Understanding Auto Loans to Make Smart Purchasing Decisions

Car ownership is accompanied by independence and convenience, but understanding financing options is critical to making the smartest purchasing decision. From loan types and interest rates to tips for securing the best deals, this guide will demonstrate how to understand and compare auto loan options and put drivers on the path to car ownership with confidence.

Understanding Auto Loan Rates

Auto loan rates vary based on a wide range of factors. Understanding the factors that contribute to loan rates is the first step in comparing and choosing financing options. Loan rates will range based on the following considerations:

1. Credit Score: Credit score plays a huge role when lenders determine loan rates. Those with poor credit scores are less likely to be approved for loans in general and often receive worse interest rates than those with good-standing credit.
2. Loan Terms: The loan term is the amount of time given to pay off the loan. A typical loan term is between 67-84 months, according to Edmunds data; however, terms vary greatly. Typically, the longer the loan term the higher the interest rate because the car depreciates over time. 
3. Lender: Auto loans can come from banks, credit unions, online lenders, and directly from dealerships. Some popular lenders include Chase, Carvana, Navy Federal Credit Union, CarMax, etc. Comparing lenders is integral in securing the best rate.
4. Debt Record: Lenders will evaluate a borrower’s debt-to-income ratio (DTI) to determine the level of risk of the borrower.
5. Down Payment: The amount put down on the car will also impact the interest rate. Paying a greater amount upfront may make interest rates lower.

Other factors that might affect the auto loan interest rate are the age of the vehicle, the buyer’s employment history, the term length, the amount borrowed, and the economic conditions at the time of purchase.

Auto Loan Pre-Approval Process

The approval process for a car loan involves the lender reviewing the financial factors of the borrower (i.e. credit score, income, debt-to-income ratio, employment) and determining the risk level of the borrower. However, with pre-qualification or pre-approval, a borrower can get an assessment of loan eligibility without a lender pulling their credit so that the borrower can understand what their loan terms might look like without it impacting their credit score.

What are the Different Types of Auto Loans?

• Secured Loans vs. Unsecured Loans: With secured loans, the car is used as collateral and can be seized and sold by the lender if the borrower defaults on the loan. This type of loan typically has a lower APR since the car itself is used as collateral. 
• Simple Interest Loans vs. Precomputed Interest Loans: With simple interest loans, the borrower’s payment is based on the interest rate and the amount of payment that goes towards the interest will change over the lifespan of the loan. With this kind of loan, the borrower can make additional principal payments and reduce the amount of interest on the loan. In comparison, with precomputed interest loans, the interest is assigned at each payment, so making additional payments will not reduce the interest or amount owed.

Understanding how auto loans and work and determining what kind of car payments one can expect when purchasing a new or used vehicle is the first step toward independence and car ownership.

Sources:

Edmunds: How Long Should My Car Loan Term Be?

NerdWallet: Getting Auto Loan Preapproval or Pre-Qualification

Lending Tree: What are the Different Types of Auto Loans?