If you’re buying a vehicle for the first time, you may be unfamiliar with a lot of the terminology and processes involved in taking out an auto loan. Because this loan is going to be a significant part of your financial future, this process may seem very intimidating!
Don’t walk in blind. The following five factors shape the process of taking out your auto loan — as well as your financial future.
1. Check Your Credit
Your credit is basically a record of your financial history over time. Good credit means you’ve paid back everything you’ve owed in a timely fashion. Bad credit means you’ve been delinquent on payments. No credit means you’re a wildcard: there isn’t necessarily enough data about your borrowing history to make a judgment about the kind of borrower you are.
You’re allowed one free in-depth look at your credit history each year. It’s a good idea to have a look at it before you take out a major loan, like an auto loan. You can see what, if anything, you haven’t paid back, so you can start taking steps to shore this up. Keep in mind that the process of raising your credit score can take months or years, and this may be difficult to do if you need a loan right now. However, even if you take a few steps to shore up your credit, the lender will see that when they run the numbers and may be more accommodating as a result.
You’ll qualify for different interest rates depending on your credit: better credit will mean a lower interest rate, which means you pay less money on your loan overall. This is because if you have good credit, your lender trusts you to pay back the money you borrow in a timely fashion.
2. Shop for a Good Interest Rate
When you borrow money (for a car, a home or anything else), you don’t just pay back the original money. You pay back an amount of money called interest, too, as a way of making it worth the lender’s time to give you that money. The exact amount of interest you pay is described as a percentage of the sum that’s added over time, and this is called the interest rate.
Lenders will run the numbers, consider your credit and the loan you’re requesting, and give you an interest rate that matches your credit and the amount of money you’re borrowing.
However, different lenders will offer you different interest rates, and you aren’t tied down to any particular lender (until you sign for your loan). Don’t be afraid to shop around and look for a good interest rate. Remember that dealers and different financial institutions will both offer you loans, and you can choose between these.
3. Think About the Length of Your Loan
When you take out a loan, you agree to pay it back within a specific length of time. Your lender may give you several options for loan length.
In general, you want a shorter loan rather than a longer one. You’ll usually pay more in your monthly payments (see below), but because interest accrues over time, you’ll pay less on your loan overall.
4. Take a Look at Your Monthly Payments
When you agree to take out a loan, you’ll agree to make a certain monthly payment every month. Many lenders offer low monthly payments on loans to rope borrowers in.
To be sure, you definitely don’t want to have to stretch considerably to make your monthly loan payments. Missing a payment can have serious consequences for your credit, and if you’re delinquent the lender may even repossess your car.
However, a very low monthly payment can have its own consequences. If your monthly payments are low, then you’re paying back your loan slowly (see point three above). You’ll pay a large amount of interest on your loan — far more than you would if you paid back your loan quickly.
This means you shouldn’t necessarily go for the lowest monthly payment. As a general rule of thumb, you want to pay about 20 percent of your income toward your loans. If you do go with a very low monthly payment, consider paying off a little extra each month — preferably as much as you can afford. This will greatly reduce the amount you pay back over time.
5. Look at Refinancing
If you have bad credit, have been pushed into a loan that doesn’t make good financial sense, or have already signed onto a loan, don’t panic. You have a very good option available to you called refinancing.
When you refinance a loan, the lender takes a fresh look at both the economy and your financial situation, including your credit. From there, they give you an adjusted interest rate on your loan. If you have multiple loans with different interest rates, you may also be able to take a special kind of refinancing called a consolidation. This simplifies the process of paying your loan back and can often reduce your interest rate.
Borrowing money creates a major financial obligation, but it doesn’t have to be scary. By keeping these tips in mind, you’ll be ahead of the game when it comes to taking out money for your new car.