What Are Auto Loans? – All You Need to Know About Vehicle Financing

Auto loans are loans that borrowers use to purchase cars. The cars mostly serve as collateral, and the lenders have the right to repossess them if borrowers default. The repayment period for an auto loan varies depending on several factors but usually ranges from 36 to 96 months.

How an Auto Loan Works

Like most loan lenders, auto loan providers require borrowers to demonstrate their creditworthiness by submitting their credit reports and credit scores. The lenders use the provided information to determine the interest rate to be charged and the loan amount to be granted. You are likely to get an auto loan at a favorable interest rate if your credit is good.

Although some auto loan lenders do not require borrowers to make down payments, experts recommend paying a down payment of at least 15% of the vehicle’s value. That reduces the money you need to borrow and the interest to be paid.

So, which financial institutions offer auto loans? You can obtain an auto loan from credit unions, banks, and online lenders.

What to Consider When Applying for an Auto Loan

Terms and Conditions: Understanding the terms and conditions set by your auto loan provider is important. For example, you need to familiarize yourself with the interest rate charged by the lender and the loan repayment period. Moreover, ensure you understand the penalties to be charged if you fail to pay your loan on time.

Credit Score: As mentioned, most auto loan lenders consider your creditworthiness. Therefore, it is crucial to check your credit score before applying for an auto loan.

Down Payment: If you have some cash in your bank account, you can use it as a down payment to lower your loan amount.

Types of Auto Loans

Secured vs. Unsecured

A secured auto loan is one that needs to be collateralized by your car. That means if you are unable to make repayments, the lender can take away the car from you and sell it to recover the unpaid loan amount. An unsecured auto loan, on the other hand, does not require collateral. Instead, it is based on the borrower’s creditworthiness.

Secured auto loans tend to attract lower fees and interest rates than unsecured. Their providers also allow borrowers to take large loan amounts and repay them over a long period.

Precomputed Interest Auto Loans vs. Simple Interest Auto Loans

In simple interest auto loans, interest rates are calculated using a borrower’s outstanding balance at a given time. Such loans are ideal for borrowers who plan to pay off their debt early.

As for precomputed interest auto loans, interest rates are calculated before the loan amount is issued and are spread evenly throughout the repayment period.

Direct Auto Financing vs. Indirect Auto Financing

In direct auto financing, a borrower applies for a car loan with a trusted lender, such as a credit union or a bank, while in indirect auto financing, the borrower works with their preferred car dealership to find the right lender. Although indirect auto loans are convenient, they come with more costs than direct auto loans.

Specialized Auto Loans

These loans are only available to certain individuals, including:

Military service members: Those who serve or have served in the military are likely to get auto loans at special discounts.

Individuals with Poor Credit: Some car dealerships usually offer special financing to people with poor credit history who would not be considered by traditional lenders. However, these loans attract considerably high interest rates, which many may find challenging to pay every month.

What Credit Score Does One Need to Obtain an Auto Loan

Different auto loan lenders have set different minimum credit scores. But in most cases, you will be required to have a credit score of at least 660 to get an auto loan.

What is the Average Interest Rate on Auto Loans?

As of June 2024, the average interest rate on an auto loan for a used car is 11%, while 7% on a loan for a new car.