What are Auto Loans and how do they work?
Also known as a vehicle or car loan, an auto loan is a good option to take if you need to buy a car, but do not currently have enough funds to pay n cash. With an auto loan, you can buy a used or new vehicle. If you avail of an auto loan, you will be required to pay with interest every month until the loan is completely paid off.
You can find a Blue Sky Financial application form on this page if you are considering taking out a loan. Whatever personal information you provide will be held in strict confidence, and will only be used to find a suitable lender for you. Read on to learn more about this type of loan.
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Various Types of Auto Loans
While some people think that all car loans are the same, there are various types of loans.
Used and New Car Loan
Borrowers normally buy brand new cars from dealerships by availing of car loans. Although it is less common, some people prefer to buy used vehicles from private entities financed by car loans. Unlike brand new cars, used units can be bought from private sellers and used car dealers.
If you qualify for a loan, you can approach your preferred dealership or vendor and evaluate the available cars for sale. This may include test drives and comparing several vehicle types. Once you have chosen a car to buy, you can officially buy the car using the proceeds of your auto loan.
Car Refinance Loan
If you have an existing auto loan and you feel that you are unnecessarily paying an excessive amount of money or if you want to pay at a more favorable interest rate, you can try to have your auto loan refinanced. This involves replacing a car loan with another that carries better terms for you.
Simply put, you want a new lender to buy out your debt in exchange for a new loan that offers better terms. This is done by paying off the remaining balance of the existing loan using the proceeds of the new auto loan. Refinancing allows you to pay lower installments, and you can use your savings for other purposes.
To qualify for refinancing, you must have a good credit rating or a better debt-to-income ratio compared to what you had at the time you purchased your car. While the lender still has to evaluate your existing debt together with your personal financial information, you have better chances of getting approval than an applicant with several red flags such as a poor credit rating.
Refinancing an auto loan is a good way to save money. This is because vehicles consistently decline in value.
Unconventional Vehicle Loan
There’s a wide variety of motor vehicles other than the usual, car, van, SUV, or truck. These unconventional types of vehicles have a specific set of buyers just like buyers of conventional vehicles.
Following are examples of unconventional vehicles that can be bought using the proceeds of unconventional vehicle loans.
- Classic Cars – Older cars can be very expensive, and collectors will usually look for a lender who can finance their purchase. Some models are so expensive that they are considered investments because they are no longer being manufactured.
- Recreational Vehicles (RVs) – An RV combines the mobility of a motor vehicle with the comforts of home. They tote expensive price tags commensurate to their enormous length and width. Thus, financing is typically required.
- Motorbikes – Expensive two-wheelers like Harleys and some dirt bikes can be acquired through motorcycle financing. Despite the comparatively small size, these specialized and rare motorbikes can be quite expensive.
- Scooters – A scooter is quite popular among urban residents and students. It is likewise eco-friendly and can be purchased using financing.
- Buggies – Rural consumers can use unconventional auto loans to purchase this type of off-road vehicle and electric neighborhood vehicles that make commuting in specific environments easier.
It must be noted that since these types of vehicles are not common, financing may only be available from specialized lenders. You have to search for these lenders if you want to avail of unconventional vehicle financing.
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How to Qualify for a Car Loan
A prospective car loan applicant must meet the specific requirements imposed by lenders. These include:
Income – You must have an income source to prove your capacity to repay. Income may come from employment, benefits, social security, retirement, and other similar sources.
Down Payment – While some lenders offer no-down-payment plans, financing can get very expensive. Paying down payment not only lowers the total borrowing and interest rate but also shows your lender that you are a responsible borrower. Usually, borrowers with poor credit records are required to put up a down payment.
Debt – Heavily indebted people usually find it difficult to get financing for their vehicle purchases. Being in debt, per se, is not a cause for automatic disqualification, but the total amount of indebtedness may be a factor.
Need for a Co-Signer
If you find it difficult to secure a loan, you can improve your chances of getting approved by having a co-signer. This is because the lender can run after the co-signer in case you default, effectively limiting the lender’s risk, especially if the co-signer has an outstanding credit record.
Common co-signers are parents co-signing on their children’s auto loans. This is particularly helpful for teenage buyers availing of a loan for the first time. Parents usually have better credit ratings than their kids.
Borrowers who have previously filed for bankruptcy and those who currently sport bad driving records usually need a co-signer to bolster their chances of getting approved.
Borrowing with an Existing Debt
Most people have been in debt at one point or another – usually credit cards, college loans, or mortgages. In itself, debt does not merit automatic disqualification for a car loan. However, it can be a factor in determining the applicable interest rate. If you have a lot of debts, lenders will see you as a bigger risk than one who doesn’t have any.
For people burdened with debt related to acquiring a college education, some lenders are willing to extend student car loan plans as these lenders see new college graduates as having good potential to earn high income in the future because of their college degrees.
Car Loan Cost and Terms
The total cost of an auto loan is mainly dependent on the interest rate which is computed based on various factors including the following:
The credit score of the borrower
Debt to income ratio of the borrower
The desired amount of proceeds, usually the value of the car being purchased
Borrowers with excellent credit ratings are in a position to get the most preferred rates, while the opposite applies to people with poor scores or no credit record at all.
A high debt to income-ratio will make it difficult for you to secure a car loan. This is because most lenders will see you as already struggling to make the required payments for your existing debts, and therefore a bigger credit risk.
People who need a huge sum of money to buy an expensive vehicle will likewise find it difficult to gain loan approval as it is riskier for a lender to provide money to buy an expensive vehicle rather than extend a loan for the purchase of a low to the moderately-priced car.
If you want to know if a particular car loan would be affordable to you, there are free online loan calculators that you can use for the purpose. You can compute how much your monthly payment would be at different interest rates. You can also compare quotes from different lenders to see which one will be best suited for your needs.
Terms of Car Loans
The average interest rate for auto loans varies monthly, but the applied interest for each borrower depends on their credit history and the agreed duration of the repayment. Following are some of the more common payment terms.
- 24 months
- 36 months
- 48 months
- 60 months
In general, the longer the repayment terms, the more expensive the loan becomes. Longer terms, however, require lower monthly amortizations.
Car Loan Pre-Qualifications
Most people are only able to look for financing after they have chosen the car to buy. By getting pre-qualified, you can already secure financing even before visiting dealerships to check out the available models you can buy.
To get pre-qualified, you must prepare your financial data and approach a prospective lender. This way, you can explain and justify the amount you are requesting. Negotiations may ensue, and if you agree, you can then directly go car-shopping.
There are many options on where to seek pre-qualification. These include dealerships, credit unions, banks, and online brokers, with each option having its own set of benefits and costs.
Dealerships
The biggest advantage of pre-qualifying with dealerships is convenience. Car buyers can get their needed financing right on the day they have decided on the car to buy. Dealerships, however, are notorious for resorting to aggressive hard-selling tactics to accept high-interest financing options. Rarely do they give various offers since they usually only have one financing company.
On the other hand, external financing usually features multiple quotes from various lenders. It also offers various categories including online lenders and other types of conventional lenders like credit unions and banks.
Credit Unions and Banks
Banks are probably the most popular source of loans, and entertain, though not necessarily approve, anyone who wants to apply. On the other hand, credit unions require an applicant to be a member to avail of the services they offer. Being owned by the members, credit unions lack the aggressive investment strategies that banks employ, and thus offer lower interest and more lenient payment terms.
Both lending institutions go through the same underwriting process when evaluating applicants before denying or approving a loan request.
Online Brokers
With online brokers, the underwriting process is fast-tracked. As the name implies, they operate online – almost on an exclusive basis. While you may not meet the lenders face-to-face, they still perform proper underwriting procedures for car loans just like banks and credit unions. They also communicate through email and offer the same range of services that credit unions, banks, and dealerships do.
Because online programs are capable of processing applications rapidly, the entire underwriting and evaluation aspect of the loan can take only a short time. And because borrowers can file their applications any time of the day – or night – they provide a very convenient option.
Ultimately, however, no matter what type of lender you opt to deal with, there will always be a certain degree of risk involved.
Involved Risks
All types of financing have risks; can loans are no different. Following are the various risks that people who take out auto loans face once they default on their payments consistently.
- Damaged credit score
- Lawsuits
- Co-signer pursuit
- Repossession
Damaged Credit Score
If you miss or default on your payments, it will be reflected in credit reporting bureaus, and that will ultimately affect your credit score negatively. You will feel the ramifications the next time you apply for a loan, even if it is not a car loan. Simply put, you will find it difficult to explain your creditworthiness to a loan officer.
Lawsuits
Lenders can sue you in court if they cannot recover the money they lent to you, and you show no sense of urgency in paying. As you know, lawsuits can be expensive and time-consuming, and may even result in a judgment against you that will only increase the money you have to pay even more.
Co-Signer Pursuit
If you were able to secure a car loan with the help of a co-signor, you must keep in mind that in case you miss your regular payments, the lender will pursue the co-signor to recover the money loaned to you. This is because co-signors are as legally bound to pay just like the borrower.
Repossession
Similar to borrowers who may lose their home to foreclosure in case of default on their home mortgage payments, your car may be repossessed if you consistently miss on your monthly car loan payments.
Once your car is repossessed, your lender assumes ownership of the vehicle and can forcibly take it from you. You cease to be the owner of the car, and the lender can confiscate it legally. The surest way you can avoid repossession is by paying your monthly obligations on time.
However, facing financial difficulties can sometimes be unavoidable; thus, talking with your car loan provider to work out a viable solution such as a temporary decrease in your monthly payments may help prevent or delay the process of repossession.
Leasing a Vehicle
Some people may not be comfortable securing a loan just to be able to buy a car. If you want to keep upgrading your vehicle for newer releases or you just want to avoid paying for financing for a property that rapidly depreciates, a good option for you is to lease a car.
Leasing is renting without having to buy a car. You pay a pre-determined fee every month. You can continue using the car for as long as you abide by the lease terms.
When the lease terms are up, you have the option to extend the lease or upgrade to a more recent car model. While this may make a lot of sense to some people, the biggest disadvantage that comes with leasing is that you will never get ownership of the car as you don’t build up enough equity that you can cash out later.
Auto Title Loan
If you are looking for auto loan options and possible lenders, you must not get confused if you come across the term auto title loan. The similarity ends in the way the two terms sound as the two are very distinct products.
An auto loan is a secured type of loan that uses your vehicle as collateral that the lender can liquidate in case of a payment default. An auto title loan is ideal for people who need immediate access to cash to pay for emergency expenses.
The loan amount depends on the vehicle’s value as assessed by the lender. The interest rate and terms are influenced by the borrower’s credit worthiness. As an auto title loan is generally intended for people with low credit scores, it usually comes with high-interest rates.