Auto Loan Learning Center

An auto loan is a type of loan that borrowers can get from banks, credit unions, auto financing companies and private lenders to purchase a new or used car. The proceeds from the loan can be used at an automotive dealership or with a private party (individual or neighbor selling a vehicle) to purchase the vehicle. The loan from the bank or credit union will be repaid through monthly payments with an interest rate fixed at the time of loan closing. These loans can have terms (loan length) of one to several years.

A down payment is money (cash) that you put towards the purchase of the vehicle at the time of purchase. Most lenders and dealers will require a minimum down payment of 10% or $1,000, whichever is lower. Since the balance of the purchase amount will be in the form of a loan, the more you put as a down payment, the less money you will pay in the long run towards the loan. Your monthly auto loan payment will have interest added to it, so having a larger down payment means you have fewer or smaller payments to make in total. This can significantly reduce the amount of interest you will pay over the term of the loan. Some lenders and dealers will try to offer borrowers a $0 down payment option, but these tend to be far more expensive than auto loans that require a down payment.

The rates for auto loans are largely dependent on two factors – your ability to repay the loan and the type of loan. Your ability to repay is determined by reviewing your credit score and calculating the loan amount as a percentage of your income. Having a good (or great) credit score will always make you eligible for the best loan rates. Scores above 740 receive the lowest rates and banks/credit unions will usually provide auto loans for scores as low as 620, but the rate may be higher. There are many sites where you can get your most recent credit report before you get pre-qualified for an auto loan. Understanding your current score may provide you the opportunity to improve it through correcting negative marks, eliminating errors or working with creditors on unpaid balances that appear on the report.
The type of loan also has an impact on the rate. Loan rates for vehicles purchased at a dealership are generally the lowest, followed by refinancing your current vehicle, buying out your lease and purchasing from a private party. Other factors that may have an impact on the auto loan rate include loan term (length) and model year of the vehicle.

The available terms or loan lengths for an auto loan are determined by the bank or credit union that will provide an auto loan. The loan term is how long it will take to repay your loan. Generally, they can be as short as one year (12 months) or as long as 7 years (84 months). It is to your advantage to have the shortest loan term possible as this will result in less overall cost for the loan. This assumes, of course, that you are comfortable with the monthly payment. Here is an example – for a $20,000 loan at 4.75% the costs will be:

• 36-month term = $597 monthly payment with $1,498 in total interest during the life of the loan
• 48-month term = $458 monthly payment with $1,999 in total interest during the life of the loan
• 60-month term = $375 monthly payment with $2,508 in total interest during the life of the loan
• 72-month term = $320 monthly payment with $3,024 in total interest during the life of the loan

Thus, by choosing the 36-month term versus a 72-month term, you will save $1,526 in interest or about half as much. It is generally recommended to keep the term at 60 months or less to ensure your vehicle will be worth more than the amount remaining on the loan.

The vehicles that qualify for an auto loan are determined by the bank or credit union that will provide an auto loan. Generally, they will not finance a vehicle that is more than 10 years old but the loan will likely cover any type of personal vehicle that you may buy – passenger car, SUV, truck, etc. Most transaction types are eligible for an auto loan, including buying a new or used vehicle from a dealer, refinancing your current vehicle for a lower interest rate, buying out your lease on your current vehicle or purchasing from a private party.

Before you buy a vehicle, it is always a good idea to get pre-qualified through your bank or credit union. Many of these lenders have an online resource that you can use to get pre-qualified in a matter of minutes. A pre-qualification means that the bank or credit union has reviewed your financial situation and determined that you are eligible for an auto loan. The pre-qualification document will generally define the interest rate, loan term (length), loan amount and, in some cases, details on the vehicle you intend to purchase. The pre-qualification process involves collecting information about your income, employment history, housing situation, other personal information, and a credit report to understand your credit score and credit worthiness. The value of a pre-qualification is that you can show the dealer that you are fully eligible for the vehicle purchase and the interest rate and loan amount have been established – less items that might require negotiation with the dealer.

A bank or credit union will need to know some key information about you before they will extend a loan for your vehicle purchase. In general, they will want to verify you are who you say you are, your income and history, your housing situation and history, and they will run a credit report to understand your credit worthiness. Here’s a list of the most common pieces of information required:

• Social security number
• Contact information including a phone number and e-mail
• Date of birth
• All sources of income with verifiable documentation
• A list of current employers and previous employers if less than 2 years on the job
• A current address and previous addresses if less than 2 years at that home

A bank or credit union can get you pre-qualified for your auto loan – often online – before you even go to an auto dealership or through a private party vehicle search. It may help to search for loans from banks or credit unions you have a history with, such as through a savings or checking account. Often, they will be able to give you a loan with a lower interest rate than the dealership. Dealers use a network of lenders that will provide you with a loan, but it generally involves some additional interest charges for the benefit of the dealer who is closing the deal.

First, there will likely be some fees associated with the auto loan itself. These could include title fees, state taxes, dealership charges and loan fees (processing, underwriting, etc.). Second, there are the ongoing costs of owning a vehicle that you should consider when calculating your budget. Examples of these charges are vehicle insurance, registration, gas, repairs and maintenance. The actual ‘cost of ownership’ for a vehicle can vary widely depending on the make, model and age of the vehicle. There are many resources that can help you estimate these costs, so it’s worth doing some homework before your vehicle purchase. A good rule of thumb is to make sure your auto loan payment and the cost of insurance are less than 15-20% of your gross (pre-tax) income.

• Amount Financed: This is the loan amount which you will borrow to make the vehicle purchase
• APR (Annual Percentage Rate):This is the actual interest you will be paying that includes the finance charge and the associated loan fees
• Finance Charge: This is the actual cost of borrowing the money needed to purchase your car which is calculated using the loan amount, interest rate and loan term
• Late Fees: This is the fee your lender can charge you if you are late in making your auto loan payment(s)
• Prepayment Penalties: Some lenders charge you if you pay off your loan early – check with your bank or credit union to understand if this applies to your loan and the costs associated with it
• Rate Variation: Some loans can have variable interest charges over the life of the loan — check with your bank or credit union to understand if this applies to your loan and the potential variability
• Total of Payments: This is the total cost of the entire loan including purchase price, fees, and interest and is the best indicator of the total sum of what it costs to buy the vehicle