Everyone needs a set of wheels regardless of your success in paying your bills in the past. Life happens, and sometimes things don’t work out the way you had intended them to – but you don’t have to settle for just four old wheels and a seat; there is still room for choosing a car loan.
Often, a dealership will run your credit several times until they find a car loan provider willing to approve your car loan application. While you might be successful in scoring the ride you wanted, they’ve likely driven your credit score even lower, and you can plan on paying an even higher interest rate.
Thus begins the vicious cycle – your credit is less than great, so you pay a higher price. When you can’t pay the higher price, your credit gets worse…sensing a theme here?
Walking into a meeting about your car loan application can be an intimidating experience, so coming prepared is a must. Let’s get schooled on choosing a car loan and talk about everything you need to know to make it a success – regardless of an arbitrary credit score.
Choosing a Car Loan - Don't Rely on the Dealer
A common mistake is to check out online customer reviews of a certain dealership without giving any thought to your car financing solutions before walking through the door.
Dealers are professionals at spinning yarn to get you into the vehicle at the top of your budget range (and usually just above it) and then sending you directly to their in-house finance guy. What seems like a courtesy and a major convenience is likely costing you thousands of dollars if you spend some time comparing car loan costs.
Check Your Credit Report Beforehand
The more information you have before showing up to purchase a vehicle, the better. Everyone is entitled to one free credit report annually in which you can check your scores on the three major reporting agencies – TransUnion, Equifax, and Experian. Getting your history and score from each is essential because it is difficult to know ahead of time which service a car loan provider uses for their verification.
Come Prepared
If you show up locked and loaded with all your requisite personal information and a chosen car loan in your back pocket, you should still hold your cards close to your chest.
First, be ready to provide the following:
- Full name and ID to prove it
- Monthly income and employment history
- Tax returns
- Your permanent address and a fairly recent utility bill
- Your exact specifications for what you want
When it comes to describing exactly what you want, try to remember that function is more important than form. If you can buy the same model automobile with all of the features you need that may not be your favorite color for the same price as a car painted your favorite color with none of your requisite features, think about the difference.
Set and Stick to a Budget
Many car buyers can get wooed by a car salesman or how a car looks. Don’t fall into that trap! Before you start shopping, sit down and assess your and your family’s monthly expense budget.
Determine what you can reasonably afford and go on from there. But don’t forget to add in, or at least consider the peripheral costs, as well. Insurance rates can differ greatly if you choose a new luxury car or a luxury SUV, simply because they cost more to fix and insurance companies have to adjust to the market.
For example, a typical 2022 four-door sedan with full coverage could cost you up to 30% less than a luxury SUV from the same manufacturing year, according to an anonymous insurance broker with knowledge of the process. For context, that can mean the difference between an annual insurance cost of $800 for a policy and $1200 for a policy. Thus, the fringe costs are important to consider.
Don't Forget Gas Mileage
This should be a pretty big no-brainer, but with the cost of gasoline soaring at present and no signs of it slowing down, it’s important to consider the gas mileage of the vehicle you’re seeking a loan on.
Maybe you can afford that Hummer, but can you afford the gas for that monster? Let’s be reasonable here! You can fit the kiddos, their car seats, their friends, and all of their tee-ball gear into a nice, sleek new crossover for a fraction of the price – especially in today’s market!
Comparing Loan Costs
This aspect is all about your relationships with local banks and credit unions. It can be tough to navigate without bombing your credit score, also. If you do the proper homework beforehand and go into local institutions with which you have a good rapport, you can basically lay out hypothetical facts.
“Here’s what my TransUnion score is. Here are my assets, and here is my annual salary – hypothetically, what do you think you could offer?” This method will save you the hard inquiry on your credit report.
Save Money for Your Down Payment
Wait, you mean that having some money upfront might be able to lower your loan costs? Like, if you pay with real money?
That’s right, y’all. Use some of that cash you’ve squirreled away for a rainy day and throw it toward your down payment. Often, people get sucked into the idea that they have to trade in their vehicles and their down payment and then just eat the rest of the cost in order to get the car and the loan that they want.
There’s no way around it – the market for used cars right now is bleak on the consumer end. You could pay much more than you anticipate for a vehicle due mainly to the old law of supply and demand. The more fluid currency that you can punch down on the table, the more likely you are to walk out with a deal (and vehicle) that you want.
The ideal amount, while not affordable for everyone, to put on a down payment for a car is 20%. This will go a long way toward keeping the terms of your car financing solutions manageable and within your budget.
Comparing Online Customer Reviews
As we briefly touched on above, online customer reviews should be taken with a grain of salt, as many who take the time to leave a review are the customers who are unhappy or have a negative agenda to follow. However, keeping an eye on legitimate Consumer Reports and Kelley Blue Book ratings can be an invaluable way to keep tabs on the car loan provider that you are considering.
It’s likely a smarter idea to read online reviews of the lender than the car manufacturer.
Understanding What Credit Scores Will Get What Interest Rates
An unfortunate reality of today’s automobile market is the nearly universal need for a car loan. As mentioned above, it is always a great idea to head into loan negotiations prepared. Along with the aforementioned documents, it is also a good move to understand what you can expect in terms of a reasonable interest rate considering your credit score.
Consider Preapproval
Rather than walking blind onto the lot of a car dealership, you can also come in with a loan preapproval in your back pocket. This will go a long way toward helping to stay within your budget and avoid temptation and a salesman’s pitch for upgrades.
For example, let’s say that you are pretty sure you can get a loan for $25,000. You show up at the dealership and the sales team asks what your budget looks like. If you tell them that your budget is $25,000, they’re going to make every effort to sell you a car for $27,000 and then extol the virtues of an extended warranty, roadside assistance services, and a bunch of other tacked-on extras.
By the time you walk out of there, you’ve got a $15,000 clunker and your head is spinning because you’ve signed a loan for $30,000!
If you show up with a preapproval, and your car financing solutions are all lined up, you can tell the dealer that the $25,000 is preapproved and it is your out-the-door ceiling. In that case, you might be able to buy yourself a little leverage – especially if you’ve got some of that cash saved up that is mentioned above.
Understanding the Four Main Types of Car Loan
While there are many iterations and variations on traditional car financing solutions, there are four main types of loans to consider while choosing a car loan.
Used Car Loans
Used Car Loans can be a double-edged sword. You are more than likely to pay a higher interest rate for a used car because the life of the car is shorter and it will depreciate faster. As a result, the lender must charge a higher interest rate to make the loan worth their investment.
Conversely, the total loan amount should be lower, as the vehicle has already begun to depreciate in the eyes of the lender and therefore the asking price is also going to be lower. The same should hold true for vehicles that you may choose to buy from a private citizen. The logic is simple – the vehicle has been used before, so the price is lower.
Playing these advantages and disadvantages off of each other is the key to making the most out of your dollar. The more fluidity that you can throw toward paying off the loan, the better.
New Car Loans
We’re in similar territory here with new car loans as we discussed above with used car loans. Only take everything from the section above and flip it – new car loans will have a much lower interest rate because the principal amount of the loan will be much higher.
Once again, the more money that you can put toward a down payment, the better. This is even more the case with a new car loan than a used car loan – there is often less room for negotiation with a new car than with a used car.
The price of a used car can be manipulated depending on the market, the need for the car, and the acumen of the salesperson. The price of a new car runs a little more strictly toward the Manufacturer’s Suggested Retail Price (the MSRP). The benefit here is that you’re relying a bit more on the factory price than the number that the dealer makes up.
Lease Buyouts
Lease buyouts are akin to rent-to-own deals. Not every lender or dealer offers such an option, so you should ask about this before assuming that you can count on it. Interest rates are typically higher than with a new car loan, as they treat them much like a used car loan.
If you don’t need or plan to put heavy mileage on the vehicle, a lease buyout can be a great investment. The vehicle will depreciate at a much slower rate if you don’t put a ton of mileage on it, especially during the life of the lease and/or loan.
Loan Refinancing
It is wise to think of car loan refinancing as nothing more than a possible option. For those experiencing the right circumstances, refinancing can be an amazing move that can save large amounts of money. However, if your credit has gotten worse or you’ve defaulted on numerous payments, it’s best to just stay the course and try to ride out your current loan terms until something changes.
The premise of car loan refinancing is this: you find or earn a loan with a better interest rate because of a special promotion or because your credit score has dramatically increased. As a result, you qualify to refinance your old (more expensive) loan by paying it off with a new (less expensive) loan. Sounds like a good deal, right?
Secured Loans vs. Unsecured Loans
This is simple – secured loans are going to be significantly cheaper than unsecured loans. This is due to the fact that secured loans involve collateral. Collateral is an asset that you agree to turn over to the lender in the event that you cannot pay the debt with currency.
Alternatively, you can offer to turn over the assets in place of money to “secure” the loan. That “security” is for the lender and it is what qualifies the loan as a “secured” loan.
The collateral mitigates the risk to the lender because it contractually allows them to recoup losses in alternative methods. If you don’t pay the loan, they get the car, in short. Regardless of how much you’ve already paid on the loan, if you default on your loan (check those loan agreements before you sign anything), the lender is legally allowed to take possession of the vehicle.
Entering into a secured loan agreement is very likely to get you a much lower interest rate than an unsecured loan because the risk is lower for the lender. Any opportunity that you can seize upon to mitigate the risk for the lender – higher down payment, more collateral, etc. – will lower the interest rate of the loan itself. If it doesn’t, then you’re working with the wrong lender!
It's All About Total Cost
Dealers have a real knack for talking up the low monthly cost of a car loan, and rightfully so – on their part. Without thinking too hard about the peripherals, what sounds better – $700 a month for three years, or $400 a month for five years? $400 a month is a no-brainer, right?
Wrong. The longer the loan, the higher the interest. The car will depreciate more over that five years than over three years, so the lender is going to want more on the back end to recoup its investment.
Okay y’all – get your calculators out. Let’s say you’ve got a $20,000 used car loan. At the average rate of 5.58% for someone with an average credit score, your balance will be $21,116 at the time you sign the contract.
This will put your monthly rate during the first year at roughly $587, which would theoretically put your total balance at about $14,072, which equals out to about $14,857 after interest. If you continue to pay $587 per month, you will pay off all but about $775 of your loan after two years. By now, you see the trend.
Now, stretch that same $20,000 at 5.58% over six years using the same (albeit rough) math used above.
Your initial monthly payments will be slightly more than $293 per month. bringing your total payments to $3,516 over the course of the first 12 months. This would leave your new balance at $18,582 after interest, and at $15,911 after interest in 24 months.
The keywords above, mind you are “average credit score.” If you are reading this, you may have some knowledge – or at least some concern – that your credit is less than average.
By now you can see a theme. The shorter the loan term, the more you save on interest. There may be some rough math in there, but you get the point.
Do Your Research on Maintenance Costs
Something that many consumers don’t take into account when purchasing a new car is the overall cost to maintain that specific vehicle. There is a wealth of information that can be found online via online customer reviews, consumer reports, or by calling an unbiased local mechanic that you trust.
While vehicle maintenance is not a primary relation to your car loan, it is still definitely an important consideration before filling out a car loan application. If you’re buying a used car that is (unbeknownst to you) infamous for transmission problems, for example, or if there are multiple recalls that need to be addressed, you should beware. The quickest way to dive-bomb your car loan is to have to shell out several thousands of dollars in unexpected maintenance costs that may force you to be delinquent on your loan due to lack of funds.
Imagine this, for instance: you just paid your mortgage and then you had to pay your kid’s college tuition for the semester. Your car payment is already bordering upon untenable when “boom!” – the front axle on your two-year-old SUV snaps. Sure, your insurance might cover it if you have an accident, but there’s still the deductible, the upfront costs associated with any medical bills, and so on, and so forth.
The moral of the story: take a very deep dive into a vehicle – especially a used vehicle, before you approach any car loan provider, regardless of your credit score.
The Bottom Line
The bottom line when choosing a car loan is to educate yourself before approaching a car loan provider in regard to your credit score and what you can be approved for. Also important is to do your homework on the specific type, make, and model of the vehicle you are interested in. But the one most overall important aspect of choosing a car loan is to remain calm and don’t let yourself fall too much in love with one specific vehicle or dealership.
It’s much more important to consider all of your car financing solutions before jumping the gun on a car loan that is going to make your questionable credit score even worse in the long run.
An educated consumer is a smart buyer. When you’re finished comparing loan costs and you are ready to talk to a car loan provider, you should know all of the ins and outs, ups and downs, and in-betweens in terms of that loan, vehicle, and provider.