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By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 5 minute read

Most people who want to buy a car have to take out a loan since, duh, cars are costly. However, that creates an entirely new set of challenges while looking for an automobile.

If you want to avoid bumps in the road when looking for a car loan, such as opting for a longer loan term with a higher interest rate since the monthly payment is cheaper, then you’ll be prepared. If you don’t, it’s possible you’ll be “taken for a ride” when you buy your next automobile.

What Is an Auto Loan?

You can get a loan to buy a car, truck, motorbike, SUV, or other speciality vehicle. Yes, and that even includes the occasional sighting of those ridiculous motorized tricycles.

In order to ensure repayment of the loan, the lender will place a lien on your car. That’s why it’s called a “repo man”; he’s the guy the lender sends if you stop paying your monthly auto loan.

In contrast, a secured loan has lower interest rates since the bank is taking less of a risk. Lenders will always set interest rates based on perceived risk, thus providing collateral allows them to provide more reasonable terms. Therefore, the interest rate on a car loan is often lower than the interest rate on a personal loan.

Important Terms to Understand

When comparing loans, it’s easy to become lost in the jargon of APRs and LTVs. To avoid feeling bewildered at the outset, it’s helpful to familiarize oneself with the terminology in use.

  • Interest Rate: The interest rate indicates how much the loan will cost you in interest. It is given as an annual rate.
  • Annual Percentage Rate (APR): The APR indicates the total annual cost of a loan, including interest and fees. Typically, the APR is slightly greater than the interest rate.
    This refers to the time period during which you will repay the loan.
  • Monthly Payment: This is the amount you owe each month without incurring any additional costs. Remember that you may make additional payments to pay off your debt faster.
  • This is your original loan balance, or the whole amount of money you borrow to purchase the vehicle. As the loan is paid down, the balance decreases. This is the amount of money you bring to the table when purchasing an automobile.
  • Loan-to-Worth Ratio (LTV): This is the proportion of the automobile’s initial value that the bank will lend you. LTV may be viewed as the opposite of the down payment. If you are required to make a 10% down payment, the lender will front you 90% of the buying price. Your LTV is consequently 90%.
  • Total Cost: The total amount, including interest and fees, that a loan will cost you throughout the term of the loan.

How Car Loans Operate

Auto loans allow consumers to finance the purchase of a vehicle and spread out monthly payments over a period of three to six years. With a longer loan term, your monthly payment will be cheaper, but you will end up paying more in interest over the life of the loan. When taking out a car loan, the shorter the term, the better.

Consider this: if you take out a three-year, $30,000 vehicle loan at 5% interest, you’ll shell out a total of $2,369. The interest on the identical car loan spread out over five years comes to $3,906.

Interest rates for loans with longer repayment terms tend to be higher. In all likelihood, the interest you pay over the course of the five years in the above example loan would be far higher.

The process of refinancing a vehicle loan is quite similar to that of a mortgage loan. This strategy can help you save money on interest or your monthly payment, but it usually results in a longer debt repayment period.

When you pay off your automobile loan, the lender releases their claim on the vehicle and provides you a release document. When you finally pay off your car, it’s time to start fretting over the high cost of maintenance.

Car Loan Varieties

Auto loans are often obtained from either vehicle dealerships or direct lenders. You may be able to negotiate better financing conditions or a lower price at the dealership. Generally speaking, it’s wiser to take the reduction offered.

Ideally, you’d pay cash for the automobile to take advantage of the price cut. If you’re not able to pay cash, though, you have several additional choices for auto financing.

Banks, credit unions, internet lenders specializing in vehicle loans, and other financial organizations are all good places to look for direct loans. Compare loan offers from several sources, such as your current bank, other banks, credit unions, and online lenders.

Don’t let potential lenders conduct a hard inquiry on your credit record until you’ve decided on a lender and a rate. Tell potential lenders your credit rating verbally after you’ve checked it yourself. The application for a loan can be formally submitted when you’ve decided on one.

In case your credit report has been dinged up here and there, put in the effort to repair it. A lower interest rate and higher credit score may save you hundreds or even thousands of dollars over the life of a loan.

Finally, remember that used automobiles are also eligible for auto loans, not simply new ones. Be aware, though, that interest rates on used auto loans tend to be higher.

How to Select a Car Loan

It goes without saying that you should always look for the lending option that has the lowest interest rate and expenses.

As a matter of fact, it’s the case nearly every time. Instead of offering price reductions as a promotional incentive, some dealerships provide financing with low or even zero percent annual percentage rates. In most cases, though, you’d be better off haggling for a lower price on the automobile itself and borrowing money from the most affordable direct lender you can find.

The reduction may be compared to the interest paid during the loan’s lifetime, which can be calculated using an online calculator. Pick the alternative that will help you save the most money over time.

Stay away from the lure of a longer loan term and go with the smallest loan period you can comfortably repay. Finally, before signing on the dotted line, make sure you get a complete breakdown of all expenses from each lender.

Bottom Line

It’s both thrilling and nerve-wracking to shop for a new automobile. Borrowing money, while necessary, does not add any thrills to the process.

However, it is not hard to do so, and you may save money on your auto loan by comparison shopping and haggling over the conditions. It’s recommended to narrow your search to a short list of five potential lenders and then negotiate with each of them.

In the same way, you should check your credit before moving further. If your credit history is as beat up as your old beater car, you may want to ask a close family member or friend to co-sign the loan with you.

If obtaining a cosigner is out of the question, bringing your credit card debt down to less than 30% of your available credit may help your score quickly. It’s best for your credit and your wallet if you can pay off your amounts in full and stop paying interest.

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