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How Does an Auto Loan Work? The Only Guide You Need

How Does an Auto Loan Work? The Only Guide You Need

how auto loan works

Buying a new vehicle is one of the most significant purchases you can make in life, so researching the right type and model should be a top priority. While choosing the perfect model and color of your car are important, so too is understanding the financing.

Knowing how an auto loan works will help you get the credit that offers the best value for your budget and needs.

A car loan involves borrowing money from a lender, who provides the necessary finances to pay for your vehicle upfront. In return, you agree to pay back the funds in monthly installments with interest, respecting the terms in the contract.

If you carefully select the right type of auto loan and maintain a decent credit rating, you should be able to get a car and still live within your budget. That’s the goal.

The Different Types of Auto Loans

If you are new to the finances of automobile buying, it pays to know the loan varieties.

Secured Auto Loans vs Unsecured Loans: What’s the Difference?

There are two types of loans: secured and unsecured. Both types of loan are “fixed,” which means you have a specific period of time to pay back the loan, usually between 24 and 84 months. Your monthly payment and interest rate will stay the same until you pay off the loan.

Secured Loans

Most auto loans are secured loans. This means your bank or credit union “secures” the loan with collateral: the car. What does that mean? If you fall behind on payments, the bank can repossess your car as payment for the loan.

Secured loans offer:

  • Lower interest rates: 5% to 21% APR
  • Longer repayment periods: 69 months, on average.

Unsecured Loans

An unsecured auto loan is not guaranteed by collateral. If you fail to keep up with your loan payments, the bank cannot take your car, but they can come after you in other legal ways.

Unsecured loans mean:

  • Higher interest rates: 7% to 113% APR
  • Shorter repayment periods: 36 months, on average

Choosing a Loan: Balancing Interest Rate and Loan Length

A longer repayment period may sound appealing because it means lower monthly payments, but the higher interest rate means that you end up paying more over the life of the loan. Signing an 84-month loan means that you’ll be making payments for seven years. Be careful not to sign a loan that will outlast the car.

Generally, the smartest choice is to pay attention to the total loan price—that is how much you will pay over the total life of the loan. Find the shortest-term loan with the lowest interest rate you can afford. Your monthly payments will be higher, but you’ll pay the loan off quicker and with minimal interest.

How to Get Best Auto Loan Rates

The best auto loan rates charge borrowers the least amount of interest and are available from reliable lenders that offer an easy and quick application process.

Finding a car loan with low interest rates can save you money, so before you go and apply for credit from the car dealer, for example, here is how to increase your chances of securing a loan with the best rates. Actually, we advise that you take several of these steps months before you consider buying a new car.

1. Know Your Credit Score and Improve Your Credit

First, you need to know your credit score and review your credit reports from each of the major reporting bureaus (Equifax, Experian, and TransUnion). You can request a free report from each of them once a year, and sometimes more often.

If your FICO score is below the excellent (700+) range, you may want to take a couple of steps to increase it before applying for a loan to purchase a car.

  • Pay off any remaining debts
  • Ask for a credit limit increase for any lenders
  • Fix errors on your credit report

If you need help with this process, you could contact a credit repair company.

2. Save for a Down Payment

The down payment amount you are able to pay can make a significant difference in your auto loan interest rates. The more money you can put down, the lower your interest rate will be. If you can’t put much down at the moment, try to save for a couple of months until you have a bigger down payment amount.

3. Compare Different Lenders

If you want to get the best auto loan rates, you shouldn’t make rash decisions. Instead, you should choose a lender based on reputation, reliability, and professional service. Also, try to experiment with different loan types to choose the best possible financing scenario for your money and needs.

Where Do You Get an Auto Loan?

Buying a vehicle is a major purchase, regardless of whether you want to get a new or used car. For this reason, it is essential to choose a reliable lender. The lender you choose should suit your financial situation and the type of vehicle you want to purchase.

Most dealerships have arrangements with lending companies, but they are not always at the best rates for you. You can also shop online through reputable banks and lenders recommended by prestigious sites such as Investopedia.

Here are a few tips that you’ll want to take into consideration before you sign for a loan through an auto loan lender.

  • Your lender should provide 100% financing of used and new cars
  • The lender should provide GAP coverage, asset protection, and other offerings
  • Check to find out if there is a pre-payment penalty

How Much Does an Auto Loan Cost?

According to the latest research, the average auto loan costs have recently increased. In 2021, the average car payment in the US was approximately $550 for new cars and $400 for used cars, which is a 2% increase from last year.

Here are a few factors that may affect your monthly payment amount:

  • The lender (for example, credit unions have lower interest rates than banks)
  • Taxes, fees, and vehicle registration
  • Interest rate (the higher the rate, the higher your monthly payment will be)
  • Credit score (interest rates are lower for people with better credit scores)
  • Vehicle age
  • The loan amount and term

Auto Loan Payment Calculator: The Best and Easiest Way to Calculate Your Loan Payments

Using an auto loan calculator is the simplest way to estimate your monthly payments. All you need to do is enter the vehicle price and the loan length (in months) to estimate how much money you can borrow from the lender and find out what your monthly payments would be.

How Do You Apply For an Auto Loan?

Once you find the right lender, here is how to apply for an auto loan:

  • Apply for pre-approval of the loan (when the lender agrees to loan you a certain amount of money based on preliminary information you provide)
  • Secure full loan approval (when the lender ensures that you, the borrower, as well as the car, are qualified for the loan you apply for)
  • Provide necessary documentation (personal information, proof of income, proof of assets, credit history, and information about the vehicle you are buying)

Conclusion

Everyone’s situation is different, and while a lower monthly payment at the cost of higher overall expenses may be the goal for some, savings on interest by having a shorter loan period could be more important for others.

Don’t forget to use auto loan calculators to estimate what loan amount works for you. Be sure to partner only with a trustworthy loan provider.

At Greater Alliance Federal Credit Union, we offer you fast and smooth ways to apply for a car loan. If you live or do business in Bergen & Passaic Counties of New Jersey, we invite you to open an account with us. We have branches in Paramus, Hackensack, and Paterson, NJ.

At Greater Alliance, our team of financial experts can help you choose the best auto loan for your budget and needs. Contact us today at to discuss your auto needs and financial situation.