It is a relatively straightforward process if you’re wondering what car financing is and how it works. It is when a loan is given by a lender to a borrower, with the understanding that the latter will use the funds to purchase a vehicle.
The loan’s conditions may depend on your credit score, income, and other factors examined during the loan application process. This process is generally easy, and some specialists can assist.
What is Car Financing? And How Does It Work?
How to Get a Car Loan
Determining if one is eligible for a specific type of vehicle loan is completed through an application process. This process asks the would-be borrower to provide personal and financial information, based on which it is then determined whether one meets the requirement for the said loan. The individual can choose the lender, or it can be chosen based on the information provided. Many lenders are available for this.
The amount and type of lenders available to give you an auto loan depends largely on your financial background. Once the loan application has been approved, it will be processed, and the funds will be disbursed to the borrower so that he/she may complete the purchase of their chosen vehicle.
Usually, at that point, the borrower transfers the funds to the vehicle merchant, who delivers the vehicle to the borrower. After that point, the borrower is supposed to start paying back the loan. The precise details of the repayment process (such as interest, etc.) are determined priorly in the agreement signed between the lender and the borrower.
Steps to Take Before Taking Out an Auto Loan
Step 1 – Determine the Size of Your Budget
The vehicle price one aims to purchase is an essential factor, as the purchase must fit within one’s budgetary constraints.
In addition to considering the range of prices for the type of vehicle you’re thinking of, it is also advisable to examine what kind of warranty comes with it, as a good warranty can help you save significant amounts of money down the road on maintenance.
Step 2 – Shop for Auto Loans
There are different types of auto loans that are available to potential borrowers. Each one comes with a series of benefits and disadvantages, and it is important to be aware of them when considering what type of auto loan to choose. Usually, most potential buyers consider the following points when deciding which auto loan provider is the best for their needs:
- Interest rate
- Repayment terms
- One’s credit score and which lenders accept it
- Lengths of time of repayment process
- Whether to make a down payment and what size
- Other extras, such as taxes, surcharges, and fees
Banks, credit unions, car dealers, and online lenders; are all entities that can provide a personal car loan.
Step 3 – Get Preapproved for a Car Loan
Certain automotive dealerships allow one to be “preapproved” for loan financing. Simply put, pre-approval is when a merchant considers a potential buyer’s financial details and declares that, based on this info, the buyer is eligible for a particular type of loan with specific conditions. It is important to note that preapproval is different from a pre-qualification.
| Pre-Approval | Pre-qualification |
| A pre-approval is when your credit score and other financial information have already been reviewed. An amount is given, and a letter of approval is issued. Once a vehicle is chosen, this preapproval is then used to purchase. | A pre-qualification means that you will likely receive the loan at the rate given based on minimal financial data. It is not a solid offer to fund you, just a snapshot of what you could get. |
| ● It does require a hard credit pull
● You’re a ‘cash buyer at a dealership or through a private seller ● You will likely get the rate offered during the pre-approval |
● Requires a soft credit pull
● The rate may change based on the hard credit pull ● Usually has a wide range of interest rates that are possible, but none are guaranteed |
Step 4 – Compare Lenders
One of the most important factors to consider when comparing car loan lenders is which one offers the best interest rate. Other essential details to look at are the terms and conditions and the payback schedule of the loan. One would be well advised to spend some time digging and researching the data mentioned above.
Step 5 – Choose and Finalize Your Loan
Only after you have done the proper amount of research will you be ready to choose a lender that is the best for your needs. After that point, you will be prepared to sign off on your loan. Because you are entering into a binding legal agreement with the lender, completing the process requires typically signing a significant amount of legal documents and various other types of paperwork. However, many online lenders have recently tried drastically reducing the paperwork needed to complete the process.
Types of Car Financing
Secured auto loans vs. unsecured auto loans
Secured auto loans are loans where the vehicle that’s purchased is being financed with the loan is also considered to be collateral for the lender. A lien is put on the vehicle until it is fully paid off. If the borrower fails to meet his/her re-payments obligations, the lender may take possession of the vehicle as compensation.
Unsecured auto loans are loans where the vehicle is not considered as collateral on the loan. The lender may not take the if the lender is unable to meet his/her repayment obligations.
Simple interest loans vs. precomputed interest auto loans
A simple interest rate is a rate that is put onto your monthly payment amount. This amount goes down each month that you pay the loan. If you choose to put more money down on the loan for a month, the interest will continue to go down.
Those who have precomputed interest rates will not have a loan whose interest rate goes down when an extra payment is made. You do not get the same interest reduction under the terms of a precomputed loan as you would with a simple interest rate.
If you pay the loan on time, there is little difference between the two because you still pay the same amount of interest, just in a different manner.
Direct auto financing vs. indirect auto financing
Direct auto financing comes directly from an institution such as a credit union or bank of your choice.
Indirect loans are either provided by the dealership itself, or a lending institution that has a priorly-established working relationship with the dealer.
Indirect lending tends to offer more programs to work with, giving the buyer more options of loan-term conditions and interest rates to choose from.
Pre-approved auto loans.
Pre-approved auto loans are given to individuals once their credit has undergone a hard pull, their financial background has been investigated, and all other necessary bits of info taken into consideration.
Obtaining a pre-approval for an auto loan helps you shop for a vehicle and not worry about the financing for it.
Special types of auto loans
These two specific loan types are reserved for special circumstances, so you may not always come across them.
Lease Buyout Loans
This is a path that a lessee can take if he/she wishes to keep the vehicle after the leasing period is over. A lender provides the funds for the lease buyout up front to the car merchant. The buyer of the car then pays this sum back to the lender.
Title Loans
These loans are for vehicle owners that require a loan. The loan is held against the vehicle as collateral. The loan can be used for anything, but the vehicle can be repossessed if it is not paid back on schedule.
Why Would You Need a Car Loan?
Those who are looking to obtain a car loan usually require a vehicle which is why they’re looking at financing options. There are many options available for those who want to purchase a vehicle.
Those who are worried about the price, you don’t have to be because the price of an average compact car in 2020 is $22,000. This is an affordable amount, especially with a personal auto loan from the right lender.
Even the highest performance car’s average price is just around $95,000, though you don’t have to go this high if you don’t need a high-performance vehicle.
Some are interested in financing the purchase of an electric car, and these can range in price depending on what you want to purchase. They are around $54,000-$64,000. These vehicles are becoming more popular because of the need many members of the public feel to reduce carbon emissions.
For example, if you are considering purchasing the New Tesla Model X, you can obtain a loan for up to $81,000 when you apply yourself. If this is an amount you’re not looking into, then you can consider a lower Model from Tesla, like the Model S which is around $71,000 for the base model.
So, whether you want a mid-size SUV ($40,000) or a large Lincoln Navigator ($76,000); you’re able to find the lender that can offer the best loan to cover either of these amounts if you qualify for them.