Understand How Auto Loans Work and Get the Best Deals

auto-loanUnless you are paying hard cash for your new or used car, your auto loan financing can make the difference between a great deal and a bad deal.

An inexperienced car buyer might assume that an auto loan is nothing more than working out an affordable monthly payment amount with his dealer.

However, an affordable payment doesn’t make it a good deal. In fact, it can be a terrible deal. With more knowledge about how car loans work, the buyer can almost certainly get either a much lower payment or buy more car for the same payment.

Auto loans are based on a number of important factors, all of which affect the monthly payment amount. Let’s take a quick look at those factors now:

Loan amount – the amount you borrow, including negotiated car price, taxes, and any extras

Down payment – cash that you pay up front to reduce the amount of your loan, and reduce payment amount

Loan term – the length of your loan, in months

Interest rate – determines the amount of finance charges added to the cost of your car loan

With these four factors, it’s easy to calculate your monthly loan payment with an online auto loan calculator.

However, you are almost never in control of all these factors. And one factor can relate to another in ways that might not be obvious.

For example, the MSRP (sticker price) of a new car — or NADA (“blue book”) value of a used car — can determine the maximum loan term. Generally, the higher the price of the car and the more recent the model year, the longer the loan that will be allowed. New cars may be approved for as much as 84 months, whereas used cars that are 5-6 years old may only be approved for 36 months. This means you could actually have lower payments on a brand new car than on an older car in the same price range. However, the longer your loan, the more you pay in finance charges.

Your credit score greatly affects the interest rate you pay on your loan. A high score gets you a low interest rate, and low payments. For example, if your score is 700+ you might pay 5.00% APR or lower, or even qualify for a special 0% APR promotional rate.

However, if your score is, say, 675-699, you might expect to pay about 7.99% or more, depending on the loan company or bank you use.

If your credit score is 575-675, you are considered sub-prime and might expect to pay 12.74% or higher, if you can find a loan company to approve you. If your score is even lower, say, 525-574, you are sub-sub-prime and should expect to pay at least 20% interest rate, if you can find a lender.

Buyers with poor credit may be limited as to the amount borrowed, which means a hefty down payment may be required to reduce the loan amount to get approved by a dealer’s finance company or a bank.

Recent bankruptcies, car repossessions, payment delinquentcies, job history, home ownership, and late child support payments are also considered when seeking auto loan approvals.

If you don’t know your most recent credit score, you should. What’s your FICO score? Find out now when you check your credit report for $1 at Experian.com!

Other factors will also affect your auto loan interest rate and approval prospects.

Your income must be sufficient to make your new car payment and pay other monthly bills you may have. This is often called your debt/income ratio. Auto loan companies typically don’t like to see more than 45% of your income going to pay your debts, including a new car payment.

Buyers with no credit or poor credit can usually be approved by getting a co-signer. A co-signer is someone who is willing to agree to take over responsibility for making loan payments if the primary borrower defaults, or is unable to pay. If the co-signer’s credit score is good and he/she has a good income, the loan approval will be based on that person’s credit and the income/debts of both the primary and co-signer. The co-signer should understand that his credit score is affected by the additional debt, as is the primary borrower’s.

In summary, different banks, credit unions, and loan companies have different loan rates, rules, and approval procedures. Therefore, you should always shop around, particularly if you have poor credit. You don’t have to finance your car at the dealer from which you buy your car. His rates and terms are not always the best.

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