Guide To Auto Loan Financing [Everything You Need To Know]
Auto loan financing is the process of borrowing money to cover the cost of the vehicle, warranty, insurance, fees, taxes, and other associated costs.
Your goal is to reduce the expenses associated with the purchase. This is mainly done by lowering your interest rate and negotiating with the dealership.
Auto Loan Financing Tools
Here are some resources and tools to help you prepare for securing an auto loan.
An auto loan calculator helps you quantify how much you might pay for an auto loan. All you have to do is input the cost of the vehicle, the interest rate you expect to get, and the term you want to borrow the money over. It will calculate monthly payment, interest charges, and the total amount you'll pay over the length of your loan.
When calculating the cost of the car don’t forget about other costs of ownership such as insurance and regular maintenance like oil changes, tires, brakes, etc.
Before you start applying for an auto loan, check your credit report and credit score.
Your credit score will help determine whether you qualify for a loan, if you need a cosigner to qualify and your interest rate.
By taking the time to review your credit score and putting in the effort to improve it, like fixing inaccuracies and eliminating debt, you can increase your score and reduce your interest rate. This extra step can save you thousands of dollars over the term of your loan.
Federal law allows you to get one free copy of your credit report from the three credit bureaus every year, so take advantage of this by doing a credit review before seeking pre-approval.
Auto Loan Financing Products
There's more to auto loan financing than just paying for your vehicle. You will be responsible for paying required dealer fees and taxes as well. You'll also have the option to purchase additional warranties and insurance to cover the vehicle.
It’s always wise to check auto insurance rate increases when you are considering a higher value vehicle. Rates are largely influenced by the type of vehicle, age, and condition, so you’ll see some fluctuation if you’re looking at a brand new high-value car versus a basic model that is only a year or so old.
Here are some of the most popular alternatives to think about when completing the financing process.
Also known as GAP insurance or GAP coverage, this additional layer of financial protection covers you if the vehicle is deemed a total loss. It will cover the gap between what your auto insurance will pay and the balance remaining on your loan.
For example, let's say you're in an accident and your vehicle is a total loss. If the balance on your loan is $10,000, yet your insurance company will only pay $8,000, your GAP insurance will kick in to cover the $2,000 difference.
Pay attention to the costs associated with GAP insurance. A credit union or bank will usually offer this coverage for much less than the dealership
Depending on the age and mileage on your vehicle, it might come with a warranty from the auto manufacturer. Many dealerships will also include a warranty. However, some are sold as-is due to their mileage or age. You can purchase an additional warranty that extends beyond the original manufacturer warranty. Often this amount can be included in your loan amount. Shop around since the warranties offered by the dealership are often much more expensive than those offered by a credit union or bank.
Auto Loan Financing Terminology
Throughout the process of getting auto loan financing, you will hear many terms that are important to understand.
Here are some of the most popular terms to need to know.
Annual Percentage Rate (APR)
The APR is the annual interest rate, including fees, you pay for your vehicle loan.
When comparing rates, be sure not to compare APR and interest rate because that's like comparing apples and oranges. You want to compare APR to APR, not interest rates.
Credit score allows lenders to gauge your creditworthiness. They look at your credit score to decide whether or not you should be approved and the interest rate you can receive.
The five factors that go into your credit score include:
Payment history - Do you pay your bills on time?
Credit utilization - How much of your available credit limits have you used? Less is better.
Length of credit history - how old is your oldest account? Always keep your oldest account open, even if you don’t use it.
New credit -Have you applied for a lot of credit recently? Again, less is better.
Mix of various credit types like auto loans, mortgages and credit cards.
Debt-to-income ratio, also known as DTI, is calculated by looking at your monthly debt payments (including your rent or mortgage) compared to your monthly income. Lenders use this number to determine how much you can afford to pay each month for a vehicle loan.
If your DTI is too high, it can be more challenging to qualify for an auto loan.
The down payment is how much you pay upfront for the vehicle. It reduces the amount you have to borrow, which lowers the monthly payment.
It’s possible to qualify for a lower interest rate if you make a larger down payment. Making a substantial down payment also reduces the likelihood that you'll wind up owing more than the vehicle is worth, which is referred to as being upside down on your loan.
The term is how long you choose to pay back the auto loan. It can go up to 8 years, or 96 months, depending on the age of your vehicle and where you obtain financing.
A longer term loan will have lower monthly payments, but you will pay more for the car. You may also end up owing more than the car is worth with a longer term, so it can be hard to get out of your loan. This is what’s referred to as being upside down on your car loan.
This is where GAP insurance comes in handy as it is designed to bridge the gap between what your auto insurance company will cover and your loan balance, if the vehicle is totaled in an accident.
One thing to keep in mind is that the longer the term, the less you'll pay each month for the loan, but the more you'll pay in interest. The opposite is true for a shorter loan. Be sure to consider this when establishing a loan term.
Understanding Auto Loan Financing
There's a lot that goes into auto loan financing, but as long as you're knowledgeable about the options and make a sound choice, you can get the funding that works best for your financial needs and lifestyle.