How Does a Car Loan Work?

Chances are, when shopping for a new or used vehicle you will need some kind of a car loan. You can secure a car loan through your bank, credit union, where you buy your vehicle, or through another third party lender. However, before you apply for a car loan you will want to know how a car loan works. By understanding how a car loan works you’ll improve your knowledge on which loan is right for you, how it will affect your credit score, and so on. Besides, whenever you apply for any kind of loan, whether it is a mortgage or a small business loan, you need to understand what kind of loan it is and how it works. 

Car Loan Basics

A car loan works in many ways to most other loans. You want to purchase something (in this instance a vehicle) that you don’t have all the money for. So, you apply for the loan. If your credit score is favorable you will be approved with a specific interest rate. The loan will be split up into individual months that you pay over a set period of time. Usually it is broken down into 12 month periods. For example, it might be for 12, 24, 35, 48, 60 or more months where you will pay the same amount of money every month until the amount of your loan is paid off. 

Typically, longer terms will reduce the amount of money you pay per month but you will pay a higher interest rate. When you apply for a specific loan you will be approved for different lengths of time. So if you’re looking to stay under a set budget and the shorter monthly payments are too large, you can draw out the payments with a higher interest. As an example, you might pay $500 for a 48 month loan at 4% interest, or you might pay $350 for a 60 month loan at 5.5% interest. So just know there are options. 

What Affects Approval?

There are a number of factors to consider when it comes to your car loan. Each of these factors will play a role in not only whether you’ll be approved for the loan but how much and the interest. Some of the factors include:

Your credit score will be one of the biggest factors regarding whether you’re approved or not. It will also play a role in how much interest you will pay for on the loan. Your down payment will also play a role in your interest and what you qualify for. While you likely won’t be rejected for a car loan based on your down payment, putting more money down on the purchase of the car may open you up to additional payment options. Your down payment may also help reduce the interest rate you pay on your car. Ideally you’ll want to put down 10% of the purchase price (at least) although all lenders and financial institutions will be a little bit different with the specifics of your car loan and the repayment options.

When you apply for a car loan you will be required to show your current and even previous tax information. If you are self-employed (or own your own business) make sure to bring at least three years of financial reports. As you are not strictly a salary employee your take home pay will vary, which means the lender will want proof you can afford the loan. So the amount of money you make will impact how much your loan will be for. Current loans and other payments you make on a monthly basis will also go into consideration. 

Who Gives Car Loans?

There are a number of locations that give car loans. First, your bank is a great location to start at. Your bank already knows your finances so it makes applying for a car loan easier.

You can apply for a car loan through the dealership as well. Often times when buying a new car dealerships will offer 0% APR on certain loans for qualified buyers. Dealerships can help you find financing for a variety of credit types as well. This is why it’s always best to compare if you want to save on auto loans.

Always Educate Yourself On Your Loan

No matter the kind of loan you’re applying for it is important for you to know the ins and outs of the loan. This holds true for your car loan. So whether you go with a car loan through the dealership, your bank, or another third party, make sure to keep all of these points of interest in mind prior to applying for the car loan. 

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