Buying a car can be a confusing process—especially if it’s your first time. Before you hit the car lots, you’ll want to know what’s available to you in the way of auto loans. That way, you’ll start the process informed and knowledgeable, ready to get the best deal for your new ride.
So, let’s start with the basics!
What Is an Auto Loan?
An auto loan is a type of personal loan that you can take out to cover the purchase of a new or used car.
There are two types of financing options for an auto loan: direct lending and dealership financing. Direct means going to your local bank or other trusted lender. Dealership financing, as the name implies, means going through the dealer, although that dealer is typically handing that loan off to an outside finance partner or an internal financing arm.
How Do Auto Loans Work?
When you take out an auto loan, you receive a lump sum to pay for the vehicle. You are then responsible for paying back the loan plus interest, which depends on the rate outlined in your loan. You’ll need to make regular payments according to the time frame established in the loan.
Your loan interest rate will depend on a few things. Lenders take a variety of factors into account when determining what loan terms to offer you. Those factors can include:
- Credit score
- Income and debts
- Loan term
- Down payment
- Type of vehicle
Obviously, the better your credit score, the better your interest is likely to be. If your credit isn’t so great, it might be a good idea to spend some time building your credit score. Try these 6 tips for raising your credit score.
Where Can I Get an Auto Loan?
For example, a dealer typically works with an outside lender which means less flexibility. They may be able to offer lower rates or special rebates in certain situations, but you risk working with an unknown lender that could lead to mediocre service down the road. A bank, by contrast, can make loans unique to each buyer and offer more flexibility because they’re familiar with their customers.
Regardless of which avenue you ultimately choose, most experts advise that you shop around for car loans. Don’t simply rely on the dealer for financing. Before going to look at cars, it’s a good idea to go to your local bank to see what interest rates you’re approved for on an auto loan. That way, you’ll have that number to compare with the dealer’s offer.
You’ll also have a better idea of what car you can afford. Based on the loan terms your bank approves you for, you’ll be able to look at your budget and see what price range will fit into your budget.
Related: Car-Buying: New or Used?
How Much Should I Borrow for a Car?
Don’t have a clearly defined budget? The Consumer Financial Protection Bureau offers some great advice for determining how much you can afford to borrow for an auto loan:
- Determine how much you pay monthly for fixed expenses. This would include things such as rent/mortgage, phone bill, utilities, insurance and student loans.
- Determine how much you spend on average for additional expenses such as food, gas and entertainment. Don’t forget to take into account your emergency fund—are you putting some money aside each month in case of an emergency?
- Keep in mind, you’ll need to pay for insurance, maintenance and registration for this new vehicle. Make sure those amounts are factored into your calculations. You can get an idea of insurance amounts by shopping around a bit online.
- Are you trading in a vehicle? If you owe more on it than the trade-in value or private sale amount, you’ll need to factor that amount in, as well.
- Once you’ve determined those amounts, add them all up and subtract them from your take-home pay and any other monthly income sources. Your auto loan payment should be less than that amount.
Taking Out an Auto Loan: Where to Get Started
As mentioned above, it’s usually a good idea to do some auto loan shopping before you start looking for cars. That way, you’ll have a good idea of what you can afford.
If you’d like to learn more about your loan options, talk to your local bank representative. They’ll be able to help you get the process started and provide you with personalized loan options.