Factors To Consider Before Taking Out a Car Loan

Buying a car is a huge financial step and a complicated task. Whether on the market for a new or used vehicle, most of us will need a car loan to help cover the upfront expense. If you don’t know what to look for with a loan, it can come with hidden costs and unnecessary stress. However, with the right preparation, finding a car and a loan that complements your lifestyle can be a relatively painless process. The following includes our top six factors to consider before taking out your next car loan.

Your Credit Score

Credit Score – Magnifying Glass by CafeCredit.com is licensed with CC BY 2.0

Your credit score is a significant factor in getting a car loan. Whether you apply for a loan through a bank or dealership, the lender will run a credit check to determine your eligibility and possible interest rates. Generally, you’ll need at least prime credit, which is a score of 661 or higher, to get a loan with a reasonable interest rate. If you don’t have excellent credit, you’ll still be able to get a loan, but your interest rate will be higher, your loan amount will be lesser, or you’ll be required to have a cosigner.

No one has just one credit score. We each have several scores that are based on different scoring models. The most widely used scoring company is FICO, which also offers the FICO Auto Score. Many dealerships use FICO Auto Scores exclusively. You can ask your lender which scores they rely on before authorizing a credit check.

Interest Rates

When taking out a car loan, interest rates vary widely depending on factors like your credit score, down payment amount, income, or loan term. An interest rate is essentially extra money you’re paying for your car, so a lower interest rate is better. For example, a five-year loan of $10,000 with an interest rate of 4.5% will cost you $11,185.81 to repay, which isn’t bad. Of course, if your interest rate is higher, you’ll spend more money over the loan’s term.

When financing through a dealer, they’ll most likely add a percentage to the lender’s interest rate to make an extra profit. This isn’t something they’ll mention, but it allows you some negotiation room with their interest rates.

Loan Term

Your loan is a long-term investment, and even if you don’t keep your car for the entire length of the loan, you’ll be responsible for paying it out. A longer loan term can be tempting as your monthly payments will be lower. However, being obligated to make that payment for ten years rather than five years might be a more prolonged investment than you wanted. It will also ultimately cost you more in interest.

Of course, there are benefits to longer repayment terms. A lower monthly payment will likely outweigh any downsides if you don’t have a ton of expendable income and you have other significant financial obligations. It’s essential to compare the interest and annual percentage rates, also referred to as APRs, for each term you’re considering.

Your Budget

This might seem obvious, but examining your finances closely is essential before determining your budget. It would help if you calculated all your regular incoming and outgoing expenses. Even your seemingly insignificant or minor spending, like subscriptions, can add up. Next, examine your savings and think about how much of it you may be willing to spend on a car. Make sure you can afford the monthly payments and set some money aside for unexpected costs. If you’re unable to make your monthly payments, it can result in your vehicle being repossessed. This would hurt your credit score.

Lenders

The typically most debated question among car buyers is whether they should take out a loan from a dealership or a bank. Dealerships tend to offer in-house financing packages, essentially a one-stop shop for the buyer. This eliminates the need for the buyer to do most of the leg work, inquiring and comparing loans from various banks. On the other hand, banks typically offer you more options and benefit from using car loan comparison sites.

The primary benefit of going through a bank is the competitive interest rates. However, not every bank has a loan package for every type of car, which is where shopping around comes in. You’ll need to find a bank that can give you a loan according to the vehicle model you want to purchase. Bank loans also typically take longer to process, and it’s harder to qualify for a loan with a credit score that’s less than stellar.

Foreclosure Penalties

When you borrow money, the lender specifies the conditions of the loan, including the repayment term. If you decide to pay it off before the term ends, it’s referred to as pre-closure or foreclosure on the loan. In theory, foreclosure is a great idea because it saves you from paying the remaining interest. However, many banks won’t let you do this, or they’ll charge penalty fees for early repayment. The average prepayment penalty for a car loan is around 2% of your remaining balance, which can be substantial. For example, if you still owe $20,000, you’ll pay $400 in penalties.

You can often get around this by refinancing your vehicle through a lender with no foreclosure penalties. That process is virtually identical to getting a car loan and won’t cost you anything upfront. Of course, the easiest way to avoid these penalties is to know what to look for at the beginning of your car search.

Borrowing large sums of money is something to be cautious about, which is why you should first equip yourself with the details. Without it, you could end up spending considerably more than you planned. Once you know what to look for, you’ll be able to shop around and find the best car loan for your needs.

Please contact us if you still have questions or want to learn more about your financing options. Our team is standing by to help you get started.