Buying a car can be an exciting and stressful time. While choosing the type of car and features you want can be fun, figuring out how you’ll finance this purchase can be confusing. Knowing your financing options can really help smooth the process and save you money along the way.
Car Loans
A car loan is basically a personal loan that is secured by the car you are purchasing. Meaning, if you default on your loan payments the lender has the authority to seize your vehicle as collateral. You can get the funding you need through a bank, an alternative lender, or the dealership itself. Most lenders will allow you to borrow from 80% to 100% of the value of the car.
New Car Loan: How Does It Work?
Repaying a car loan from a bank, alternative lender or dealership involves paying them regular payments plus interest over an agreed-upon period. Payments can usually be made weekly, bi-weekly, monthly, or semi-monthly depending on your lender.
Used Car Loans: How Does It Work?
A used car loan works exactly like a new car loan except it has some limitations. Used car loans typically have limits set against them as lenders and dealerships don’t want to loan an amount that is more than the car’s value. Why? Because from the lender’s perspective, if the vehicle you’ve secured the loan against depreciates in value far below the loan amount, the lender will lose money if you were to default on your payments. As such, the interest rate for used cars can be higher than a loan for a new car.
How Long is a Car Loan Term?
Whether you’re financing a new or used car, loan terms typically vary between two to eight years.
Auto Refinancing
Auto refinancing involves replacing your current car loan with a new loan that has different rates and terms. You can choose to refinance your car loan by renegotiating the terms with your current lender or you can choose to switch lenders completely. Regardless of which way you choose to go, consumers typically refinance car loans for two reasons; to extend their term or to qualify for a lower interest rate.
How Does It Work?
When you decide to refinance your car, you basically take out a new loan to pay off the old car loan. The new car loan will then have to be repaid in installments with interest.
How Long is an Auto Refinancing Term?
Generally, the auto refinancing term can be between 2 and 7 years.
Interested in Refinancing Your Car?
Rent-to-Own
The rent-to-own option is great for people with bad credit who are unable to get approved for a lease through traditional means. There’s no credit check, you just need a personal ID, proof of residence, and an income source. The rent-to-own option involves “leasing” a used car for a period of time. After this, you can choose to return or buy the car.
How Does It Work?
The rent-to-own option works a lot like a car lease where you make periodic installment payments over an agreed-upon time and then at the end of the term you have the option to return the car or buy the car. If you decide to buy, payments that were made for “leasing” can be used to cover a portion of the car. However, if you don’t have sufficient funds to purchase the car, you can opt to return the car instead. Payments are made directly to the dealership or car rental company rather than a bank or third-party lender.
How Long is a Rent-to-Own Term?
Are not as long as leases, typically lasting 1-2 years.
In-House Financing
Dealers typically offer in-house financing for cars that are older and have high mileage. These features make it an optimal option for people with bad credit. Instead of financing your car through a bank or a third-party lender, in-house financing streamlines the process by giving you the option to choose your car and pay for your car from the same place.
How Does It Work?
In-house financing works just like a regular car loan. You simply choose a car you like, the dealer will then finance the car for you after which you will repay them in equal installments with interest over a predetermined period.
How Long is an In-House Financing Term?
Terms usually last up to five years.
Lease Buyout
When you lease a car, typically a new one, you have the option of returning the car or buying the car at the end of the contract term. Buying the car at the end of the lease term is what you would call a lease buyout.
How Does It Work?
When you lease you enter a contract where you make regular payments over the agreed-upon period. At the end of the lease, you can buy the car with a loan from a bank or third-party lender assuming you cannot afford the car in one lump sum payment. Whether you should buy it depends on the residual value of the car and how much you are willing to pay for it.
How Long is a Lease Term?
A leasing term usually lasts between 3-5 years.
Related Links
- Is a lease takeover the right option for you?
- Should you buy an extended warranty for a new or used vehicle?
- The good and bad of 84-month auto loans.
- How an auto loan can help you rebuild credit.
- Auto equity loans explained.
Costs Associated With Auto Financing
- Interest: The interest you pay on your car can vary greatly from lender to lender. Take account of the interest you will pay along with the principal.
- Term: The length of your loan term will significantly affect the cost of your loan. The shorter your term, the higher your monthly payments but the more you’ll save on interest. The longer your term is the more affordable your payments will be, but overall, it is more expensive as you’ll be paying more on interest.
- Fees: Be sure to account for all the fees tacked on to your car loan like administrative fees, origination fees, penalty fees, etc.
Advantages of Auto Financing
- High approval rates. Car loans are secured against the car you purchase, so lenders are more lenient on their lending requirements.
- You own the car. After you’ve paid off your loan, you’ll have complete ownership of the car and no more monthly payments.
- You can build equity in your car. You have equity when your car loan balance is less than the value of your car. You can gain equity in your car by making a big down payment and by having a short-payment term.
Auto Financing 101:
Steps To Apply For A Car Loan
How To Apply For A Car Loan?
Why Was My Car Loan Application Rejected?
There are a number of reasons your application may have been rejected. Here are some of the most common reasons you may not have been approved.
- Your debt-to-income ratio is high. Many lenders will see this as a warning sign that you won’t be able to pay for a car loan with all the debt you currently have.
- Your income is unreliable. If you don’t have a steady source of income, many lenders will be wary of approving you.
- You’ve requested a loan that is too high. If the car loan amount is too high relative to your financial health, lenders will be less inclined to approve you.
- There is a mistake on the application. Any wrong or incomplete information on the form as well as missing documents will put a halt to your approval.
- You have bad credit. Your credit history is one of the most common factors banks, credit unions, and alternative lenders will use to determine your creditworthiness or risk.
Car Loan FAQs
Do I have to provide a down payment to get an auto loan?
How do I get pre-approved for an auto loan?
Can I buy a car online?
Can I get an auto loan with bad credit?
Are 72+ month auto loans bad?
- You spend way more on interest
- Interest rates are higher when you go for loan terms over 60 months
- Less equity. You build equity when your car is worth more than your loan. With stretched out payments, you end up with negative equity.
- You can end up paying more than the actual value of the car
