banks, credit unions, and private lenders. Even if you are a buyer with less than ideal credit, we recommend avoiding these dealerships due to their high interest rates.

These dealerships also have a tendency to repossess cars after just one missed payment. If you decide to work with a “Buy Here Pay Here”, be sure to read the contract fully and in-depth, These dealerships are also notorious for installing tracking devices and kill switches in cars that can be activated after just 1 missed payment.

Banks and Credit Unions

A bank or credit union can get you pre-approved for your auto loan before you even go inside your local dealership. It may help to search for loans from banks you have a history with, such as through a savings or checking account. A credit union is similar to a bank, but with lower overhead costs. A credit union may be able to give you a loan with lower interest as well since their lending criteria are more lenient than most large banks.

Online Car Loans

Getting an auto loan online is just as convenient as it sounds. You search and apply for a few loans online and you will know instantly if you are approved or denied. Online lenders can sometimes offer less expensive loans since they do not have the expense of a physical location filled with employees. If you have less than ideal credit, an online lender like CrediReady may be the best choice.

Before you begin applying left and right for an auto loan, remember that a large number of inquiries in a short time frame can lower your credit score. Try to apply for all your loans within a two week period so all the inquiries will count as just one single inquiry.

You can use our auto loan calculator below to see what your estimated monthly payments will be.

$
%

Your Estimated Monthly Payment

$270

Total Principal Paid
$15,000

Total Interest Paid
$1,172

The Loan Term

The loan term is just how long you will spend to repay your lender. Usually, most auto loans are set up for 5 years or 60 months. However, with more consumers looking to pay less per month, lenders now have 72-month (or 6 years) long loan terms. We advise that you stick with the shorter loan term if possible. If you get a 6-year loan term instead of a 5-year loan term, you will be stuck with an additional 12 months of interest expense.

Lenders and dealers will try and trick you by telling you a longer-term loan means lower monthly payments, but it can lead to a much larger interest bill than expected. As an example, if you borrow $20,000 at 4% interest with a typical 60-month repayment plan, your payments will be $368 per month with a total of $2,1000 going towards interest expense over the life of the loan.

If you take that same loan an extend the payments over 72 months (6 years), your payments will only be $313, but the total interest expense over the life of the loan adds up to $2,529. This is almost $500 more expensive than the shorter-term loan.


Check Current Rates

Just as with any other purchase, you want to ensure that you are getting the best “price” on a loan as possible. You can start off by searching online for average auto loan interest rates. Many websites will tell you what the current lending rates are nationwide.

Some of these websites will attempt to ask you for personal information to see specific rates. Be wary of giving out any private information when searching for an auto loan, as you could get swamped by calls and emails from potential lenders looking to finance you.


Impact on Your Credit Score

If you have been shopping around for an auto loan, you may be concerned about how searching for a loan can affect your credit. Although any hard money loan will lead to a hard credit inquiry, you can minimize the impact by following a simple rule.

Establish a timeframe that you will give yourself to apply for loans. Try to apply for various auto loans in a 14-day period. When you apply for multiple loans in 14 days or less, the multiple hard inquiries lenders will make will only count as one hard inquiry. Hard inquiries impact your credit score and can stay on your credit report for up to 2 years.


Negotiating and Closing Your Car Loan

Just as with any other purchase, there is always room to negotiate with your A blue infographic that lists negotiable items on a car loan lender and/or dealer. Understand that when negotiating, you are trying to lower how much you are paying. Do not fear being aggressive with your lender in terms of negotiating. As the borrower, you have the power to leave the deal at any time. A good negotiation could literally save you thousands of dollars over the life of the loan.

Here are some of the most common factors that are negotiated in an auto loan:

● The purchase price of the vehicle
● The Annual Percentage Rate (APR) and interest rate
● The total length/term of the loan
● Any prepayment penalties
● Fees charged by the lender including financing fees, preparation fees, and document charges


The Total Cost

Many buyers consider the monthly payment to be the main focus. However, a lower payment does not necessarily mean an overall lower cost. Having a lower payment means you are paying for a longer time. Interest is also added to that “extra time” as well. The most effective way to compare your loan is to use the total cost of the loan.

The total loan cost includes the total amount financed. This is the principal amount you are borrowing to pay for the vehicle. This includes the price of the vehicle (MSRP), taxes, licensing fees, government fees, and possibly more.

Often, this is referred to as the amount financed. You must also include the cost of borrowing the money, called interest. In the financial industry, this is known as the finance charge. The finance charge includes the interest and fees associated with borrowing the initial capital.


Keeping Track

There are multiple factors you’ll need to keep track of to negotiate your auto loan successfully. If you are trying to negotiate the interest rate offered to you, know the total length of the loan and other aspects.

Do not be afraid to ask questions. You should be asking your lending representative about the total price, the trade-in value of your older car, the terms of the loan, and more. Be sure to clearly write down the answers that the lender provides you. If the lender takes your offer on a certain interest rate, be sure that none of the other factors on the loan have changed. Dealerships and sales representatives are notoriously sneaky and have the skill to make it seem as if though you are getting a better deal when you really aren’t.


Making the Deal

Once you and the lender have reached terms you are both happy with, you are ready to finalize the deal. Before you sign, verify that you are getting what you agreed to. Lenders must provide you with specific documentation and disclosures in writing. Thanks to the Truth in Lending Act (TILA), consumers can be more aware than ever.

Some important terms to know for your auto loan include:

Amount Financed: This is the amount of the loan itself. Think of it as the exact dollar amount you are trying to borrow

APR (Annual Percentage Rate): This is the cost of money at a yearly rate

Finance Charge: This is the total cost of borrowing money. This includes interest and all fees associated with borrowing the money

Late Fees: This is the total penalty amount your lender can charge you if you’re behind on your payments

Prepayment Penalties: Lenders can actually charge you for paying off your loan early. The final documentation you receive should include the cost of the prepayment penalty

Rate Variation: All loans are either fixed or varied. A varied loan’s interest rates change over time while a fixed rate loan stays the same. Thanks to TILA, lenders are required to tell you if your loan is fixed or varied.

Total of Payments: This is the total cost of the entire loan including purchase price, fees, and interest. This is essentially the complete sum of what it costs to buy a car.


Final Check

Before you leave your lenders office, re-examine all the paperwork provided before signing. Ensure that the loan terms and all contingencies are as you discussed when you were negotiating with your lender.

Do not be afraid to ask your lender questions if you aren’t clear on a specific topic. Never sign any document until all your questions have been answered. This is a major purchase and life commitment, so think twice before signing.

Have a copy of all the documents. Make sure the documents you receive are signed by you and also the lender you are working with. Search the documents for any clerical errors that could cause a headache later on. One single misplaced decimal can mean a financial disaster if it’s not caught early enough.


Shopping for Your New Car

With so many makes, models, and features, choosing a car that’s right for you can be overwhelming. However, once you have a set budget in mind along with a down payment, be sure to only shop for cars within that budget. Dealers and salesmen are notorious for high-pressure tactics that upsell consumers on features and options they most likely do not need. Again, we always recommend that consumers get preapproved for an auto loan before they start shopping for a car.

The Hunt

Once you’ve gotten pre-approved for your auto loan, the hunt can begin. Although there are endless options with dealerships, take the time to do your own research, Being an informed consumer could save you from buying a future lemon that will cost you thousands in repair work.

We recommend that you first look at online offers from dealerships in your local area. When you search online, you can avoid the time and energy it takes to jump from dealer to dealer. IIt’sbest to browse a dealerships inventory online first to save time and to avoid being upsold on a more expensive car than you did not plan to purchase.

Bring your pre-approval to the dealership with you. By bringing this document, you are essentially telling the dealership: “This is what I can afford, and not a penny more”. Again, having the pre-approval form with you can prevent you from falling victim to a car salesman’s upselling tactics.


Final Note

Auto loans are a great way to get into a new car without having to front a large amount of cash. With so many lenders and providers available, it would be hard to not find a loan that fits your exact needs.

Shopping for a new car can be an exciting yet stressful time. With so many financing and car options, it’s hard to keep track of what the best options for you are. By taking the steps outlined in this guide, you should find yourself in a car you love at a price and rate you can afford to pay.

If you are looking to buy a new car but need financing, CrediReady can help. Our nationwide network of trusted dealers and verified lenders work with buyers in all credit situations. Take a moment to fill out our free no-obligation loan inquiry form and start shopping for your dream car today!