Do you know how car loans work? Read on to learn more about key loan terms, where to get an auto loan, and how you can better approach your next car loan.
7 minutes
11.30.2023
For most people, owning a car can only happen with a car loan. Financing a car can unlock several options, but these loans typically have restrictions and limitations. Understanding how a car loan works and using one to your advantage is critical to approaching your next car purchase with your best foot forward.
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A car loan is a type of loan that you obtain when you want to purchase a vehicle, whether for a new or used car. The lender agrees to set up an installment plan based on your financial circumstances, with monthly payments and terms outlined in a legally binding contract. You can obtain a car loan from several lending institutions that maintain vehicle ownership until you pay off the loan in full.
Below are the basic steps involved in obtaining a car loan:
You can also explore other options, such as a FINN car subscription. Subscribing to FINN can help give you more time to decide—and test drive several vehicles to contextualize your purchase.
If you’re unsure what credit score you need to buy a car or how long you can get a car loan for, beginning your education with a few key terms can help. Here are a few to get you started:
Any time you come across a term you don’t know, take a minute to look it up to better understand not only the term itself but also how it affects other facets of a car loan. Understanding the inner workings of car loans will help you better approach your next purchase, regardless of your budget.
There are two main types of car loans available:
Regardless of which car loan type you choose, you can make a balloon payment at any point to pay off the loan. Balloon payments are lump-sum payments that significantly reduce your principal or pay it off entirely. Some lenders charge prepayment penalties if you pay off your loan early, so read the fine print before making a balloon payment.
The annual percentage rate (APR) on a car loan represents the interest you pay on the loan and any other associated financing fees. Figuring out how to calculate APR on a car loan requires simply knowing the principal finance amount, the interest rate you qualify for, and any associated lender fees. You can easily compare lenders based on their APRs, from how much they charge in administrative fees to what it costs to originate the loan. While your credit score factors into the APR on a car loan, any additional fees are often non-negotiable and predetermined by the lender.
You can obtain a car loan from several lending or financial institutions, including:
No-credit-check/no-proof-of-income car dealerships may also offer auto financing. You can also look into buy here pay here dealerships for an auto loan. Comparing rates between lenders will help you find the best loan terms, given your financial situation.
Car loans work well for borrowers with a solid financial foundation for the foreseeable future (three to five years), high credit scores, and enough savings for a down payment. Low debt-to-income ratios can also help borrowers afford a car payment, initially and over the loan. Adding another vehicle to the mix as a trade-in can really stack the cards in your favor.
For many people, car loans come as a necessity. A credit score above 680 is ideal for getting the best loan terms without signing up for staggeringly high interest rates. However, sometimes the best move is to improve your credit score, lower your debt, or increase your income before obtaining a car loan. These changes alone can boost your ability to get a car loan and terms that work with your budget, not against it.
Car loans come with several disadvantages worth considering. A car loan requires an ongoing financial commitment that could quickly become overwhelming should your circumstances (i.e., income) change. Cars also depreciate, especially brand-new and luxury vehicles, lowering your potential equity in that vehicle.
Car ownership costs can quickly drain your bank account. Regular and unscheduled maintenance, fuel, and car insurance premiums make up the bulk of additional car ownership costs on top of your monthly car loan payment. Your lender may also require additional car insurance coverage that increases your premium significantly. If you want to trade in or sell your car, you must first fulfill your loan obligation.
Car loans are paid back via monthly payments spread over a specific loan term. These monthly payments include paying the principal loan amount and any associated interest. Paying down the principal can help you pay off a car loan faster, but most lenders require you to pay down interest before you can apply payments to your principal. When you’ve paid off your loan, you receive the car’s title and own it outright.
Several factors affect your monthly car payment, including:
Many factors can significantly affect how much you pay for your car overall. For example, consider a $40,000 financed loan amount and a 7% interest rate. A loan term of 48 months would put the monthly payment under $1,000, but extending that to 84 months (another three years) would lower the payment to just over $600. Putting $5,000 down would lower your monthly payment by around $100, but a 12% interest rate would nearly double the interest paid on your original loan balance.
No, financing a car doesn’t mean you own it. You must pay off the car loan first before you technically own the vehicle. Until that time, the lender holds the title to the car.
Getting a car loan can seem overwhelming, especially if it’s your first time. Figuring out how car loans work often requires going through the motions at least once to get the lay of the land. However, it’s easy to make mistakes if you’re unsure what a term means, how a particular rate will affect your monthly payments, or what may or may not be required.
If you’d rather skip taking out a car loan, check out a FINN car subscription. FINN allows you to choose the subscription terms that fit your needs, from monthly mileage counts to subscription terms of up to 24 months. Subscribe to a FINN vehicle, and you’ll have the pick of the fleet, including trucks, electric cars, premium sedans, and SUVs. Your next car subscription awaits.
Getting a car loan can seem overwhelming, especially if it’s your first time. Figuring out how car loans work often requires going through the motions at least once to get the lay of the land. However, it’s easy to make mistakes if you’re unsure what a term means, how a particular rate will affect your monthly payments, or what may or may not be required.
If you’d rather skip taking out a car loan, check out a FINN car subscription. FINN allows you to choose the subscription terms that fit your needs, from monthly mileage counts to subscription terms of up to 24 months. Subscribe to a FINN vehicle, and you’ll have the pick of the fleet, including trucks, electric cars, premium sedans, and SUVs. Your next car subscription awaits.
APR represents the total cost of borrowing money for a loan, including the interest rate and other fees, stated as an annual percentage. Find out the factors that affect the rate and how to determine if an APR is ‘good’.
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