Car buying can be a fun but scary process if you don’t know what you’re doing. In a perfect world we’d all be able to save up enough money to purchase our vehicles outright. But sometimes, for a variety of reasons, that’s not feasible, and some people therefore decide to take out a car loan. But how do car loans work and how do you know if you should get one? To get you started, here are…
The basics of getting a car loan
Most people take out auto loans from a bank or from the dealership where they purchase the vehicle. Auto loans are considered “secured” loans since they are guaranteed by property (in this case the vehicle itself) which may be taken by the lender if the borrower fails to pay back the loan.
There are numerous ways to obtain a car loan for a new or used vehicle, including:
- Car companies
- Independent lenders
- Local banks and credit unions
- Subprime lenders
You have to be careful with which you choose, since not all lenders are created equal. In most cases, a bank or credit union will give you a better deal than the dealership – because the dealership needs to tack on a commission to the fee. If you don’t do your homework, you could find yourself the victim of hidden fees, extra charges and exorbitant or fluctuating interest rates. That’s why you need to understand…
How to find the best deal on a car loan
Before purchasing a new or used vehicle and taking out a car loan, it’s a good idea to check KBB.com to verifiy the blue book value. This will ensure you don’t overpay for the car and could even be used as a bargaining chip to get a discount.
Next, you’ll want to research the loan details. Find out the exact amount you’re paying for the car, including sales tax, registration and title fees. Then look at interest rate and payoff terms.
Most vehicles are financed for 48 months but some loan companies offer the option to pay off the balance over 60 – 72 months. But remember, the longer the payment terms the more interest you’ll be paying to the lender. Which brings us to our next point…
How to find the best interest rate on a car loan
When you take out an auto loan, it generally comes with an interest rate – a certain percentage of a loan that you must pay back in addition to the original loan amount. So, if you borrow a principle amount of $10,000 at 5 percent interest, you’re going to end up paying $10,500 over the life of the loan. The lower the interest rate you can get, the less you’ll end up paying to the bank and the sooner you can pay off your loan. If you have perfect credit, you can sometimes qualify for a 0% interest rate loan.
However, interest rates on car loans fluctuate depending on your credit score and payment history. They also vary depending on how quickly you’ll pay back the loan. The shorter the term of your car loan, the lower your interest rate will be since your quick repayment time is a sign that you’re not a risky borrower. Defaulting on a car loan, by the way, is the quickest way (besides not paying your mortgage) to ruin your credit rating. When considering how to get a car loan, you should always…
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Consider your credit history
If you don’t have nearly perfect credit, consider checking with a local community bank or credit union to see if you can get a decent interest through them. They offer lower interest rates since they don’t have the big overhead costs or stockholders to pay like bigger banks do. The customer service is better and they tend to be more willing to work with you.
In the event you can’t get approved for a car loan through a bank or local credit union, try a subprime lender. They will lend to people who don’t qualify for standard loans, but unfortunately they tend to have much higher interest rates and have fewer options than normal lenders.
Getting a loan from the dealership or auto company won’t leave you with many negotiating options. Financing car loans, is one of the biggest ways dealerships make their money, so they don’t normally offer a low interest rate.
When I bought my new car two years ago, I financed it through the dealership at 5.75% which was the standard rate. Even though I have really good credit, that’s the only rate they offered. If I had gone through a local bank, I could have saved over two and a half percent on interest payments and cut my loan repayment time in half. Before even getting a loan, I’d recommend that you…
Determine how much car loan you can afford
The first step in deciding how much car loan you can really afford, is to figure out your monthly take home income (after taxes). Conventional wisdom says you should calculate approximately 20% of that amount to put towards paying back your loan. For instance: If you bring home $2,000 you don’t want a payment that’s more than $400 a month.
But while this 20% estimate is a good guideline as far as a maximum car loan payment, you shouldn’t necessarily go that high. Instead, it’s smart to look at your entire budget, with income and expenses, and take those into consideration. You should also include the cost of vehicle maintenance and insurance in your estimates. With that said, the real question is…
Do you really need a car loan?
Anytime you borrow money it’s a risk. You run the risk of not being able to pay it back due to a financial setback or other emergency. The best scenario is to save up cash to pay for a new car outright. But if that’s just not possible, consider saving at least 50% of the loan as a large down payment. That’s what I’ve done with all my car purchases and I’ve saved a lot of money in additional interest payments.
The best thing to remember before deciding whether or not to take out an auto loan is that your car is a depreciating asset. Which means, from the moment you drive it off the lot, it will continue to go down in value. You never want to overextend yourself financially, especially on an asset that doesn’t go up in value.
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