Car Loans 101

Down payments, interest rates, term length, all have to do with getting a car loan, and finding the correct one for your current financial situation.

Car Loans 101

You’ve just learned that your credit score is above 800, so you’re ready for your triumphant arrival to the dealership that has your dream car waiting for you, but now you must apply for a car loan.

Unfortunately, it’s not as clear-cut as using a credit card to pay for a bicycle and as it turns out there are several different elements that make up a car loan or at the very least ensure eligibility for a car loan.

Down payment

The larger down payment you put down, that is, the more money you pay upfront, the less the loan is going to be (obviously), but it also means you’re going to pay less interest over the course of your loan. Typically a good down payment comes out to about 20% of the car’s sticker price, but more is always better if you can manage it.

Interest Rates

APR is the interest percentage you’ll be charged per year. This is directly related to your credit score, so take care of that and it’ll take care of you. A good APR is somewhere around 5-8% but can be typically as low as 2% for someone with a stellar credit score and as high as 20% for someone with less than desirable credit.

Term Length

More and more people are opting for a longer loan term, in favor of smaller monthly payments. While this might seem like a good idea, read the fine print and understand that a longer term means more interest. So if you can manage the monthly payments, get as short a term as possible. The faster you pay off the loan, the less interest you pay and the sooner you’ll be relieved of debt.

What Lenders Consider

When you apply for a loan, lenders consider several factors before accepting or declining your request. They look at your FICO (which may include your Auto FICO), your loan to value ratio (loan amount to value of the car), debt to income ratio (how much debt compared to how much money you make) and how likely you are to pay off your auto loan.

They also look at your payment to income ratio, which dictates what percentage of your monthly income is going to be consumed by your auto loan, which is typically desired to be roughly 15%.

Car Loans 101
Dealer V. Direct Loans

There are two ways to which you can obtain an auto loan. You can go to a lender yourself, like a bank (preferably one you know), or have the dealer set up the loan for you.

There are pros and cons to each, but basically, a direct loan, when you obtain the loan yourself, puts you in complete control of the process from start to finish, but you might need very good credit to get the loan you want. A dealer loan is useful for people with lower credit scores, as dealerships will sometimes advertise that they will finance on a lower credit score.

There are also some pitfalls you should be aware of if you’re in the middle of financing a car.

Rolling over debt

If you get tired of your car during the underwater period, or, the years when the car is worth less than you owe, you have the option of trading in the car and using the remainder of the loan as a down payment towards another new car.

However, this is not necessarily recommended as it will pile on more and more debt. The best practice is to see the car through to the point where it finally is above ground. Take good care of it until that point, so as to maximize the amount of money you can get when you sell it.

Avoid (or recover from) Repossession

Repossession is when you’ve defaulted on your loan and the lender comes out and takes your car from you. If you’re in a tight spot financially speaking, you can call your lender and ask for them to postpone a payment, and then perhaps renegotiate your contractual agreement and potentially lower your monthly payments.

Alternatively, you can try to pay the loan before the car is sold at auction, or refinance your loan agreement if you can foresee a problem down the road, for instance in the case of losing your job, you may want to refinance. Also, don’t forget, you can always sell your car on Instamotor to pay off your loan. Recovering from repossession is as simple (not necessarily easy) as building back up your credit.

Pay off your car faster

You are not bound to paying once per month, you may, in fact, pay multiple times per month. Be aware that some lenders won’t charge you for the next month if you exercise this method, so ask them what bi-weekly payments entail. Also directing your payments toward the principal or the part of the original loan that doesn’t include the interest will help pay off the loan faster.

The Instamotor TeamThe Instamotor Team

Not your typical used car salesman. Our team is here to provide honest and transparent advice about car buying and selling.