A car purchased with an auto loan.

Basics Of Auto Loans

If you are new to auto loans, there may be much you do not know. Luckily. this is a fairly simple type of loan, but there are still some basics that you should understand. Let’s take a look at these basics so that you can be a prepared borrower.

What Is An Auto Loan?

Obviously, this is simply a loan that is intended to be used for the purchase of a vehicle. This could be a car, truck or the ever popular SUV. Beyond that simplicity though, these loans have a few traits you should know about. Have a look.

The Interest Rate Is Fixed

An auto loan will have a fixed interest rate, which means that the rate you pay can not go up over time. You may be familiar with loans such as adjustable rate mortgages where the rates can change after a few years, but this is not the case with an auto loan. That allows you to know what your auto loan payment will be over the long term.

The Loan Is Secured

When you take out an auto loan, the loan is secured by the actual vehicle that you purchase. This means that the lender has an interest in the vehicle and, if you default, they can seize it to recoup their costs. While that might sound bad, this security interest will generally give an auto loan a lower interest rate than an unsecured loan. It gives the lender insurance that they will be paid back and any time you lower risk for a lender, the rate will drop.

This Is An Installment Loan

An installment loan is simply that, a loan that you pay in installments. For most major banks, the loan will be paid with 12 equal monthly payments. Some “buy here pay here” auto dealers might have biweekly payments, but larger banks will stick to calendar months. What this does for you is give you an easy way to budget your monthly expenses.

Terms You Should Know

Now, lets go over a few of the terms that you are likely to hear in the finance office. Familiarize yourself with these so that you can better understand your loan contract.

APR – Annual Percentage Rate

Many people think of this as the interest rate, but the interest rate is just one part of the APR. The APR also includes fees. This allows you to better compare loan offers because one loan might have a lower interest rate, but higher fees. The APR will average all of this out and that allows you to compare apples to apples to get the best loan.

Down Payment

This is the amount of money that you put down on the vehicle, reducing the principal. This could be a cash down payment or it could be equity that you have in your trade in. Ideally you would want to put down 20 percent in order to get the best APR possible, but this rarely happens these days. In general, the more you put down, the lower your APR.

Monthly Payment

This is obvious, but this is the amount that you will have to pay every month to pay off your loan. With most loans, the monthly payment will stay the same over the entire course of the loan, with the final payment varying by a few dollars. This makes the loan predictable, because if the payment is 400 dollars, it will always be 400 dollars.

Principal

This is the amount of money that you are borrowing. As you make your monthly payments, part of the money will go to paying down the principal. The rest will go towards fees and interest. Should you decide to pay off your loan faster, you can make additional payments directly to the principal.

Term

This is the loan length expressed in months. For the best APR, shorter loan terms are best. A short terms will be less risky for a lender and it allows you to pay less interest over the course of the loan.

Where To Get An Auto Loan

Many people tend to leave financing to the dealer, but this could be a very costly mistake. Why? Because a dealer makes money on every step of the auto buying process, including financing.

Dealer Finance Department

The dealer financing department will take your credit information and shop you to several local and national banks. They will then present you with the loan APR. This APR is generally several points higher than what the bank or credit union is actually offering. The extra money goes directly into the auto dealers pocket. This allows the dealer to make money on a vehicle sale, even if they sell the car at cost. In fact, many dealers make far more money on the back end of the loan than they do on the front end.

A Better Choice

The better option when it comes to obtaining an auto loan is to get pre approved from a local bank or credit union before you hit the dealership. This will allow you to se the rate that you actually deserve. Get the best rate you can and then give the dealership an opportunity to beat it. This may take you more time and effort, but it can also put 2000 dollars or more in your pocket.

Posted by
James Car

James Car is a finance, loan and budget expert based in the United States. After attending Brookhaven college, he went on to become a successful entrepreneur. He now enjoys writing articles that help people save and make the most of their money.