Auto Loans 101: Your guide to rates, terms, and repayments.in Buying a Car
Paying for a vehicle in cash isn’t always possible — nor is it always recommended. Auto loans can offer an easy and affordable way to fund a vehicle. And with some prudent financial skills, there are ways to prevent going into too much debt, while also helping your financial situation.
Today, I’ll walk through the basics of the auto loan process and educate you on what each step entails. Once you understand what you can afford, how to apply for an auto loan, and what to expect in a loan agreement, you’ll have the confidence you need to purchase your next vehicle.
Let’s Get Started
How Much Can You Afford?
Knowing how much you can afford is crucial to know prior to applying for an auto loan. You’ll want to make sure you can afford any down payment, as well as the monthly payments, before purchasing a vehicle. Generally speaking, financial experts recommend you spend no more than 10% of your household’s net income on an auto loan.
After you’ve budgeted appropriately, you can start researching vehicles that meet your personal and financial needs. We recommend taking advantage of credible resources, like Kelley Blue Book or Edmunds, to find important vehicle information, such as safety features, reviews, comparison charts, and much more.
Also, keep in mind that when it comes to vehicle costs, you’ll also need to budget for expenses beyond the sticker price. These costs include sales tax, dealership fees, auto insurance, registration fees, as well as ongoing maintenance costs. Experts recommend spending no more than 20% of your household’s net income for total car costs.
How to Apply For an Auto Loan
Once you understand what you can afford, you can begin shopping around for auto loans. Institutions that offer loans include credit unions, banks, and dealerships. Oftentimes, credit unions can offer members lower interest rates and better loan terms than dealerships and some larger banks.
To secure an auto loan, you’ll have to apply and then be approved by the lending institution. For this reason, it can be beneficial to go through the preapproval process.
Auto Loan Preapproval Process
Getting a preapproval means the lender will review your credit history and other specifics about your financial situation to determine your eligibility for a loan. The preapproval may also include the potential interest rate(s) and term that you qualify for.
During the preapproval process, lenders perform a “hard” credit check, which means they check your full credit report in addition to your score. (Hard credit checks do show up as a credit inquiry on your credit report. If you have too many credit inquiries in a short period of time, this can negatively affect your credit score. The good news is most credit scoring models allow consumers to shop around for auto loan rates without seriously damaging their credit scores. Multiple hard inquiries for auto loan preapprovals are generally treated as a single inquiry by scoring models if they occur within a 14-day window.
A preapproval is a strong indicator of your likelihood to receive a specific interest rate and term, which is advantageous to you because when you’ve already been pre-approved for a car loan, you’re like a cash buyer. This gives you a big advantage when negotiating a price and can also help you to avoid upsells. You will also have the freedom to go to any dealer you choose and can check out several different ones. There are other benefits to getting a preapproval as well, such as helping you budget more accurately, narrowing down vehicles to ones within your budget, and even comparing loan rates between lenders.
Keep in mind that getting a preapproval does not automatically guarantee you’ll be offered the loan. Your application must still be approved by an underwriting team at the time you apply. However, a preapproval is a strong indicator of whether or not you’ll be able to secure funding and how much funding you can secure.
Applying for a Loan
After you’ve been preapproved, you may decide to officially apply for a loan.
There are several items you’ll want to have on hand to simplify the process. You’ll need the details of the vehicle you’re trying to purchase, records of the purchase agreements, registrations, and titles readily available. You’ll also need personal documents such as your driver’s license, proof of income, and residence.
Once you receive an official approval, you should then make sure you understand the terms and conditions of your auto loan before signing, such as the rates, repayment terms, and repayment process.
Understanding Auto Loan Rates
Interest is simply the cost of borrowing money. When it comes to auto loans, you’ll often see the interest rate expressed as an Annual Percentage Rate, or APR. APR is the cost you pay yearly in both interest and fees. APRs allow borrowers to get a better glimpse at the full range of costs they’ll be paying over the course of a year.
Keep an eye out for how APRs are marketed. Dealerships will often advertise low APRs as an enticement to purchase vehicles, and in some cases will even promote 0% financing. However, these offers can be misleading in both their availability and overall savings, as the rate may only apply to those with pristine credit and can also involve extra costs overall.
Lending institutions have their own ways of determining interest rates and APRs for their loans. Your credit score will almost always be a major deciding factor of the interest rate you’re eligible for. The higher your credit score, the lower the APR you may qualify for (and vice versa).
In addition to your credit history, there are other factors that will influence the APR such as the age of the vehicle you’re purchasing, the presence of a co-signer, the size of your down payment, and the length of your loan repayment term.
Understanding Auto Loan Terms
The loan term refers to the length of the repayment schedule. Common terms for auto loans can range between 24 to 84 months. Generally, the longer your loan term is, the lower your monthly payment will be. While this is advantageous for those looking for a lower payment and can fit it in their budget, but keep in mind you’ll likely end up paying more because the APR will typically be higher.
Some financial institutions offer the option adjust your auto loan’s terms through a refinancing process. But the viability of this option will change depending on your particular financial situation. It can make sense to refinance in cases where you didn’t get the best offer, interest rates have dropped, or you can’t keep up with payments, but refinancing isn’t an option for everyone, nor is it always optimal. There are circumstances where refinancing may not be in your best interest. For instance, if your vehicle has significant wear and tear, refinancing your loan may put you at risk if the vehicle ends up needing major repairs. Additionally, if origination and other loan fees outweigh the benefits of a lower APR or monthly payment, refinancing may not be worth it.
The obligation to repay your loan goes into effect immediately, usually about a month or so after you’ve finalized your loan. It’s usually set up through monthly (or other frequency) repayments with a predetermined rate for the term of your loan. You’ll be expected to make on-time payments for the entire duration of your loan term.
Shorter term loans typically involve higher monthly payments and lower APRs. The opposite is true for longer term loans. More specifically, an auto loan with a longer term may have lower monthly payments but a higher APR.
If you want to pay off an auto loan early, you can usually do so without incurring early repayment penalties. However, some auto loans may come with a prepayment penalty, so make sure you check your loan agreement before doing so.
If you’re unable to make your repayment loans on time, you may experience some negative repercussions. For example, you may incur late payment fees, and even repossession of your vehicle. Additionally, your credit score can be drastically impacted.
If you find yourself in a (hopefully rare) situation where you need to make a late payment, check your loan agreement and reach out to your lender to understand your options and consequences.
Let Lafayette Federal Fund Your Next Vehicle
At Lafayette Federal Credit Union, we provide competitive auto loan rates and terms in the Washington, D.C. metro area. Presently, we offer loan terms up to 84 months and APRs as low as 2.375%. We also offer financing up to 125% (based on the Automobile Invoice Service Manual’s appraised value) on any previously unregistered or untitled vehicle purchased from a licensed dealer. Members are also eligible for the Green Auto Loan discount, which offers 0.125% percent off on U.S. EPA-designated Smartway certified vehicles. Interested members can contact us or stop by one of our branch locations where a Member Service Representative can assist.
Not a Lafayette Federal member yet? You can become a member by completing an online membership application, scheduling an appointment or walking into a branch, or scheduling a virtual meeting with a Business Development Officer.