All You Need to Know About Auto Loans

woman buying a car

If you’re in the market to buy a car, you’re also likely shopping for an auto loan. Your auto loan will affect your monthly budget for the full term of the loan, so it’s important to do your research and make an informed decision before finalizing it. Here’s all you need to know about auto loans and how to choose the one that’s best for you.

How do auto loans work?

Auto loans make it possible for consumers to purchase a car without having all the cash on hand. With an auto loan from a credit union or bank, you’ll receive the funds you need to purchase the vehicle in one lump sum. You’ll have a set monthly payment that is applied towards the outstanding loan balance, which includes interest and is paid back over the term of the loan. There are various loan terms available which generally last between 5-7 years.

Where do I apply for an auto loan?

There are two primary sources for auto loans.

  • Financial Institutions
    You’ll likely have the opportunity to get pre-approved for an auto loan through a credit union or bank, which can make your car shopping quick and easy.
  • Dealership Financing
    This option enables you to purchase and finance your car in one location. Convenience aside, a dealership loan may be accompanied by a higher interest rate and enticing offers for upcharge add-ons and/or extra protection that may be more expensive than a financial institution.

How high will my monthly payment be?

Your monthly payment amount is determined by several key factors.

  • The loan amount
    The amount you borrow can vary, typically it will be equal to the value of the vehicle you’re purchasing, or slightly higher if you added GAP or warranty. A great minimizer of the overall cost is making a sizable down payment and/or trading in your old vehicle to the dealership. You can calculate your monthly payment with our free auto loan calculator.
  • The annual percentage rate
    Usually referred to as the APR, this is the interest rate you pay on the loan. Your interest rate is determined by your credit score and other general creditworthiness or financial factors. It can also increase based off of the loan term and the loan-to-value of the vehicle. The loan-to-value is determined by dividing the loan amount by the value of the car.
  • The loan term
    The default length of most auto loans is five years, but most lenders offer to extend the term up to seven years or even longer. A longer-term loan means paying less each month, but it also means paying more in interest throughout the life of the loan. A shorter-term loan also means you’ll own the car free and clear sooner.

How can I score the lowest interest rate on my auto loan?

The interest rate on your auto loan will directly affect your monthly payments throughout the loan term, so it’s important to make every effort to score the lowest rate possible. Here’s how.

Shop around for a lender
Do your research. Contact multiple credit unions and banks and ask what the lowest rate is for a 5-year term auto loan with your current estimated credit score. Credit unions are known for having lower interest rates when it comes to auto loans. At a credit union, members are the owners. At a bank, stockholders are the owners. This allows credit unions the opportunity to distribute profits among members in the form of lower loan rates and fewer fees.

Boost your credit score before applying for a loan
In the months before you apply for an auto loan, take steps to boost your credit score, including paying all credit card bills on time, working to pay down outstanding balances, not opening new credit cards and reviewing your credit report for fraud.

Save up for a bigger down payment
If you don’t have a substantial down payment saved up, you may want to delay your auto loan purchase until you can save more, borrow less and qualify for a lower interest payment.

Shopping for a new vehicle is exciting, and you may be itching to get behind the wheel of a newer car. However, since your auto loan directly impacts your monthly budget, it’s important to do your research carefully before finalizing your loan.