Lenders help customers borrow money for a variety of purposes, one of which is buying a vehicle. If you are looking to buy a car online, you can approach a variety of lenders and receive different terms and rates. Dealers also offer loans, giving people with no other options a way to become mobile and steer their financial situation in the right direction.
The Difference Between a Car Loan and Other Loans
What sets an auto loan apart from an all-purpose bank loan, a personal loan, or a line of credit?
Security: All auto loans are secured, meaning that the vehicle also serves as the loan’s collateral. While failure to make payments could result in the lender repossessing the vehicle to cover the remainder of the obligation, secured loans also result in more favorable interest rates and loan terms.
Low-Credit Friendly: Generally, because a vehicle represents a smaller investment than a house or small business, and because it is obtained via a secured loan, the bar is set much lower where your credit score is concerned. If you have low or poor credit, you can still obtain a reasonable auto loan, whereas this may not be the case for other types of loans. Car loans are also comparatively short, lasting a maximum of around seven years, making them less risky and thus more favorable for customers.
Flexibility: If you want to purchase a car online, an auto loan is an excellent option because of the flexibility it offers. You can trade in an old car to reduce your obligations to some degree, pay on a more frequent schedule to speed up the loan repayment timeline, or even take a loan that allows you to replace your car mid-term for a different model.
Key Differences Between New and Used Car Loans
The main difference between new car loans and used car loans is that new car loans generally come with a lower interest rate. For people with good credit, the difference might be marginal, but for people with weak credit, there can be a significant difference in interest rate between auto loans for new and used vehicles.
Some car manufacturers offer special rates and bonus cash on certain models and model-year vehicles, offering another incentive to buy a new vehicle instead of a cheaper used vehicle.
New cars tend to be more expensive than used cars, and therefore new car loans tend to be more expensive. Therefore, even if the interest rate is lower for a new car loan, the new car will have a higher principal and usually higher overall payments.
Refinancing Car Loans
Refinancing a current car loan is a smart choice for many car owners. It could conceivably mean paying less over the lifetime of a loan because you trade the current loan for one with a lower interest rate. You may also be able to renegotiate your repayment terms helping you to lower and spread out the payments or condense the payments to pay off the loan sooner.
While you can technically refinance your car loan whenever you want, if you want to get the most out of the deal, look before you leap. Before you refinance your car loan, make sure of a few things:
- It is not best practice to try and refinance before three months have passed from the date you originally took out the loan. Your credit score may have taken a slight dip from all the necessary credit checks, and you have not given yourself enough time to build your score back up again or make any improvements. So, it’s not likely that you’ll get a better rate, and you may end up doing more damage than good to your credit score.
- Six months into a loan is a much more advisable time to consider refinancing a car loan, and after a year is even more reasonable.
- If this is the first time that you are buying a car, then definitely wait the full year before refinancing. This will give you an opportunity to prove your creditworthiness to lenders who are more likely to give you a much better interest rate the second time around.
Refinancing is also an excellent option if you are looking to either remove or add a cosigner to your current loan. If you cannot get approved for a loan on your own, you may take out a loan with a cosigner. The cosigner, however, does not want to be tied to your loan for its entire lifespan. Refinancing is an easy way for you and your cosigner to part ways. Additionally, losing a cosigner will reflect better on your credit history.
Alternatively, you might want to add a co-borrower to your loan. This might be a business transaction, or it might be your way of dealing with the financial burden of a hefty auto loan. Either way, you can refinance to secure a place at the table for a co-borrower.
Car Loan Amortization
Car loan amortization sounds complex. In simple terms, however, car loan amortization is one way of paying off your auto loan. Each month when you make a payment to your car loan provider, the payment gets divided into three sections:
The principal is the actual loan amount that you borrowed to buy the car. The interest is the percentage that the lender charged you to provide you with their services, and the fees are any additional charges that might be bundled with your loan.
The way car loan amortization works is that the amount of your payment that is allocated to each area changes gradually over the course of your loan. At the beginning of your loan repayment, when the principal balance is still high, more of your monthly payment will go toward interest. As the principal balance reduces over time, the amount of your monthly payment allocated to interest goes down and the amount allocated to the principal goes up.
How much of a down payment you pay, your interest rate, and the length of your loan will all affect the amortization schedule.
How to Get the Best Car Loan
Optimize Credit: Before attempting to get an auto loan, make sure you know your credit score, and thoroughly explore your credit report. By fixing erroneous entries on a credit report before applying for an auto loan, you can potentially save thousands of dollars over your repayment term.
Avoid a Monthly Payment Mindset: If you are shopping around online for a suitable loan to buy your car, it's best to think in terms of the total obligation and not just the monthly payment. While a monthly payment may be easier to consider, it does not account for maintenance, insurance, or other financial emergencies. Anyone can "afford" a new sports car in monthly payments, but this is unrealistic because, usually, it's only affordable because the duration of the loan has been lengthened to the maximum time available. This heightens the risk of having an underwater loan near the end of the term, when the remaining amount owed is worth more than the car itself. Not to mention that by this time, the car is older and is likely to need repairs.
Deny the Dealer: Another tip is to use dealership loans as a last resort when making an online purchase. Dealers will grant almost anyone a loan and offer less than reasonable terms. In fact, most of the money that dealerships make from the sale of a car is not from the car itself, but from the financing. For this reason, dealership loan offers should be avoided unless you're comparing it to a stack of other offers.
Finding the Best Lender for Your Loan Needs
When applying for loans from a variety of sources, complete the applications within two weeks of one another. Each application is a credit inquiry, which temporarily lowers your credit score. By grouping applications, they will count as a single inquiry, keeping credit scores healthy.
Before buying a car through an online dealer, make sure to shop around for the best deals and the best loan terms. Lenders might include banks, online lenders, credit unions, peer-to-peer sources, or the dealership itself.
Stir up the competition by getting proof of your pre-approval, which is basically a blank check from a single lender that illustrates how much it is willing to lend and at what terms. Having these pre-approval papers handy when dealing with another lender will force it to match or eclipse the offer, or risk your walking away.
Things to Watch Out For
There are a few things to check for in the loan contract before it is finalized. First is prepayment penalties, which restrict your ability to pay back the loan ahead of schedule. These are fees that lenders charge if you make extra payments to reduce the term of your loan. Make sure you know what to expect before signing any contract.
Another potentially troublesome clause is mandatory binding arbitration, meaning that if you get into a dispute with the lender, it will be settled out of court by an arbitrator. This puts you at a disadvantage.
Variable interest rates might also find their way into an auto loan agreement. These are not all bad but can mean higher interest payments over the life of the loan, depending on how rates evolve over time. Always calculate monthly payments based on the highest rate if this is the case, or risk getting an unaffordable loan.
Last but not least, check that any agreed-upon changes to the contract make it into the final version.
Before making any final decisions, take a moment to review the top auto lenders around. Choose the one that will help you drive away in the car you’ve always wanted with your budget intact.