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Financing a car with a loan

“It’s extremely common for individuals to be heavily addicted to purchasing a brand new car. This is why they often end up being some of the last things that many car consumers fear, when they should actually be a top priority. Acquiring the dream vehicle that fits your needs and budget is a significant achievement. However, understanding how to pay for it and secure a car loan should be addressed early in your car purchasing journey.

A minority of buyers can afford to pay for a new or used car upfront. More commonly, consumers opt for a loan to cover most or all of the costs of their vehicle. Like many aspects of the car buying process, the COVID-19 pandemic has accelerated the uptake of hassle-free online car loan tools. Comparing lenders and applying for a loan while lounging on your sofa and enjoying your favorite movie has never been easier.

Understanding how much you need to borrow, the applicable interest rates, and the loan term your lender offers is crucial. It gives you a better grasp of how many cars you can afford. Securing the right loan with the best rates can save you money. Conversely, choosing the wrong loan can be costly in various ways, potentially harming your credit score.

The monthly payments cover the financing of the car, which is only a part of the total cost of owning a new or used car. Additionally, consumers have to budget for fuel, maintenance, insurance, parking, and unforeseen accidents.

“When you venture out, make sure your aim isn’t just to say ‘I want to pay $300 a month,'” emphasizes Erin Crepaski, Executive Director of Strategic Alliances at Ally Financial. When it aligns with your mileage needs and desired features, we have the resources and offerings that suit you. We present a comprehensive ownership experience instead of merely purchasing a vehicle outright.”

Our comprehensive reviews of new and used cars will guide you in finding the ideal vehicle. Moreover, the steps outlined below will aid you in securing an advantageous deal on your car loan.

Many car buyers consider financing options offered by the dealership’s financing company. Unfortunately, this can lead to overcommitment, potentially putting your car loan and financial stability at risk. Savvy buyers precisely determine the vehicles they can afford and plan to finance their new vehicles before even contemplating a dealership visit. While you can arrange financing through a dealer, if they don’t have an unbeatable offer, you lack the incentive to negotiate a favorable deal.

Familiarize yourself with financing terminology before embarking on your auto financing journey. Here are the two most crucial terms:

Car Loan (also known as auto loan or car financing): A car loan is an agreement between a lender who agrees to finance the purchase of a new or used car and the borrower who commits to paying it back over a specified period. Unless you secure a 0% loan, you’ll have monthly payments on the loan balance. Some lenders also impose an interest rate.

Interest Rate (also finance charge): The interest rate represents the cost of borrowing money from a lender. It’s expressed as a percentage (often termed as an annual percentage rate or APR). Interest rates cover the costs and risks for the lender and provide a profit margin. The interest rate on the loan is stipulated in the loan documents.

Interest rates fluctuate over time. Auto financing rates have hovered near historically low levels in recent years, slowly inching towards a more historically typical range. The APR you pay is influenced by several factors, some of which you can control and others you cannot. Your personal credit history, desired loan term, and the type of vehicle you purchase can significantly impact the interest rate you can expect. Different dealers may offer vastly different interest rates for purchasing the same vehicle. Loan Term for Automobiles: The loan term is the duration of the automobile loan, usually expressed in months. A loan term of 36 to 48 months used to be the most common requirement. However, with rising car prices, loans of 60 to 72 months or more are becoming more prevalent. We recommend dividing the loan term by 12 to determine how many years it will take to pay off the vehicle.

The longer the loan term, the higher the risk for the lender, resulting in a generally higher interest rate. In general, you want your loan to be as short as possible. A shorter loan avoids the dilemma of paying for repairs as they become more expensive with the aging of the vehicle. You don’t want to be faced with the choice between covering repairs or diverting funds to monthly car payments.

Principal Amount: The loan amount and the remaining loan balance. When you take out a loan for the first time, it constitutes the total value of the loan. As you make monthly payments, the principal amount reduces. With each payment, a portion goes towards interest, and the remainder goes towards reducing the principal.

Down Payment: The down payment is the amount you pay when you purchase your first car. It can be in the form of cash payment, trade-in, or a combination of both. The loan amount needed is the difference between the car price and the down payment. For instance, if you want to purchase a $40,000 minivan with a $10,000 down payment, you’ll need to secure a $30,000 loan.

Monthly Payments (or Monthly Installments): You need to make monthly payments to cover the principal and interest on the loan. The monthly payments are consistent and have a specific due date.

Calculating the monthly payment for a given loan involves a fairly complex calculation. This is because each month, you pay slightly less towards the principal as the loan balance decreases. Fortunately, you can quickly find the answer by inputting some numbers into our car payment calculator. When comparing car loans, it’s crucial to consider the car price and the total amount owed. Simply focusing on monthly payments, interest rates, or finance charges doesn’t provide the complete picture of the total cost of a vehicle.

Credit Score: A credit score is a three-digit number that represents an evaluation of your credit history by a credit bureau. The higher the score, the better. It’s based on various factors, including on-time payment history, types and amounts of credit you have, and how much of that credit you’re utilizing.

Vehicle Title: A document issued by the government confirming ownership of the vehicle. Initially, you visit a company that provides car loans. The lender retains ownership of the vehicle until the loan is fully paid off.

Loan-to-Value Ratio: The relationship between the loan balance and the current value of the car. This number should be less than 100%. Anything above 100% is considered negative equity on your car loan.

Knowing your credit score and understanding why it’s important A credit score is a snapshot of your creditworthiness and ability to repay your car loan (or any other type of loan or credit). Essentially, it’s information from your credit report distilled into a three-digit number. A higher number indicates that the borrower is more likely to repay the loan. Conversely, a lower number implies a greater likelihood of defaulting on the loan.

In reality, there are multiple credit scores because different credit bureaus calculate scores differently. The three main credit bureaus are Experian, TransUnion, and Equifax. Credit scores are sometimes referred to as FICO scores, but FICO scores are just one type of credit score available to lenders. Most credit score models range from 300 to 850 points, but some use different scales. The scores from one scoring model cannot be directly compared to scores from other models.

If you have good credit, you’re more likely to obtain a car loan at a lower interest rate compared to someone with poor credit. Consumers with low scores often struggle to secure credit and face higher interest rates. If you have a stable job and score above 720 on most scales, you shouldn’t encounter difficulties in obtaining financing.

What does your credit report reveal?

The two most critical factors are your payment history — whether you make your payments on time or are frequently late or delinquent. The more times you fall behind, the more points will be deducted from your score. If a creditor has to charge off a balance that you haven’t paid, it will negatively impact your credit for several years.

Next is the amount owed in relation to the available credit. For instance, using 90% of your available credit will result in a lower credit score than utilizing just 30% of your available credit. If you’re contemplating canceling your credit cards, wait until after you secure a car loan. Canceling cards reduces available credit, increases your credit utilization ratio, and decreases your score.

Less important, yet still relevant, is the date the account was opened and the most recent activity on the account. Creditors seek stability, and having numerous recent account openings can significantly lower your credit score. The report also reflects a mix of types of loans, with revolving accounts like credit cards weighted differently in their scores compared to installment accounts like car payments.

Lastly, the score reflects recent attempts to obtain credit. Each time a potential creditor requests a credit check for your application, your score will slightly drop. Avoid making multiple requests for the same type of activity. For example, multiple applications for new car loans are treated as one inquiry and don’t significantly impact your score.

In most cases, payment histories with merchants or utility providers aren’t included in the credit history. Credit agency Experian recently launched a service that incorporates payment history from these types of accounts into your credit score. According to the company, participation in the program resulted in an average increase of 10 points or more in credit quality for participants.

How to access and correct your credit report The worst time to discover you have bad credit or other credit issues is when you’re in the process of buying a car and trying to finance it. Many buyers don’t realize that their credit will be checked in the finance department of a dealership, or that it can affect their eligibility for favorable financing deals if they want (or need) to buy a car.

US consumers have a legal entitlement to a free credit report from Experian, TransUnion, and Equifax each year. Although you’re not legally obligated to provide your credit score, it’s readily available on numerous credit card issuer and lender websites.

Obtain a copy of your credit report and thoroughly review it for errors or negative information well before you start shopping for a car. Obtaining your own copy of the report each year won’t impact your score based on creditor inquiries.

Correcting errors can take time, and it may take months of timely payments to significantly improve your score. If you plan to make several major purchases that necessitate a substantial amount of credit, such as a car or a house, stagger your purchases to avoid negatively impacting your credit all at once. It may seem tempting, but refrain from opening new credit cards to improve your credit score. This can lead to increased credit utilization and a lower score instead of a higher one.

If you need to refinance a car loan for better terms, you generally know that you can refinance your car loan at any time during the term. Be mindful of prepayment penalties, but if your credit score improves before refinancing, you can potentially save a significant amount of money.

What else do lenders evaluate? There are aspects of your credit report that aren’t reflected in your credit score. Factors like your age, income, marital status, rights, or occupation don’t show up in your score. However, creditors may request this information in your loan application and use it within the bounds of the law.

“They assess the whole customer,” states Klepaski.

Beyond the information in your credit report, lenders evaluate your ability to repay the loan. Do you have the means to make monthly payments? What’s your monthly rent amount? They’re interested in your income, sources of income, and stability in your job or profession.

“If you’ve been in the same profession for 10 years and recently started another, it’s likely going well,” adds Klepaski. “If you’ve had 14 jobs this year, that could be a red flag.”

Lenders utilize information from your credit report and auto loan application to calculate your debt-to-income ratio. If you owe a significant amount relative to your income, you might face a higher interest rate, need to reduce your loan amount, make a larger down payment, or secure a smaller loan. If the numbers don’t add up, the lender may reject your application outright.

Lenders also consider the quality of the collateral. In a car loan, the collateral is the car you’re seeking a loan to purchase. You maintain ownership of the collateral until the loan is fully paid off.

Buyers who seek a loan greater than the cash value of the vehicle they’re buying might face a higher interest rate or be required to agree to a shorter loan term compared to those who provide a larger down payment. Why would you want the loan amount to exceed the purchase price at the start of the loan term? Creating a loan-to-value ratio (LTV) greater than 100% involves rolling over the balance of an old loan into the new loan. It’s always an unwise move, yet some people do it. We recommend waiting until the current car loan balance is paid off before starting to look for a new vehicle. If having the latest car, whether new or used, is important to you, consider leasing to access the latest technology and upgrade your vehicle every few years.

Finding the Right Loan Agreement Various lenders establish interest rates for auto loans based on market demand, your credit history, and the amount borrowed in relation to your car’s value (loan-to-value ratio). Market appetites for risk can cause interest rates to vary widely between lenders. With a bit of research, you can easily find promotional offers with competitive rates and favorable terms.

Where can you secure a car loan?

Just as you need to shop around at various dealerships to purchase a car, you should explore loan options with multiple financial institutions to find the best car loan deal. Car buyers now have an abundance of loan options and easily accessible interest rate information. Auto financing is available through major national banks, small community banks, credit unions, finance companies, and online-only banks, as well as loans from the financial arms of many automakers.

Most car dealerships typically don’t provide the financing themselves. Instead, they act as intermediaries for third-party lenders like banks, credit unions, and finance companies. They receive compensation from the lender for arranging the loan. The financing suggested by the dealer may not offer the best deal, but it provides the dealer with the best return.

Major national banks are well-known financial institutions. Examples include Bank of America, Wells Fargo, Capital One, and Chase. They have numerous branches, smartphone applications, and online portals across the country. Community banks typically have one to a few dozen branches in a smaller geographical area. They offer all the services of a national bank, but if you need assistance with loans, it may be easier to consult with your local representative.

Online-only banks don’t have physical branches, but many offer all the services of major national banks. Ally Bank is an example of an online bank that collaborates closely with car dealerships to create a seamless buying and financing experience.

Most automakers have a financing division known as a captive finance company. In addition to financing regular vehicles, they’re responsible for financing special loans for automakers. Typically, you won’t find other lenders offering 0% interest rates or anything significantly below the market average.

When a car isn’t selling as quickly as the automaker desires, they offer incentives to boost sales. The most common incentives include low-interest loans or interest-free loans, which banks and other lenders often can’t match. A 0% auto loan means you won’t pay a single cent in interest throughout the life of the loan. Great car loan deals can be found on our pages for new car deals and used car deals.

Credit Unions Credit unions differ from other lenders. They’re member-owned cooperatives, returning excess earnings to members in the form of lower interest rates on loans and higher interest rates on deposit accounts, instead of distributing profits to shareholders. Credit unions range in size from small, private organizations to large institutions rivaling some national banks. The largest credit unions in the country include Navy Federal Credit Union, State Employees Credit Union, BECU (formerly Boeing Employees Credit Union), and PenFed Credit Union.

Not all credit unions are open to all consumers. For instance, only individuals with specific occupations can join Navy Federal Credit Union. Most people can join other organizations like BECU and PenFed. To find eligible credit unions, visit MyCreditUnion.gov. To secure a car loan from a credit union, you’ll need to deposit a nominal amount to become a member. Non-members aren’t eligible to receive loans from the credit union.

Finance Companies Finance companies offer financing for various consumer purchases, including automobiles. They lend money like any other financial institution, but most of them don’t accept deposits. Lenders typically offer specialized services for specific types of clients, such as those with subprime credit or those buying a car from a franchised dealership.

Dealers Buy Here, Pay Here Some dealerships directly provide loans to buyers. These are known as “Buy Here, Pay Here” dealerships. Often a last resort for desperate car buyers with poor credit, Buy Here, Pay Here dealerships should be avoided due to their often exorbitant interest rates and aggressive repossession tactics.

Now that you have all this crucial information, it’s the perfect time to compare and choose the right option!”