What You Need to Know About Car Loans

What You Need to Know About Car Loans

Unless you’re paying the cost of the car up front, you need financing, such as a car loan. And you’re not alone, seeing how up to 85% of all new vehicles are purchased with some kind of financing and car loan debt totaling over $1 trillion in this country. With car loans being so common, there are some predatory lenders that target trusting consumers. It’s also possible to confuse the many details of a car loan. And, with a car loan, just how much car can you get? This guide answers your car loan questions so you can get a great car you can actually afford.

Avoiding Predatory Lending

Most lenders are honest, but some use predatory practices on their customers. The rule of thumb is this: if it sounds too good to be true, it probably is. The cartoon version of predatory behavior is one that we’re all familiar with: a greasy used car salesperson that finances every buyer, no questions asked. But not every predatory lender fits this stereotype. Dealerships, banks, and even credit unions could engage in predatory lending. Keep in mind that you are your own best advocate and the only one responsible to keep your best interests first.

Many dealerships offer financing in addition to the vehicle you’re interested in, and many buyers think they must use financing from the dealer. That’s not true. Look at this offer for what it is: a separate and optional transaction. Do not feel pressured to finance with the dealership. It’s possible to buy a car from a dealership and finance the transaction elsewhere, even at dealerships that offer financing. For example, you can go to your bank or credit union instead. Before you decide on your financing package, find out who the actual lender is for the financing package at the dealership (it’s not always the dealership). If the dealership pressures you into financing with them, decline until you’ve weighed some alternatives.

Borrowing from a lender with which you already have a relationship can be hugely beneficial to you. If you have had great experiences with your bank or credit union, you might start there. At the very least, give your bank a call to see what interest rates they would be willing to offer you based on your history and credit rating. Information is power in a situation like this, and you can make wiser financial decisions if you have the right information. If you know, for example, that your bank would be willing to finance your deal at 5% interest, you’ll be less likely to opt for the dealer’s 7%.

Some dealerships customarily offer auto, disability, and even life insurance. They may try to upsell you if you don’t have these. Treat any of these offers as optional transactions, separate from any car loan. Proceed in the same way for each offer, shopping around and feeling no pressure. By knowing what you are required to do and what is optional, you can prevent yourself from signing onto a lending agreement that will hurt more than help.

By the Numbers

Three numbers are important when looking at a car loan: the down payment, the interest rate, and the total cost. You might be tempted to look only at the monthly payment. Many people do. But the monthly payment is an elastic number than can be stretched to make any deal look great. If a lender is trying to sell you based primarily on the monthly payment, pay very close attention to the interest rate and payoff date. If the interest rate is high and the monthly payments stretch too long, you could end up paying far more than the car is worth in the long run.

Also ask your dealer or lender about prepayment. If you can afford to make extra payments, you should. Make sure there are no hidden fees or penalties for paying off a loan early. No one wants to be shackled to debt and accruing interest they don’t actually need.

How Much Car Can I Afford?

In general, it’s good practice to put at least a 20 percent down payment in a vehicle. If you can put down more, that’s even better. Think of it this way-you’ll never pay interest on whatever you pay up front.

After that, try to establish a monthly payment that is low enough that you can pay it but not so low that it will take forever to pay off the loan. We recommend no more than 10 percent of your monthly income should go to car loans and insurance. Under ideal conditions, you shouldn’t be paying on a loan for any more than five years. A car loan is not a mortgage and shouldn’t take 20 or 30 years to pay off. You should always pay off the loan before the car has outlived its usefulness.

Bonus: Credit Score

One thing you’ll likely hear a lot as you begin your financing process is your credit score. Your credit score is shorthand for how well you’ve been able to manage your debt in the past. This number ranges from 300 to 800, the higher the better. One of the best ways to get a good car loan is to have a great credit score. Know your credit score before you go shopping for a car loan. Lenders will run their own credit check, but they’re under no obligation to tell you their findings or which service they used.

If you have bad or no credit, it’s still possible to get a car loan. These loans are known as subprime and deep subprime loans. You generally have to accept terms that aren’t quite as good, but our advice still applies. Some dealerships might make you feel you must accept their terms. But don’t feel pressured into anything. Shop around for the best loan you can find.