Ultimate Guide to Auto Loans

Everything you need to know about auto loans.

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Are you ready for your next car, but need an auto loan to pay for it? If so, you are like 85% of new car buyers and 54% of used car buyers in the U.S., according to Experian’s 2018 State of the Automotive Finance Market report.

Of auto loan borrowers don’t originate their lowest available interest rate. In other words, their credit score should have allowed them to get a better interest rate.

Unfortunately, many factors come into play when financing a vehicle, and things can quickly get confusing. However, if you do your homework before walking into the situation, you can walk out with confidence knowing you got a good deal.

Here, you will find everything you need to know to brush up on auto loans.

How do auto loans work

First, let’s look at the different parts of an auto loan.

Interest rates

Auto loan interest rates are communicated in the form of an annual percentage rate (APR), which is the cost of credit (including fees) per year expressed as a percentage.

All lenders are required by the Truth in Lending Act (TILA) to specifically disclose the APR to the borrower before they are legally obligated by the loan. This is great because it gives you a way to compare one lender’s offer to another’s.

According to Experian, here are the average auto loan rates by credit tier for Q1 of 2018:

Most auto loans have variable rates, which will adjust based on the prime rate or another index. When the rate goes up or down, the monthly payment also goes up or down. The longer the loan term, the higher the risk that the variable rate will increase.

Fixed rates, on the other hand, stay the same throughout the loan term.

Loan terms

The loan term is the length of your loan, and it is expressed in months.

Most lenders offer terms in 12-month increments ranging from 24 to 84 months (two to seven years). In 2018, the average term on new auto loans is about 69 months, while it is about 64 months for used auto loans.

The longer the loan term you choose, the more you will end up paying in interest. However, longer terms can lower your monthly payment amount.

It’s best to consider the total loan cost and the monthly payment amount for the various loan term options in order to identify the best solution for your situation.

Down payments

The down payment is the bulk amount that you put down at the time of purchase. For example, if a car costs $20,000, you may put down $5,000 and finance the other $15,000.

The more you can put down, the more you will save on interest as the loan amount will be less.

If you get approved for a loan amount that is less than the price of the car, you will have to pay the difference as the down payment. If you get approved for the full amount, some lenders may still require a down payment while others will offer 100% financing.

Even if you can get 100% financing, it’s usually a good idea to put a down payment on the car so you don’t end up owing more than the car is worth. New cars can lose up to 25% of their value in the first year, so it’s good to put down at least 20%.

Vehicle pricing

The vehicle price is the amount you pay for a vehicle. It’s important to use the resources available (consumer guides, Edmunds, NADA guides, online classifieds, etc.) to understand the fair market value of a vehicle before you agree to a price. You’ll want to have a number in mind before meeting with the seller.

Monthly payments

Loan repayments typically involve monthly payments, which are calculated based on your principal loan amount, interest rate, and loan term.

Trade-ins

A trade-in refers to a buyer trading in his or her current vehicle to buy a new one. Buyers may sell the trade-in to the dealer and apply the agreed-upon amount to your purchase or sell it on their own and use the proceeds as the down payment.

Dealer incentives

Many dealers offer incentives to entice buyers and close deals. Often, you can choose between a discount on your interest rate and a cash rebate, which the dealer will deduct from the vehicle price.

Other costs

In addition to the vehicle price, other items may increase your expenses, such as:

  • Extras: Dealers may offer you optional services and features like GAP insurance, extended warranties, tire and wheel protection, paint protection, alarm systems, window tinting, etc.
  • Title and registration: These fees are set by your local and state government and depend on your vehicle weight and age.
  • Documentation fees: These are negotiable fees set by the dealer to prepare paperwork, ship the vehicle, prepare the car for sale, etc. Be sure to check how much you are being charged. Some states cap this fee while others don’t. Median doc fees range from around $100 to around $800, varying by state.
  • Taxes: Taxes are non-negotiable and will vary by state, ranging from 0% in New Hampshire to 12% in Arkansas.

All of these add-ons, except for the taxes, can typically be rolled into the loan. While convenient, because you don’t have to pay out-of-pocket, it can cause you to owe more than your car is worth and will increase your monthly payment amount.

The total cost of your loan will include the vehicle price, interest over the loan term, and add-ons minus any down payment, incentives, or trade-ins.

It’s important to understand how auto loans work so that no lender can pull a fast one on you. You should analyze all offers by looking at the total cost, the breakdown of costs, and the monthly payment amount.

With this holistic view, you will be able to select which one is the best on all fronts.

Negotiating an auto loan

The process of buying a car notoriously involves haggling. The thought of negotiating is enough to make some people put off buying a car until the absolute last minute. Only 31.6% of car buyers negotiate the interest rate on their loan

A recent survey by the Federal Reserve reported that 76.1% of car buyers negotiated the purchase price with the seller, but only 31.6% negotiated the interest rate on their loan. It gets worse. 27.1% of car buyers considered the monthly payment on their auto loan as the most important factor, but only 6.1% considered the interest rate on the loan as the most important factor (source).

Comparing financing costs is not as easy.

There are two main reasons car buyers overpay in financing costs.

  • A lack of transparency on available rates
  • Not understanding the actual cost of auto financing.

SuperMoney solves both of these problems through its transparent auto loan offer engine.

Dealerships can hide interest hikes behind longer terms precisely because they know most borrowers focus on the monthly payment amount, not the overall cost.

In a recent study, about 54% of borrowers did not originate their lowest available interest rate? In other words, their credit score should have allowed them to get a better interest rate, if they had shopped around.

However, there are some things you can do to make it less painful while increasing your chances of success.

First, let’s look at which parts of an auto loan are negotiable:

You may need to negotiate with two parties: the seller and your lender. However, they might end up being one and the same.

It’s important that you keep your eye on the big picture throughout the negotiations, being careful that you aren’t saving in one place while paying more in another. For example, a lender might lower your interest rate but extend your loan term.

Keep your eyes on all of the factors as you make efforts to save. You’ll gain leverage by shopping around for financing and getting pre-approved before speaking to a dealer about buying a vehicle.

Doing so allows you to shop for a car with the negotiating power of a cash buyer. You’ll be able to confidently negotiate the vehicle purchase price, add-ons, doc fees, and lending details.

Where can you get an auto loan?

Many financial institutions extend auto loans to borrowers including dealers, banks, credit unions, and online non-bank lenders.

Dealers and car manufacturers

Dealers and car manufacturers often work with a network of financing companies to offer buyers a one-stop shop. Once you find the car you want, you can apply and the dealer will come back with a financing solution for you.

While this can be convenient, it’s not always the best option. Dealers can be biased and may work your financing in their best interest rather than yours. Further, they may not have the best deal, so it’s always good to shop around.

Banks

Most banks, from large to small, offer auto loans as well. You can often apply online or by visiting a branch.

Credit unions

Credit unions also offer auto loans and are known for their competitive interest rates. However, you will have to be a member to apply for their loans.

Online non-bank lenders

Lastly, a large number of non-bank financial companies that offer auto loans have cropped up. You can easily apply with many of them in just a few minutes and can get funding directly deposited into your account within days.

With so many lending options, how do you decide which is best for you? There’s only one way to find out what you can get, and that is to get pre-approved.

Various lenders advertise low APRs and attractive terms, but those are not always going to be available to you. It’s best to perform some research, build a short list of lenders with good reputations, and get quotes from each of them.

After doing so, you can compare the offers to the offer you received from a dealer and see which provides the best value. No matter what, never take the first offer you get – always compare at least three.

Factors that auto loan lenders consider when approving borrowers

When you apply for an auto loan, what will the lender consider? Well, lenders can vary in their eligibility requirements and standards. However, the two common factors that will play a role in the decision are your debt-to-income ratio and your credit.

Debt-to-income ratio

Your debt-to-income (DTI) ratio represents the amount of debt you have compared to your income.

For example, if you make $4,000 per month and pay $1,000 to your mortgage, $200 to your credit cards, and $300 to an installment loan, your DTI  would be 37.5% ($1,500 divided by $4,000).

Most lenders will generally want your DTI to be 40% or less, including the debt you will owe them. This reduces the risk that you will default on the loan.

Credit

Secondly, one of the best ways for lenders to understand the level of risk you present is to look at how you have handled credit in the past. Being so, they will check your credit report and credit score.

The credit score is determined by looking at your payment history, amount owed, length of credit history, credit mix, and new credit. Lenders will use this information to decide if they will lend to you and what interest rate you will have to pay.

According to Experian, here is the auto loan balance risk distribution across credit score categories in the U.S.:

Many lenders have minimum credit requirements around 620. However, there are those that specialize in helping people with subprime credit as well as those with super prime credit.

So, it’s good to shop around.

Auto loan refinancing

What if you already have an auto loan but think you can get a better one? In this case, you may want to consider auto loan refinancing.

What is auto loan refinancing?

Auto loan refinancing involves getting a new auto loan which you use to pay off your current one.

Learn more about how to refinance an auto loan

When is it a good idea to refinance an auto loan?

It’s usually a good idea to refinance your auto loan when you can save money by doing so.

You will likely be able to save if:

  • Your credit has improved since your last loan
  • More competitive rates are available now
  • You got a bad deal on your current loan

Jim Landy, CEO at SpringboardAuto, says, “It is a good idea to regularly check your auto loan to see if you can reduce the payment or interest. At SpringboardAuto, we’ve made it easy for customers to see if they would benefit from a refinance.

Our customers simply fill out a three-minute application, hit submit, and instantly see their potential savings without impacting their credit score. On average, our recent customers have saved $85 on their monthly payment, over $1500 in interest, and we’ve been able to reduce APRs by 6.7%.”

Some people also opt to refinance as a last resort before defaulting on their loan. By extending the loan term, you can often lower your monthly payment amount. However, keep in mind, doing so will cost you more in the long run.

Should you refinance your auto loan?

Auto refinance lenders

Wondering where to find the best place to refinance your auto loan?

Try out SuperMoney’s auto loan engine. Within minutes, you can get pre-approval offers from a variety of competing banks and alternative lenders.

Browse auto loan refinancing companies

Auto loan FAQs

Now let’s look at some frequently asked questions.

Should I buy or lease my next vehicle?

Both options have their pros and cons.

If you choose to lease, you can save on your monthly payment, get a new car every couple of years, and put less down. However, you won’t be earning equity, you’ll have to stay under a mileage limit, and you must keep the car in great condition.

Buying the car is more of a long-term commitment, which can be more expensive per month and up front. However, you will eventually own it and can do with it as you please.

Read more about buying vs. leasing. 

How much can I afford?

We recommend keeping your car costs, including the ongoing costs of ownership (gas, maintenance, registration, etc.), to a total of 20% or less of your monthly take-home income. If you are only focusing on the monthly payment, use the 20/4/10 rule as a guideline. In other words, put 20% down on the car, don’t finance it for more than 4 years, and keep the payments at 10% or less your income.

Should I buy new or used?

Although new cars are great, there are several advantages to purchasing a used car. Price being chief among them. You might not realize that your brand new Jeep Cherokee is worth $10,000 (or more) less than when you drove it off of the lot, but that’s the reality. The better option is to let someone else take the hit for that first one or two years of depreciation, and then purchase a slightly used vehicle that still feels like new. These cars are more affordable, have many of the most advanced features, and usually still have a year left on their warranty.

Of course, it will depend on your needs and preferences. Read the pros and cons of both options here. 

Do I need gap insurance?

If you total your car, gap insurance pays the difference between the actual cash value paid by your insurance and the balance you owe on the car.

If that gap is going to be an amount you don’t want to be responsible for in the event of an accident, gap insurance is a good idea. Further, some lenders will require it if you don’t have a sizable down payment to put down. Read more about gap insurance

What is zero percent financing?

Zero percent financing in when you get a loan and pay no interest on it. Sounds too good to be true, but it does exist.

Find out where to find it and how to get it. 

Why should I focus on the total cost of the loan?

Many factors go into an auto loan, and they can be confusing. Looking at the total cost will help you understand how all the components impact the bottom line.

Can I get an auto loan with bad credit?

While getting an auto loan with bad credit can be more difficult, it’s not impossible.

Learn more about how to do so here. 

Find your best auto loan rate in minutes!

Now that you’ve freshened up on your auto loan knowledge, you’re ready to get out there and find the best deal.

To help make that process as easy as possible, SuperMoney has developed an efficient auto loan engine that does the hard work for you. All you need to do is click the link below and answer a few quick questions.

Then, you can receive competing offers from multiple auto loan lenders without hurting your credit score. It simplifies the process and allows you to quickly compare lenders side-by-side.

Find your best auto loan offer here!

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