How do auto loans work?
Auto loans make it possible for consumers to purchase a car without requiring all the cash on hand when buying. With a car loan from a financial institution or private lender, you’ll receive the funds you need to purchase the vehicle in one lump sum. Each month, you’ll pay a portion of the loan back, with interest, for the term of the loan.
Where do I apply for an auto loan?
There are two primary sources for auto loans:
- Direct lenders. This includes financial institutions like banks, credit unions or online lenders. You’ll likely have the opportunity to get pre-approved for a vehicle loan through these lenders, which can make your car shopping quick and easy.
- Dealership financing. This option enables you to purchase and finance your car in one location.
How high will my monthly payment be?
Your monthly payment amount will be determined by several key factors:
- The loan amount. The amount you borrow will be equal to the value of the car you’re purchasing. A great way to minimize the overall loan is to make a sizable down payment and/or trade in your old vehicle when buying a new one.
- The annual percentage rate. Usually referred to as the APR, this is the effective interest rate you pay on your loan. Your interest rate is determined by your credit score and other general creditworthiness or financial wellness factors.
- The loan term. The default length of most auto loans is five years, but some lenders offer to stretch the term to seven years or even longer. A longer-term loan means paying less each month, but it also means paying more in overall interest throughout the life of the loan. A shorter-term loan also means you’ll own the car sooner.
How can I score the lowest interest rate on my auto loan?
The interest rate on your auto loan will directly affect your monthly payments throughout the loan term, so it’s important to make every effort to score the lowest rate possible. Here’s how:
- Shop around for a lender. Don’t accept the first offer you receive for an auto loan. Get quotes from several lenders to find the one that offers the lowest interest rate.
- Boost your credit score before applying for a loan. In the months before you apply for an auto loan, take steps to boost your credit score, including paying all credit card bills on time, working to pay down outstanding balances, not opening new cards, and reviewing your credit report for fraud. Learn more about how you can increase your credit score in our article, How to stay on top of your credit.
- Borrow less than you qualify for. While it’s tempting to max out your eligibility, consider borrowing less than you qualify for when taking out an auto loan. A smaller loan amount generally means a lower interest rate as well.
- Save up for a bigger down payment. If you don’t have a substantial down payment saved up, you may want to delay your auto loan application until you can save more, borrow less, and qualify for a lower interest payment.
Are auto loans secured or unsecured?
A traditional auto loan is considered a secured loan. This means the lender, like a bank or credit union, puts a lien on the vehicle that is being purchased or other collateral owned by the borrower. With a secured auto loan, a borrower is typically offered a better APR rate and terms. An unsecured loan refers to loans such as personal, credit and debit, or personal lines of credit. Since they are unsecured, they do not have any assets linked to them and may come with a higher finance charge.
It’s important to remember that your auto loan will directly impact your monthly budget; do your research carefully before finalizing your loan.
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