What Exactly Is An Auto Loan, and How Does It Work?

Buying a new or used car may be one of the biggest financial decisions of your life. However, before taking the bold step of getting a new ride, you must, first of all, arrange for vehicle financing.

With an Auto loan, which is a type of financing, you can purchase any car of your dreams. However, you need to understand that you are simply borrowing to pay for the vehicle. The terms for an Auto loan vary, so it is best to understand the process to get the best auto loan possible.

Many financial institutions offer auto loans, however, their details vary. As such before opting for an auto loan, you need to understand what it is and how it actually works.

What is An Auto Loan?

An auto loan is a loan taken from a financial institution that allows you to purchase a car. You’ll be required to repay the loan in fixed installments over a set period of time, and interest will be charged on the money you borrow.

Individuals with a high credit score may be able to qualify for a lower interest rate, which will save you some bucks over time. Furthermore, your credit score helps determine the initial loan amount and required down payment.

Auto Loan Terms

Before opting for auto loan with any financial institution, it is best to understand some of the terms involved with auto loans.

• Interest rate: This is the amount that you’ll pay to the lender in interest on top of your loan principal payments. Individuals with a higher credit score or shorter loan term generally pay a lower interest rate.
• Down payment: This is an amount you may offer to the seller in cash, effectively reducing the amount you need to finance. The larger the down payment, the better terms you can obtain.
• Annual percentage rate (APR): The APR is the total borrowing cost of the loan, including the interest rate and other fees, expressed as an annual percentage. It is important to note that different financial institutions offer different APRs.
• Loan term: The loan term or repayment period is the window of time during which you’ll make payments on the auto loan. Loans with shorter repayment terms tend to offer more favorable terms, but higher monthly repayments.
• Principal: This is the amount you’re borrowing to purchase the vehicle minus the interest and fees. The principal plus the down payment equals the cost of the car.
• Total cost of the loan: This figure includes the principal, interest and fees paid to acquire the vehicle.
• Collateral: Auto loans are typically secured loans, which means they use the vehicle as collateral. As a result, auto loans tend to have lower interest rates than unsecured loans, such as personal loans. That said, the lender technically owns the car and holds the title until you pay off the loan. If you fail to keep up with payments, the lender can repossess the vehicle.
• Prepayment penalty: Some lenders may charge a prepayment penalty if you pay off the loan too soon. Watch out for this in the contract before you sign it.
  

How Auto Loans Work

An auto loan is paid back to the lender in monthly installments call loan repayments. Your monthly payment will depend on several factors including the amount of the loan, the loan term, and the amount of interest you’ll have to pay over the loan term.

Also, auto loans come in a variety of ways including direct lending and dealer financing.

Direct Lending

Direct lenders include banks, credit unions, and other financial institutions like online lenders. Borrowing from one of these lenders can give you the opportunity to compare shops for the best loan terms for you and may give you the option to get preapproved for a specific loan before you shop. And when you’re ready to buy, you’ll use this loan to pay for the car.

Dealership Financing

This option, which is handled by your dealer’s finance department, makes it convenient to shop for your vehicle and auto loan in one place. Dealers generally have relationships with multiple lenders, so you may be able to compare terms and may even qualify for manufacturer-sponsored low-rate or incentive programs. But be on the lookout for “buy here, pay here” dealers offering high-interest in-house auto loans to buyers who don’t have great credit.

Requirements for Applying for an Auto Loan

To apply and get an auto loan, you’ll need to complete a loan application form that includes your personal information and financial situation. Generally, below is the information you should have handy when applying for an auto loan.

• Social Security number
• Current and past addresses
• Current and past employment information
• Total income and income sources
• Information on any other debt you may have

Conclusion

An auto loan is simply an agreement between you, the borrower, and the lender, allowing the lender to lend you money for an agreed-upon term to purchase a car. If you do not want to take an auto loan or do not qualify for approval, consider saving for it or asking a family member for help.