Not everyone has the kind of money on hand to be able to purchase a vehicle out of pocket. Even if you’re looking to buy an automobile that has already been used, there’s a good chance that you are going to need some financing to get started. The most common way of meeting this requirement is to acquire an auto loan.
The premise of this loan is simple. The lending entity provides you with the full cost of the vehicle minus a deposit that you must pay upfront. For example, if you wanted a car that had a price tag of $30,000, your lender may require that you provide a 10% deposit before you are given access to the loan. In this case, you would need to have $3,000 on hand to contribute to the price of the vehicle. The lender would be responsible for the other $27,000.
Note, however, that you would need to request a loan with a value that is a little bit more than you need to purchase the vehicle. This is because there are various processing fees involved, and if these were to be deducted from the loan amount, what you would end up with is a figure less than $27,000. These fees tend to equate to a small percentage of the loan amount. Using the same example, imagine that the processing fee is equal to 2% of the amount being requested. With a $27,000 loan request, the processing fees would be $540. Therefore, it may be in your best interest to ask for a loan of at least $27,540.
Auto loans fall under the umbrella of secure loan offerings. Unlike their unsecured counterparts, secured loans typically require one or more assets to be used as collateral. If you default on the loan, the lender can recover the unpaid value by repossessing the assets you selected. This is not much of a worry for auto loans, as the vehicle being purchased typically serves as the collateral.
The process of getting the auto loan tends to be very straightforward, as lenders are usually keen on getting in business. However, most people don’t get all the information that they need from the lending entity before deciding to get a loan. While you may get a rundown of the terms and conditions that surround their agreement, it is unlikely that the lender is going to spend time ensuring that you know everything about auto loans to make an informed decision.
That’s where this article comes into the picture. Instead of going over the loan application process, this is an outline of some useful information to have where auto loans are concerned.
1. Preapproval Is King
You should never underestimate the value that loan preapproval can have on your car purchasing process. It could be the reason that you get access to incredibly lucrative dealer financing that would otherwise have been hidden from you. Some people think that getting preapproved for a loan means committing to taking it. However, this is not the case, as a preapproval is nothing more than a promise accompanied by a printed statement, which indicates that a lending institution is willing to offer you a loan with certain conditions.
While getting a preapproval allows you to maintain a reliable option with the lender that gives it, it can also offer you significant leverage at the dealer. Most automobile dealers have in-house financing options that they provide to buyers. In most cases, the dealer is simply an intermediary, as there is a lending institution that offers the loan indirectly. While this means that the process of acquiring the financing is more straightforward, things could take a costly turn if you opt for dealer financing.
This is because dealers tend to modify terms to make a profit on the financing being offered. However, if the dealer is given the impression that you are already guaranteed favorable funding, you may get an offer with terms that are almost too good to refuse.
Getting preapproved for a loan is an excellent way of achieving this. If the dealer’s terms are not up to standard, you can simply indicate that you’ve been preapproved for a loan elsewhere. Typically, when preapproval is granted, the potential borrower is provided with a document that shows this. Ensure that you walk with this document in hand as you go to check out a prospective vehicle.
Once the dealer informs you of the terms and conditions, you can use your preapproval letter to show what amazing terms you can get elsewhere. You may be surprised at the kind of offers that are thrown at you after that. Remember that the goal is to ensure that you get the best rate possible, so there is nothing wrong with using leverage where you have it.
2. Consider Gap Insurance
Typically, seeking any form of insurance has nothing to do with your auto loan. The point of auto insurance tends to be along the lines of vehicle repair or replacement, as well as addressing medical emergencies when they occur by virtue of motor vehicle operation. Even if your car was totaled, you would still have the responsibility of ensuring that the loan that you took got paid off. It’s an unfortunate situation, but your commitment to the lender would’ve been to pay an agreed amount at regular intervals.
This agreement is not dependent on the functionality of the car and how accessible it may be. In fact, the only issue totaling the vehicle would create is a lack of collateral for the lender to repossess if you default on the loan. If you have an insurance plan that covers damage to your own vehicle, then you may end up getting a replacement car. Even so, the money that you took to pay for the original vehicle still needs to be provided to the bank.
While it’s not the most common situation, there’s much to be said about how discomforting it can feel to be making payments for a vehicle that you no longer get the benefit of using.
This is where the concept of Gap Insurance comes into the mix. Gap insurance is an option available to those who have purchased a new vehicle. This insurance type ensures that you are taken care of in the event that an accident totals the car. The idea is that, if you should lose the ability to enjoy your vehicle because of an accident, Gap insurance covers whatever you owe on the automobile loan.
3. Keep the Term Short
The importance of getting favorable loan terms is something that cannot be emphasized enough. This is the reason that people are always advised to shop around before deciding on which lender to use for an auto loan. It’s not uncommon for people to go to a bank or some other lending institution and accept the first loan that comes their way because the terms seem favorable.
Remember that this is a payment that is likely going to be on your books for years. So whenever the opportunity knocks on your doors to make things a little easier, there is no reason not to take it.
Statistics have shown that over 30% of auto loan borrowers end up having the loan longer than they have the vehicle that the said loan corresponds to. Bear in mind that outstanding loan balances require a monthly payment that is subject to interest. The point here is that the longer the loan goes on, the more interest needs to be paid.
This is the reason that you are advised to take the shortest possible loan term that is available to you. Car loans in the ballpark of six years are the most common. If you could access a loan that provides you with the required funds and a short repayment period, then it would be in your best interest to get this loan.
Of course, there is the matter of affordability that needs to be considered. For example, you may have the option of paying $500 monthly for six years on your auto loan or paying $1,000 monthly for three years. It may be in your best interest to take the $1,000 option, as you get to deal with less interest. However, if $1,000 is too much for you to afford monthly, there would be no point in taking such a loan, since you would be setting yourself up to have the vehicle repossessed.
Therefore, the best way to tackle this is to approach the situation with the intention to optimize as best as possible. This means that you should try to get the shortest term possible that lies within the boundaries off your affordability. The small monthly payments that tend to come with car loans that run for six or more years seem very attractive, but the accumulated interest adds up over time, and you could end up paying a total that is excessively above the purchase price of the car.
4. Your Credit Score Matters
Your credit situation matters in the procuring of an auto loan more than you may realize. When you go to apply for your loan, the lender checks in with a credit bureau to see what your credit history is like and what your score is. Note that this is done using a hard inquiry, so it can lead to your credit score taking a hit.
The credit score check forms a part of the loan approval process, which accounts for a portion of the processing fee that you pay. The credit check that is done is usually not free, so the lender charges you to have this completed.
So what does your credit score have to do with you getting a loan? The first point revolves around understanding your payment behavior and the likelihood of your repaying the loan. This can be ascertained based on what you had done in the past when you were afforded credit. Of course, there are many factors that could make this loan payment experience much different from the others, but what has been documented in black and white is all that the bank has available to use as a basis for the decision. Offering loans is risky, and anything that can be done to mitigate the level of risk is always welcome.
Apart from just determining whether you are given the loan are not, the credit score also directly affects the kind of terms that you get. People with higher credit scores tend to be given better terms because they are assumed to be more responsible. For such persons, lenders have no problem setting minuscule interest rates.
One of the reasons for interest is to ensure that lenders profit from the whole situation. If you need a car loan of $50,000, and you are successful in being approved for it, repaying $50,000 doesn’t do much for the lender. Interest, however, makes all the difference. If the interest rate leads to your paying a total of $60,000, then the lender makes a $10,000 profit margin from giving you the loan.
For people with good credit scores, it is more likely that consistent payments can be expected throughout the entire loan term. This means that the lender is exposed to less risk when collecting payments slowly. If your credit is not that good, however, then the business needs to recoup the cost of the loan from you as quickly as possible. Therefore, the strategy employed to achieve this is to use high interest rates to collect both the principal and some interest in short order.
The best advice here is to plan for your car purchase so that you can work on getting your credit score as high as possible prior to your loan application. There are free ways of checking your credit score, and these are done using soft inquiries, which means that your score remains unaffected.
5. Go for the Biggest Down Payment Possible
Down payments have always been synonymous with auto loans. As stated before, you typically need to have cash upfront to make a deposit before the lender covers the remainder of the purchase cost of the car. Note that there are exceptions to this rule since loan options do exist that offer 100% financing.
The amount of financing that you are given typically depends on the lender, as well as car specifics, such as the vehicle’s age, condition, and value. The rule of thumb is that new cars that were released recently tend to get preferential treatment. Therefore, if you were to seek a loan for an unused 2021 vehicle in the year 2021, then you would be more likely to receive 100% financing.
Even if you can get everything fully financed, it is probably in your best interest to not do so. Many people try their hardest to find car loans that require little to no down payment to get started. This offers a lot in the way of convenience at the beginning of the loan, since larger down payments can hit your finances hard. However, this must be evaluated as a short-term benefit versus a long term one.
While it is true that smaller and nonexistent down payments offer you a lot in the way of convenience at the beginning, you may be setting yourself up for a position of negative equity. The concept of negative equity comes from a combination of low down payments and long loan terms. You may end up owing so much for the vehicle that it exceeds what the said vehicle is worth.
This tends to be the result of the way cars depreciate. Most fixed assets go through a process of deterioration, but that of automobiles happens rather quickly. You can avoid this whole negative equity situation by making the most substantial down payment that you can. If the requirement is 10% and you can afford to put down 30%, don’t hesitate to go for that 30%.
6. Make Several Applications in 14 Days
Remember that advice about shopping around before settling on a lender? There is a 14-day system, which most lenders don’t clue you in on since they want to ensure that you do business with them. Earlier, the matter of your credit score was discussed, and it was stated that lenders make a hard inquiry on your score, which drops it by 10 points. For a score that has a maximum number of 850, 10 might not seem like such a big deal.
However, consider the fact that a good credit score is usually anything that is above 700. If your score were 705, then a fall of 10 would bring it down to 695. That small change could take you out of the grouping of those with good credit, which means that you could probably start to see less favorable terms, such as high interest rates based on your new credit score.
While shopping around, you need to make applications to multiple lenders as you work on deciding from whom you plan to take a loan. So you must be wondering about how all these hard inquiries factor into your credit score. After all, if one inquiry can drop your score by 10, shouldn’t five drop your score by 50?
The truth is it all depends on timing. There is a bit of a loophole that allows you to make multiple applications that generate numerous hard inquires without your having to worry about your credit score taking a significant hit.
The secret is to ensure that your loan applications are all made within a 14-day time frame. This is because any inquiries that are completed within 14 days of the first are not evaluated as separate checks. So you could have numerous inquiries done, and they would simply be grouped as one.
Of course, once you step out of that 14 days, then things start to go downhill. Generally, it’s best to wait six months after a hard inquiry is made to do another one. The only time when it’s safe to go against this is when there are multiple loan applications made within the stated 14 days.
7. Banks Aren’t Loan Monopolies
Many people have all but relegated themselves to obtaining their auto loans from a bank. Of course, banks have the most considerable resources to put into their marketing efforts so that potential buyers are aware of their offerings. Additionally, when people go into banks to do other transactions, there are various ways in which they are informed about the different auto loans and perks that they can access.
While it is more traditional to use a bank, you may stand to gain a lot more by opting for another lender type. For example, consider getting a loan from a credit union. Of course, most credit unions require you to become a member before you can access their loan facilities. This is a membership that is well worth having, as there are a host of other benefits that fall outside of the spectrum of obtaining a car loan.
On the topic of obtaining such a loan, though, credit unions tend to have some of the most favorable rates that you can find. While a bank may be offering you a loan with an APR of 11%, you may find that a credit union is willing to provide you with a loan for the same value, but with an APR of 6%.
Finding Your Ideal Auto Loan
The man takeaway from all this is to avoid jumping at the first auto loan you see without doing your due diligence. While any loan that you’re approved for can get you behind the wheel of your new car, you may end up causing yourself a lot of financial stress in the future to get it paid off.
Plan properly and take note of the various points that were made above as you embark on the journey. An auto loan can be a fantastic thing, or it can be a complete nightmare. What makes a difference is the approach that you take to getting one.