After a home, a new car is the biggest purchase many people will make. However, like a home, most people cannot pay cash to new car dealerships for a car purchase. Instead, most people need affordable car loans to spread out the cost of their car purchase over time so they can afford it.
However, the process that lenders use to sell and approve affordable car loans can be a mystery for many car buyers. Here are some keys to understanding how to find and qualify for affordable car loans:
Dealer Loans Offer Convenience
When you see TV commercials for auto dealers that offer loans with zero-down and zero-interest for twelve months, they are usually referring to dealer loans. Dealer loans are often the most convenient affordable car loans that you will be able to find because the dealer handles your loan application right on site.
This means that the same dealership that offers new SUV sales can sell you a car and finance the sale directly. Since you never need to leave the dealership, the sale is facilitated by the convenience of the dealer loan. This allows you to drive away from the dealership in the new car, benefitting both you and the dealer.
Although a dealer loan is convenient, you should be aware that they can be:
- More expensive: Dealer loans are often originated by the dealer on behalf of a finance company or bank. For the dealer to make money off the loan, it may add fees or set the interest rate above the rate set by the finance company or bank. For example, if a dealer originates loans from a bank with 3% interest, the dealer may quote you 3.5% interest so it can make 0.5% interest off the loan.
- Easier to qualify for: Some dealer loans are financed by the manufacturer’s finance division rather than a bank or finance company. Since they are designed to sell cars, these manufacturer-originated affordable car loans often use looser criteria for loan qualification. This means that someone with poor credit can often qualify for a dealer loan even if they would not qualify for a loan from a bank or finance company.
- Likely to be transferred: When a dealer loan is originated for a bank or finance company, your loan might look like it comes from the dealer of manufacturer, but you will make your payments to the bank or finance company. When a dealer loan is originated for the manufacturer’s finance division, the loan payments will be made to the manufacturer. However, depending on the loan terms, a manufacturer will often sell loans from its portfolio to a bank at a discount to improve the profitability of its loan portfolio.
Bank Loans Often Have Better Terms
Bank loans are an alternative to dealer loans for affordable car loans. Even though they are not as convenient, bank loans have some benefits compared to dealer loans that make them more attractive under some circumstances. For example:
- Cheaper: Bank loans are often more strict about who qualifies for a car loan. As a result, bank loans are usually cheaper because the bank only provides loans to low risk borrowers.
- Promotional terms: Banks often offer special terms for their existing customers, such as lower interest rates and reduced fees. This can make bank loans even more affordable if you already have a relationship with a bank.
- Quicker: If you apply for a loan from a bank where you already have an account, loan approval is usually quicker than applying elsewhere. This is because customers already have a history with that bank and they can combine that history with the customers’ credit reports to quickly approve affordable car loans. By contrast, a lender that you have no history with can require much more documentation from the credit agencies and even your accounting firm to verify your employment, salary, and credit rating.
Qualifying for a Car Loan
A lender will look at a few factors when deciding whether to approve your auto loan:
- Credit rating: There are fewer hard and fast rules for auto loans than mortgages. Nevertheless, a credit rating of less than 700 might only qualify you for higher interest loans and a credit rating of less than 500 might prevent you from getting a car loan altogether. However, if you have a credit rating of 700 or higher, you will likely be the best loan terms that a lender offers.
- Debt to income ratio: Debt to income ratio is a quick way for lenders to determine how much debt you have relative to your salary. For example, if you make $5,000 per month and pay $2,000 per month for your mortgage and credit card bills, you have a 40% debt to income ratio. Lenders look for a debt-to-income ratio of 36% or less to issue a new loan.
- Employment history: In addition to your salary, which is used to calculate your debt to income ratio, a lender often will want to know how long you have been employed at your job. The more stable your employment is, the more comfortable the lender is about issuing an auto loan.
Bear in mind that the term of your car loan will likely be anywhere from 36 to 60 months. This means that the lender must have enough confidence in your ability to repay to enter into a relationship that will last several years. If you have a stable job with a consistent income and a clean credit history, you should have no problem qualifying for an auto loan. However, if you have late bills from your credit card company, gas company, or even garage door repair company and a history of jumping from job to job, you might have difficulty qualifying for affordable car loans and may need to pay cash for a car or take out a high-interest loan.
You Will Need Insurance
Regardless of whether you obtain a bank loan or a dealer loan, you will be required by your lender to obtain auto insurance. The reason for this is that the lender has legal title to your car until the loan is paid. If the car is damaged or destroyed, the lender suffers the loss.
As a result, the lender will often specify in your loan agreement that you buy collision and comprehensive coverage. Collision will reimburse the lender if the car is damaged or destroyed in a crash. Comprehensive will pay the lender if the car is destroyed in a natural disaster or stolen.
When you contact an insurance agency about insuring a car that is subject to a lien, the insurance policy will name the lender as a beneficiary of the insurance. This means that if the car is in an accident, the insurance company will:
- Determine the extent of the damage.
- Calculate the claim payment.
- Allocate the claim payment to the lender first.
- Send you the difference if there is anything left after the lender is paid.
If you fail to purchase the insurance required by your loan agreement, the lender can buy insurance for the vehicle and add the premiums it to your monthly loan payment. However, this “force-placed” insurance might only cover the lender’s interest in your vehicle.
Thus, with force-placed insurance, you might be in violation of your state’s mandatory auto insurance laws because it might not include property damage and bodily injury liability insurance. Aside from leaving you exposed to a citation for driving without insurance, this could also leave you open to being personally sued by a car accident attorney if you cause an accident. Keep in mind that American roads see over 6 million accidents per year, so your risk of getting into an accident should not be ignored.
Including Options in a Car Loan
When you buy a new car, the dealer will offer options for the vehicle. From upgraded equipment to undercoating, these options are above and beyond the sticker price. For example, if the sticker price for a new vehicle is $35,000, the options you add could drive your final price up to $40,000.
You have a few options for these added options:
- Negotiate to get the dealer to include them for free.
- Pay for the options separately. In the example above, you would need to come up with $5,000 in cash for the options.
- Finance the cost of the options in your car loan. The main disadvantage of this is that you will have to pay interest on your options, making your affordable car loans more expensive.
So, for example, many high-value vehicles require an extended warranty and maintenance plan to be affordable over the long term. For example, parts, like a Mercedes Benz oil filter, can be costly without an extended warranty and maintenance plan. However, if you finance your car along with extended coverage, you can spread out the cost of your maintenance plan and extended warranty over the life of your car loan.
Paying the Loan
You can usually pay off affordable car loans early. However, this will usually not result in paying less over the life of the loan.
With a mortgage, paying off the loan early can result in hundreds, or even thousands, of dollars in savings. This is because interest is compounded as long as the loan is unpaid. This means that taking the entire term to pay off a mortgage will result in accrual of interest over the entire term.
By contrast, the interest on a car loan is usually calculated at the beginning of the loan and spread out over the term of the loan. This has certain benefits to you:
- You will pay less in interest over the life of the loan because the interest is only calculated on the principle.
- Your interest payments are locked at the beginning of the loan, which eliminates surprises in your loan payments if interest rates change.
- Prepaying your loan will not save you any money.
Alternatives to Car Loans
You have a few financing options besides a car loan to pay for a new car. Technically speaking, a car loan is a purchase money loan. This means that the loan is taken out to purchase the vehicle. The key feature of a purchase money loan is that the lender takes a security interest in the vehicle. If you default on the loan by missing payments, the lender can exercise its security interest and repossess the vehicle. For more information, don’t hesitate to reach out to a car accident attorney for help.
To eliminate the risk of repossession, you can pay for your car using other financing options including
- Cash: If you have cash from an inheritance, insurance or lawsuit settlement, or savings, you do not need a loan to pay for your vehicle. Instead, once you receive your cash from the estate, personal injury attorney, or bank withdrawal, you can purchase your car outright.
- Unsecured loan: An unsecured loan is money that is loaned to you without collateral. For example, a credit card provides unsecured credit. The benefit of using an unsecured loan from a bank, family member, or credit card issuer is that your lender does not have a legal right to repossess your vehicle if you miss your loan payments.
- Home equity loan: If you have substantial equity in your home, you may be eligible for a home equity loan. The benefit of a home equity loan is that your vehicle would not be subject to repossession if you default on your loan. The downside is that your home could be at risk of foreclosure if you default on your loan.
- Business loan: If you use your vehicle for business, such as cargo shipping, you might be eligible to use the proceeds of a business loan to purchase your vehicle. While the car might still be subject to repossession if your business fails to satisfy the loan terms, your personal credit will probably not take a hit if the loan goes into default. The only way the business loan will impact your personal credit history is if you provide a personal guarantee to the lender.
- Lease: A lease will not result in ownership of the vehicle. Instead, a lease allows you to use the vehicle in exchange for the lease payments. The lease can be structured so you can purchase the vehicle at the end of the lease for a buyout payment. The benefit of a lease is that it might be cheaper than even the most affordable car loans.
Used Car Loans
Used car loans work the same way as new car loans. However, some lenders are reluctant to make used car loans because the low principle amount means the lender earns very little interest for the risk they take.
On the other hand, many used car dealers offer dealer financing for used cars that are targeted to consumers who are unable to qualify for a new car loan. This allows you the option of buying a used car when you have poor credit, recently declared bankruptcy, or had a car repossessed.
Affordable car loans are available for nearly every consumer regardless of whether the vehicle is new or used. Moreover, these car loans are available to businesses and individuals. Keep in mind that you should carefully compare the terms of dealer loans and bank loans to choose the best option for you. Moreover, investigate other options, like unsecured loans or leases, to determine if the cost and terms fit your needs.