How do Car Loans Work?

car loan transaction

Buying a car is a big purchase, but just like buying a home, it’s a worthwhile investment—one that requires understanding the process and shopping around to get the best price.

While cars are designed to take you from A to B, vehicles today are equipped with all kinds of high-tech and luxurious features to make the journey as comfortable and safe as possible. But what about the price tag?

Whatever your financial situation, a car loan may be the solution you need to afford the car of your dreams.

In this article, we’ll review how car loans work and what you need to know.

Best Car loans

Types of Car Loans

Similar to other types of loans, auto loans come in two varieties: secured and unsecured. So what’s the difference and which should you choose?

Let’s take a look.

Secured Loan

A secured auto loan means the lender has a lien on the vehicle, which is essentially an insurance policy for the lender that allows them to reclaim the vehicle if the borrower fails to pay back the loan for any reason.

Only once the car is paid off in full will the lender sign over the title to the borrower and release the lien. In short, you’re using your car as collateral on the loan, which comes with some benefits.

The appeal in taking out a secured car loan is that they’re easier to qualify for and you’re more likely to secure a better interest rate.

Unsecured Loan

An unsecured loan simply means that there is no lien on the car’s title and the lender wouldn’t be able to repossess the vehicle if the borrower were to default on their loan. If this happened, the lender would have to pursue other avenues in reclaiming the auto payments, like sending the debt to collections.

This, of course, means more risk for lenders since they don’t have any collateral on loan, which would result in higher interest rates and stricter qualification requirements for the loan.

How the Process Works

A car loan works fairly similarly to other kinds of loans. You find a lender to borrow money from (assuming you’re not going to be paying for the car in cash) and you pay that money back over a fixed period of time—plus interest and fees.

How to Find Lenders

Finding auto loan lenders has never been easier and goes beyond your brick-and-mortar banks. There’s a wealth of reputable online lenders that cater to borrowers from all kinds of financial backgrounds.

Some specialize in offering car loans to borrowers with low credit scores (which means higher interest rates) and others are best suited for those with good credit scores (meaning low-interest rates).

LightStream is one online lender that offers a variety of loans online, including auto loans, for low rates, but you’ll need to have excellent credit to qualify.

Best Egg is an online lender that offers personal loans for cars with a fixed APR. You can visit their website and get a quick quote by submitting some basic information to see what you qualify for.

If you’re more interested in quickly comparing rates from multiple lenders, Lending Tree is a platform that allows you to search through their network of lenders to find a loan with the best rates based on your specific financial profile. Rather than wasting time submitting multiple applications, you can submit your information on their website and immediately get matched with lenders.

Application Process

A big benefit to using an online lender is that everything is conducted online. There’s no need to step foot in a bank. So where does the process begin?

To find the best auto loan rates, you’ll need to shop around. Once you find a few reputable lenders, you’ll want to get pre-approved. Getting pre-approved just means that you’ll be able to see the interest rate and loan terms you qualify for. If they’re favorable, you can go ahead and complete the application process.

This process will vary somewhat, depending on the lender—for example, some will require a hard credit check and others won’t—but generally, they all require the same personal details, like your name, address, credit score, social security number, salary, and debts.

Credit Score and Debt-to-income-ratio

Your credit score is an important factor in the application process, as is your