What are the ins and outs of car loans?



There are plenty of decent used cars on the market in the $5,000-$8,000 price range, which you may be able to pay for up front.  But if you don’t have access to that kind of cash or want something more expensive, you may need to obtain a car loan.  You can get these loans from car dealers, banks, and credit unions.

This section outlines the considerations you should be aware of when you’re thinking about taking out a car loan.

1. Calculating the monthly payment you can afford
Car loans are generally paid off in monthly installments. With your budget and finances in order, you’ll be able to calculate how much you can afford to put towards a car payment.  But don’t forget that loan payments are not the only cost of owning a car. 

Use a tool such as Edmunds True Cost to Own Calculator to estimate other costs, including annual taxes and fees, fuel, insurance, maintenance, and repairs.  Plug in the year, the make and model, and your ZIP code to find the true cost of owning many popular car models.  This “true cost” estimate includes depreciation, which is a loss you should be aware of, but not an outlay that you need to include in your budget.  Additionally, the “true cost” estimate includes financing charges, but not principal loan payments, which do need to be included in your budget.

2. Comparing car loans
APR: This is the “annual percentage rate” of interest you’ll pay on the money you borrow.  It is the most important factor in comparing loan terms.
Compare APR options to find the lowest: Low Interest Auto Financing Calculator
Sometimes zero-interest isn’t the best deal. Paying interest with a rebate might be better. Do the math instead of taking the offer that looks best at a glance.

Down Payment: The more you put down toward a car’s total purchase price, the less you need to borrow. If you have tarnished credit, a larger down payment may earn you a lower APR due to the decreased risk for the lender.

Additional Finance Charges: Lenders may charge additional fees for originating a loan.  Be clear on whether these are rolled into the APR or need to be considered separately.

Loan Term: The length, or “term,” of a car loan can stretch to 72 or 84 months.
Six- and seven-year car loans are not recommended.  Interest rates will be higher.  Plus, such extended loans with lower monthly payments may cause you to purchase a car that you can’t really afford; what if your car loses all value and needs replacement with two years left on the loan?
36- to 60-month loans are recommended.

Prepayment Penalty: Lenders may charge a fee for paying off your loan early. This compensates the lender for their administrative costs in the event they don’t earn all the interest they anticipated.  Many lenders, however, do not penalize early payment, so do your research.

Miscellaneous Fees: Avoid offers that charge you a ton of random fees. You can find offers without these fees. 

3. Credit scores and loans
Your Credit score will determine what interest rate you qualify for:

700+Most favorable APRs (as low as 0-1% from dealers, as of 2012)
600-700Reasonable APRs (a few percentage points)
Less than 600You are a credit risk; expect a high APR (8%+)

In addition to a credit score, a credit application asks for:

  • Present and past addresses, to establish how long you've been in an area
  • Occupation and employment history, for the same reason they require your addresses, plus to estimate your annual income
  • Additional sources of income
  • All loans and credit cards you have

Got Bad Credit? Your lender may put less weight to your credit score and more on current salary and recent history (90-120 days) of credit card payments.  Make timely payments and take care of your credit!

4. Obtaining a loan from a bank or credit union:

  • Investigate what loans your bank or credit union offers.
  • Check APRs on the loans they’re offering.  You may qualify for a discounted rate if you use the same financial institution for your checking account, etc.
  • Compare your institution’s rates with:
        - Other banks and lenders: Bankrate.com compares auto loans from multiple lenders. You can compare a lender’s APRs with prevailing rates.
        - Your car dealer: Getting financing through the dealer is relatively quick and easy, but it’s not always the most affordable route
  • Once you have been approved for a loan, you can provide the dealer with required documents that prove you are pre-qualified for a loan.

5. Dealer's terms
Beware of special offers and extras in the terms and financing options. For example:

  • Credit Insurance – This insurance helps pay off your loan should you die or become disabled. That should be the dealer’s concern. You should avoid paying for it.
  • Guaranteed Auto Protection – Pays the difference between your car’s value and what you still owe on the loan should the vehicle be stolen or totaled. This is not something most people need, and at any rate, it can be cheaper through banks and credit unions.

6. Sealing the deal
Once you have negotiated a price, thoroughly compared loan options, and gotten approved by a bank, credit union, or dealer, you can drive home in your new automobile. The lender will hold onto the car’s physical title until you pay off the loan.

7. Make payments on time
Don’t miss payments!  It will hurt your credit and can lead to repossession of your vehicle.
Make it automatic: If you have your checking account and car loan at the same bank or credit union, you can set up automatic transfers to make monthly payments. Otherwise, you can have the lender debit your checking account every month.

If you have a setback, contact your lender right away and try to work out a revised payment plan that works for everyone.