The Auto Loan Basics You Need To Know And How To Make Them Work For You

Buying a new car is an exciting experience when you are prepared for all of the decisions you will need to make. Choosing the car you want to buy is the fun part, figuring out the ins and outs of auto loans can often be seen as stressful or confusing. However, auto loans are not as complicated as some people believe them to be. Knowing the basics of them and how they work can make your whole car buying process easy.


You need to determine how much of a car payment you can afford to make. This will be one of the determining factors in how much you can ultimately spend on your new vehicle. Be sure to consider how much you will owe to insure the vehicle. Most auto loans require you to carry full coverage auto insurance for the duration of the loan.

There are some factors that can help you change what your payment will be. A down payment can lower your payment considerably and in some cases might be required by the financial institution depending on the vehicle you are trying to finance, your credit score or your current debt to income ratio. You can also choose the term of your loan which influences your payment amount. Popular options range from 48 to 84 months with many intervals in between. While a longer term may lower your payment, there is a downside to that which will be explained with the interest rate and should be considered. The final influential factor for your auto loan payment will be your credit score which will determine the interest rates that you will be offered by the competing financial institutions.

Credit Score and Interest Rates

Your credit score is simply a numeric rating system used to identify how well you have done with making payments. Financial institutions use this score to determine their risk when considering loaning you money or extending a line of credit. Understanding it is pretty simple, low scores are bad and the higher the score, the better. The higher your credit score is, the more likely you are to be approved for your auto loan. A higher credit score can also contribute to you being offered a lower interest rate on your auto loan. In most cases when you hear a car dealership advertising an extremely low rate, that will be reserved for buyers with very high credit scores, often above 750 or 800. This is important because the lower the interest rate you can obtain, the lower your payment will be. Interest rate is also extremely important if you are considering a longer term for your auto loan. The total interest paid over the course of an 84 month loan can be almost triple what is paid over the course of a sixty month loan even when the total amount financed is the same in both examples. Financial institutions will compete to earn your business and their primary means of competing with each other is through the interest rate. Take the time to compare offers or allow the car dealership’s finance department to shop for the lowest rate for you. Even a fraction of a percentage point will save you money over the course of the loan.

Used or New

Both the age of a vehicle and the mileage on the vehicle are important factors in the approval process for an auto loan as well as whether the vehicle being financed is a used vehicle or a new one. If you are looking at an older vehicle or one with high mileage simply because they cost less and you want a lower payment, this might actually work against you. The financial institution might limit the term of the loan to 36, 48 or 60 months depending on the age of a vehicle or the mileage on a vehicle simply because those two factors heavily influence the vehicle’s value. The financial institution will try to make sure that the vehicle will be worth the amount owed on it, or very close to the amount owed on it for the term of the loan to protect themselves in the case that you default on the loan. Because of this, it is possible to get a lower car payment with a newer vehicle even if the price of the newer vehicle is higher simply because you can take the loan out for a longer term.

Gap Insurance

Gap Insurance is often misunderstood and poorly explained even though it has a very relevant purpose when it comes to buying a vehicle that you will be financing. Gap insurance is guaranteed asset protection insurance. The car you are purchasing is the asset and it is an asset that also loses value over time. In most cases that vehicle will depreciate faster than you will pay the loan down toward the beginning of the loan. The difference between the amount owed and the value of the vehicle is more pronounced at the beginning of auto loans and in loans where there was a very low down payment or no down payment at all. While this usually does not pose a problem, it can if an accident occurs. If you are involved in an auto accident that results in your financed vehicle being deemed a total loss, you are still responsible for the balance of your auto loan whether the amount the insurance company pays you covers the total amount owed or not. This is where gap insurance can really save the day. Gap insurance will pay the difference between the amount the insurance company paid for the vehicle and the amount you had left on your auto loan at the time of the accident. That added coverage allows you the peace of mind to know that if anything happens, you will be free of your auto loan to start shopping for a replacement vehicle instead of being left to figure out how to pay off a vehicle you no longer have because of an automobile accident.

With a general understanding of these basic factors associated with auto loans, you should be well prepared to begin the process of buying your next vehicle. Keep the basic factors that affect the payment in mind when negotiating so you can pay as little interest as possible over the course of your auto loan.