Car Loans and Financing: Advice for Buyers to Save Money

Car loans and financing play a crucial role in enabling individuals to own their vehicles without making an immediate full payment. As car prices continue to rise, understanding the intricacies of car loans and financing options becomes increasingly important for prospective buyers.

In this blog post, we provide a comprehensive guide to car loans and financing options to empower you to make informed decisions and secure the best possible financing terms for your next vehicle purchase.

Car Loan Basics

1. Loan Structure: A car loan is a type of installment loan where a lender provides some or all of the necessary funds to purchase a vehicle. The borrower (customer) agrees to repay the loan amount, plus interest, over a specified period of time.
2. Loan Term: The loan term refers to the duration within which the borrower must repay the loan. Typical car loan terms range from 36 to 72 months (3-6 years). A “standard” loan term would be 60 months (5 years) and longer terms may be available depending on the type of vehicle, buyer’s creditworthiness, and the lending institution itself.
3. Interest Rates: Interest rates determine the cost of borrowing and are a crucial aspect of car loans. Rates can vary based on factors such as creditworthiness, loan term, and overall market conditions. While dealerships can and do help their customers secure financing, the rates and terms are ultimately set by the lending institutions and not the dealership itself.
4. Loan Amount and Down Payment: The loan amount is the total sum borrowed to purchase the car and the down payment is the initial cash payment made by the borrower. A down payment reduces the loan amount and affects the loan-to-value (LTV) ratio.

Financing Options

1. Dealership Financing: Many car buyers choose dealership financing, where the dealer acts as the intermediary between the buyer and the lender. Dealership financing offers convenience and competitive terms, depending on the effectiveness of the in-house finance team. Reputable dealerships have relationships with multiple lenders, increasing the chances of securing favorable terms since the dealership’s finance department has an opportunity to negotiate on their customers’ behalf.
2. Banks and Credit Unions: Traditional financial institutions such as banks and credit unions also offer car loans. Typically, they provide the most competitive interest rates and terms to those customers who already have an existing relationship with them.
3. Financing Through Manufacturers: Car manufacturers sometimes offer financing options directly to consumers. These programs may include special incentives, low-interest rates, or extended warranty coverage, providing added benefits to buyers.

Pro Tip: Well-established, reputable dealerships will have deep relationships with major national banks and local credit unions, and can typically negotiate better loan terms for their customers than the customers can negotiate on their own, even in the case of preapprovals. Institutions such as Bank of America, Capital One, Chase, PNC, Santander, and many others allow dealerships direct access to key car loan decision-makers.

It always makes sense to call ahead and verify that the dealer works with your bank, because they will be able to mediate the decision before the bank locks you in at a higher rate. Once a pre-approval is complete, there is little to no opportunity for a dealership to call in a favor. Worst case: The dealer obtains the same rate from the customer’s bank that the customer would have gotten on their own, and has simply saved you hours of legwork, transportation, and negotiation.

Factors Affecting Loan Approval

1. Credit Score: Your credit score plays a significant role in determining your loan eligibility and interest rates. A higher credit score generally leads to more favorable loan terms, including lower interest rates and larger loan amounts.

Pro Tip: Automotive lenders will typically look at a specialized FICO score to determine automotive creditworthiness. This score is different from the VantageScore offered by common credit monitoring services, like Credit Karma, and is also different than the common FICO score returned by some consumer banking institutions. In most jurisdictions, dealers are required by law to provide documentation regarding a customer’s credit score after pulling it.

2. Income and Employment: Lenders assess your income and employment stability to determine your ability to repay the loan. A steady income and employment history significantly improve your chances of loan approval.
3. Debt-to-Income Ratio: Lenders also evaluate your debt-to-income ratio, which measures the proportion of your monthly income that goes toward debt payments. A lower debt-to-income ratio demonstrates your ability to manage additional debt and is a crucial factor in getting a car loan approved.
4. Loan-to-Value Ratio (LTV): The LTV ratio represents the loan amount as a percentage of the car’s value. A lower LTV ratio can result in more favorable loan terms, as it reduces the lender’s risk. We review LTV in greater detail in the next Happy Car Deal blog post.

Understanding Loan Documents and Terms

1. APR and Total Cost of the Loan: The annual percentage rate (APR) represents the total cost of the loan, including the interest rate and any applicable fees. This is effectively what the bank is charging you to loan the money. Understanding the APR allows you to compare loan offers accurately.
2. Prepayment Penalties: Some loans may include prepayment penalties if you choose to pay off the loan early. Be sure to review the loan terms and inquire about any potential penalties before signing the agreement.
3. Insurance Requirements: Lenders often require borrowers to maintain comprehensive and collision insurance coverage on the financed vehicle. Understanding the insurance requirements and associated costs is crucial when budgeting for the loan. Not maintaining adequate insurance could be considered a breach of contract and the lender may take out an insurance policy on your behalf to protect their collateral (your vehicle).

Tips for Securing Favorable Financing

1. Check Your Credit Report: Before applying for a car loan, check your credit report and address any errors or issues that may negatively impact your credit score. Improving your credit score can lead to more favorable loan terms. While free services like Credit Karma are not reliable sources for determining automotive credit scores, they do offer an excellent way of monitoring your credit file for activity, history, and general up/down trends.
2. Shop Around: Don’t settle for the first financing offer you receive. Shop around, compare interest rates, loan terms, and fees from multiple lenders to secure the best possible financing terms. Luckily, any reputable local dealership will be able to complete the legwork for you electronically in a highly efficient manner.
3. Read the Fine Print: Carefully review all loan documents and understand the terms and conditions before signing. Pay attention to fees, prepayment penalties, and any other potential costs associated with the loan.

Conclusion

Car loans and financing options provide the means for many individuals to purchase their dream vehicles. By understanding the basics of car loans, exploring different financing options, considering the factors that affect loan approval, and being aware of the loan terms, you can navigate the car financing process more confidently. Remember to conduct thorough research, compare offers, and consider your financial situation and goals when selecting the most suitable financing option. With the right knowledge and approach, you can secure a car loan that aligns with your needs and allows you to enjoy your new vehicle while maintaining financial stability.

Now that we have a basic understanding of down payments and financing options, we’ll dive into LTV a bit deeper in the next post. Click Next to continue.