Many of us secure an auto loan without fully understanding what it is. However, the more you know about what you are signing, the more likely you’ll get a loan that meets your needs, and that will help you avoid being taking advantage of by lenders who are less than honest. Why is this important? Because a car is a major purchase. Think about having the knowledge as a way to protect your hard-earned money.
What Makes Up a Used Car Auto Loan?
The basic makeup of an auto loan includes the following:
- Price of car
- Down payment
- Your credit score
- Interest rate
- How long the car loan is for
- Other fees and charges
To understand it further, you can break each component down and how it works within your auto loan:
Price of car – This will be the number that lenders begin working with. It is the dealer price, or the price you negotiate with the dealer. It will be listed in the purchase agreement. In general, a lender will want you to get the overall price of the car down a bit as a show of good faith that you can buy it (see down payment).
Down payment – This amount is a percentage of the overall price of the car. It is also shows that you are serious about making the purchase, and will help lower your monthly payment amount. While there is no set percentage for a down payment, the amount commonly ranges between 5-20% of the purchase price. This means if you purchased a car at the price of $15,000, a down payment of 10% would be $1500. The key is to do a down payment amount that you feel comfortable with, but also shows the lender that you are financially responsible so you can potentially get a better interest rate. A great way to get a down payment is to trade in your old vehicle.
Your credit score – Your credit score is a combination of your debt, payment history and any negative credit history you have. Your score affects whether you get a loan or not, and what your interest rate will be. Poor credit scores often mean higher interest rates (because of risk), and that means a higher monthly payment. For some people, it’s necessary to improve your credit score before applying for a loan so they can get the best deal possible.
Interest rate – An interest rate is basically payment for securing a loan. A lender needs incentive to lend out money, and the interest rate is how they do that. Some of the things that will affect your interest rate are:
- The market rate
- Your credit score
- Your debt-to-income ratio
- The loan to value ratio
The interest will be a part of the total loan. It increases the purchase amount, and will be paid off in your monthly payments. You can read here to understand interest better.
How long the car loan is for – The length of your car loan will be a big factor in determining your monthly payment. The longer it is, the less the monthly payment is. However, the longer it is, the longer you will be paying on your vehicle. Typical car loan lengths are anywhere from 36-60 months. The key is to choose a car you can afford and pay it off as quickly as possible.
Other fees and charges – Taxes, licenses and other fees and charges will often be wrapped into the grand total of your car loan. This helps offset upfront costs.
Avoiding Common Auto Loan Mistakes
The most common mistake people make when securing an auto loan is they look at their monthly payment rather than how much the loan will cost them in the end. This could leave you in a situation where you pay far more than the vehicle is worth. One way to prevent this is to shop around. Be willing to go with a great used car dealer who can provide you the best rates and terms.
What Are Your Used Auto Loan Choices?
Consumers have several choices for car loans. There are traditional lenders, lenders that specialize in complex loans or poor credit history and dealers that offer in-house financing. Look at your financial situation and determine who can do the best for your situation. Make a sound decision—which means if your credit is poor, take some time to improve it so you can get a loan that doesn’t hurt you financially. Also, look at what you want to spend on a car and be realistic, even if it means settling for something more affordable.
The more you understand auto loans, the better chance you have of finding an auto loan that gets you a great car at a great price.
