The world of car loans can be overwhelming, so it’s best to start with the basics. Understanding how a car loan works is the first step in getting a good deal.
What Is a Car Loan?
A car loan is a personal loan that you use to purchase a vehicle. More specifically, a lender loans the borrower (you) the cash it takes to buy a vehicle. In return, you agree to pay back the lender the amount of the loan plus interest, usually in monthly payments, until the amount owed is fully paid off. Many personal loans are unsecured loans. That is, the loan is made based on the borrower’s creditworthiness, and not secured by some form of collateral. Collateral is property or assets that the lender could take back and sell if you don’t repay the loan. Car loans are different in that they are almost always secured loans, and the collateral is the vehicle itself. That means if you fail to make your payments, your vehicle could be repossessed and sold to pay off the loan debt.
The Building Blocks of a Car Loan
A car loan (and most loans in general) consists of four factors you should consider before you sign on the dotted line: loan costs, interest rate, down payment, and terms.
Loan Costs
There are two basic parts to the cost of a car loan: the principal and the interest. The principal is the negotiated cost of the vehicle itself. The interest refers to the costs accrued over the life of the loan based on the principal amount and the stated interest rate. Your loan costs may also include fees. Some of these fees, like taxes and title costs, aren’t negotiable. Some fees, like delivery charges and origination fees, are negotiable.
Interest Rate
An interest rate is a basic rate charged to the borrower for the money loaned. Your car loan may show two rates: your annual percentage rate (APR) and your interest rate. The APR includes fees associated with the loan. When you’re loan shopping, make sure to compare APR to APR and interest rate to interest rate so you’re comparing apples to apples.
Down Payment
The down payment is an upfront payment you make at the time of the purchase of the vehicle. You can also use a trade-in vehicle as a down payment. Your down payment is usually expressed in terms of a percentage of the total price. The larger your down payment is, the less you need to borrow.
Terms and Conditions
These are all of the other items that make up a car loan, including the loan term (normally stated in a number of months or years), insurance and registration requirements, loan payoff and resale terms, maintenance requirements, conditions regarding theft or accidents, and conditions of loan default and repossession. There may be other conditions as well, and it’s important to read them over carefully and have a clear understanding of what they mean before signing on.
The Car Loan Process
Follow these five steps to help your car loan process go smoothly.
Improving Your Chances of Getting Approved for a Car Loan
What if your credit isn’t good enough to get a car loan on your own? Here are a couple of ways to improve your odds.
Get a Cosigner
Is your credit score too low (or nonexistent) to qualify for a decent car loan? A cosigner can change all of that. A cosigner puts their name and credit score on the line for your purchase. If you don’t pay, their credit will be affected just as if the loan were solely in their name. Typically, a cosigner is a very close relative such as a parent. It’s a good way for you to establish credit and build a great credit score.
Peer-to-Peer Auto Loan
Can’t find a cosigner to back you? Peer-to-peer auto loan websites are available to help connect lenders and buyers. With peer-to-peer lending, instead of applying for a loan from a large corporation, you’re seeking a loan from individual investors. After setting up a profile explaining why you need the loan, your credit score will be run, and you will be slated “high risk” if you have a low or nonexistent score. Individuals will review your profile and decide whether or not to fund the loan. If there’s enough interest, your loan will be funded and you can use the proceeds to buy a car. You repay the loan through the peer-to-peer platform and the investors benefit from the interest you pay. The riskier the loan is for investors, the higher the interest rate. It’s another lending source worth considering whether your credit is good or bad.
