An auto loan helps you buy a car that costs more than you can afford with cash. Unless you have a substantial amount of savings to pay for a car all at once, you’ll probably need to borrow money and pay off your vehicle by making monthly payments. If you borrow wisely, you can enjoy two important benefits:
- You’ll spend less (perhaps thousands of dollars less) on your vehicle.
- You’ll have the flexibility to change vehicles and fund other goals within a few short years.
Properly planning for a loan before you shop for a car can improve your chances of receiving the loan and a car that fits your budget. Plus, when it’s time to make a deal, you’ll be ready to proceed with confidence.
Your credit, in combination with your income, determines whether you will be approved for a loan. Your credit is your history of borrowing from other lenders and indicates whether you borrowed in the past and if you repaid those loans on time. With a good credit score, you’ll get a lower interest rate, which means you’ll pay less for your vehicle both in terms of the total interest costs, and the monthly payment, which is based on your interest rate.
Check your credit by reviewing your credit reports before you apply for auto loans or visit a dealership. All U.S. consumers are entitled to a free credit report under federal law, so exercise your rights. Make sure that your credit score appears as favorable as possible. Lenders will largely make their loan decision based on this number. Read through your credit report carefully and fix any errors that can drop your score, as errors are a common occurrence.
Determine how much you can spend, accounting for the down payment and monthly payments, before you start looking at cars. Also, note that some salespeople can make it appear as if the car is affordable with fancy math and long-term loans when, realistically, it is not in your budget. To determine how you want to control your payments, you must first understand what they mean:
- Down payment: A payment that you make up front when purchasing your car. The larger your down payment, the smaller your loan and the resulting monthly payments. It is uncomfortable writing a large check up front, but you’ll enjoy more flexibility later if you do so.
- Monthly payments: Regular payments that you make for a specified number of years. Keep the amount payment at a comfortable level to account for unanticipated events that could affect your income. Your income could decrease, or you might face unexpected expenses in the coming years. If you spend as much as you can today, you’re putting your future at risk.
How Loans Work
Understand how loans work, and you’re better equipped to make smart decisions about your loan. When car buyers lose perspective, they may make mistakes such as focusing on the monthly payment as opposed to the purchase price and total cost including interest, or needing to buy a certain car or certain features, even if they do not fit within their budget
It’s tempting to focus on the monthly payment when deciding how much you can afford to spend on a car, and some auto dealers use this selling tactic. Also, it’s tempting to know that monthly payments can be easily reduced by extending the loan payoff period. However, this also dramatically raises interest costs. In addition, your loan is likely to become an upside-down loan, which is when you owe more on the vehicle than it is worth.
Also, making a small down payment may be comfortable, but means you will need to borrow more money, which also increases your chances of going upside-down. Make sure you’re buying a car that you can realistically afford and avoid taking on a loan that can hurt you financially. Unless you pay cash, it’s best to make a down payment of at least 20 percent and get a loan for five years or less.
Auto dealerships are not the only place to obtain an auto loan. Other options are credit unions, banks, online lenders, or peer-to-peer (P2P) lending sources. In most cases, your car dealer won’t have the best auto loan, however, some dealer offers can’t be beat, so it’s important to compare loans. Consulting with an alternate lender before you step onto a car lot will arm you with knowledge of what’s available to you, which gives you bargaining power.
Make sure that your auto loan contract allows you the flexibility to accelerate payments or pay off the loan entirely without penalties. After all, life is unpredictable and you may need to pay off your debts quickly, if necessary. Find a lender that will allow you to make extra payments or pay off the loan entirely without any penalties. It’s important to read the fine print, as some penalties aren’t called “penalties,” and old-fashioned prepayment penalties have been outlawed in some states, so lenders have to find other ways to discourage payment.
Lenders sometimes ask about life and disability insurance when you buy a car. They’re not asking out of kindness; they’d like to sell additional insurance with your loan. Credit insurance helps to cover your loan payments, but it’s rarely a good deal to get credit insurance with your lender. Evaluate your existing life and disability policies that you own as an individual or that you get through your employer.
You’ll also want this insurance information before you go car shopping. Plus, it’s just wise to know how you and your family are protected if something happens. If you feel like you need coverage, compare offers from several different sources, including an individual insurance agent that is not affiliated with your lender.
When you borrow money to buy a car, your lender is already protected. They can repossess the vehicle if you stop making payments, so focus on protecting yourself and your loved ones.
Arming yourself with the proper knowledge prior to car shopping can increase your chances of getting a great deal on a car. In addition, when you do enter a dealership, be realistic about your budget to avoid being seduced by seemingly good deals on shiny new cars that you cannot afford. With the right preparation, you can purchase a car that fits your lifestyle.