When looking to buy a car, you’ll also need to shop for the right financing. Navigating that process can be daunting if you’ve never gone through the car buying process before, and you’ll likely have questions. The information here will answer most questions you have about how auto loan financing works.
The Basic Parts of an Auto Loan
Auto loans have four main components, which are described below.
Your lender may require a downpayment on your loan, which is the amount you pay out pocket for your new car. It’s calculated as a percentage of the vehicle’s total value, such as 10%.
The principal is the total loan amount. It equals the car’s value minus whatever you pay down, and it’s reduced whenever you make a car payment.
The term of an auto loan is the time you have to pay it back, usually represented in months. The longer the term, the lower your monthly payments, though shorter terms mean you’ll pay it off sooner.
The rate is the amount of interest charged on your loan. Your monthly payments will partly go toward paying off the interest on the loan. The higher the rate or the longer the loan term, the more interest will accrue before you pay it off.
The Auto Loan Financing Process
To start the auto loan financing process, you should follow these steps.
Know your budget and credit score
First, it helps to know your monthly income and debt obligations. Those will be used by your lender when approving you for a loan and determining the loan amount, interest rate, and down payment.
In addition to your monthly budget, your lender will also evaluate your credit score. It helps to look up your credit report before applying since it gives you a chance to get any errors fixed, potentially improving your score.
Collect necessary documents
The auto financing process requires specific documents, including:
- ID, such as a drivers’ license
- Proof of income, such as pay stubs, bank statements, or tax returns
- Proof of insurance
- Proof of residence
- Vehicle information (if you have already selected a vehicle)
Apply to get preapproved for a loan
With the information above, you’ll be ready to talk to your lender and ask about getting pre-approved for a loan. Getting pre-approved establishes the budget you have to work with when shopping for a car, making the process a bit easier.
Find the right car
With your pre-approved loan amount ready, it will be time to find the right car. While you can technically shop right up to the loan limit, it’s often wise to choose a vehicle that’s well under your budget, allowing for additional fees such as sales tax, dealer processing fees, and GAP or warranty products that you may decide to purchase.
Finalize the deal
Once you’ve chosen the right car, you can make the deal final with the dealer and your lender. You’ll have some final paperwork to fill out with your lender, and they’ll use the information you provide to approve you for the car financing you need.
Once it’s approved, you’ll start making monthly payments until the entire loan is paid off.
Auto Loan Financing FAQs
Going into the process, it's important to understand as much as you can about auto loan financing. The following are some of the most commonly asked questions.
How much will it cost?
The overall cost of your car will depend on these factors:
- The make and model of the vehicle
- Whether the vehicle is new or used
- Your credit score (for determining interest)
- The amount you pay down (which can reduce interest)
- The interest rate charged
In 2019 to 2020, the average cost of a new vehicle may range from $20,000 for small cars to about $55,000 for luxury vehicles.
Are there ways to save money on my auto loan?
There are many ways you can save money on your auto loan, including:
- Fixing errors on your credit report (if any)
- Paying more down on the car (at least 10%)
- Finding a lender with favorable rates
- Negotiating with dealers to get a lower price
- Opting for a shorter loan term
What loan options are available?
As far as loan options, you have several to choose from, including:
- New car loans
- Used car loans
- Auto loan refinancing (if you currently have a car loan)
Do I need insurance before buying a car?
When buying a car, you will need proof of insurance before you can drive it off the lot. It’s worth noting that approval for a car loan is dependent upon whether you have insurance. That said, your lender may be able to get coverage for the vehicle if you don’t have a policy already in place.
How does good credit help?
Good credit shows that you can be trusted to make car payments on time. As such, the higher your credit score:
- The more your lender will be willing to lend you
- The lower your interest rate will be
- The higher your likelihood of being approved
How does refinancing an auto loan work?
If you already have an auto loan that you have been paying off for a while, you may want to refinance, which will pay off your existing loan with a new one with new terms. Doing so could get you lower rates and better terms.
For instance, if your credit or finances have improved, you might want to refinance to a shorter loan term with lower interest.
Uncovering How Auto Loan Financing Works
Once you know a few things about how auto loan financing works and what’s expected of you as a borrower, the process becomes much less intimidating. This information should give you a solid start on finding the right car loan for your situation.