Types of Auto Loans: Everything You Need to Know
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Cars are a significant investment. Despite trying to protect your vehicle with a car cover or prolong its life with regular car maintenance, you may find yourself in a position where you need to buy a car without the cash readily available.
If you don’t have the funds on hand to pay in cash, going to the dealership and buying a car can be intimidating. With all the auto loans available, it’s critical to research your options before committing.
1. Secured Loans
Secured loans are the most common loans on the market. Once you select your new vehicle, the dealership will likely offer you a secured loan for financing. The typical auto loan is a secured loan with a lien on the vehicle. If you fall behind on payments, your lender has the right to seize the car.
The average loan term is roughly 72 months, and the loan amount you’re approved for often depends on your credit score, annual income, and the value of your vehicle. The average current APR (annual percentage rate) for a traditional secured loan is 3.24% to 13.97% for a new car and 4.08% to 20.67% for a used car.
Balloon loans are also secure loans. Not as popular as the traditional model, this loan allows you to make small payments for a few years before making one lump sum payment. When it is time to make the large payment, you could pay off the vehicle and own it, trade it in at the dealership, or sell it.
2. Unsecured Loans
Unsecured loans differ from secured loans, as they lack restrictions on how you use the money. Like secured loans, the amount you receive depends on your credit and income. The average loan length for an unsecured loan is 36 months with an 8.05% to 35.89% average APR. While there are no restrictions to how you spend the money, unsecured loans have higher finance charges than secured ones. However, unlike most other loan types, they do not require any collateral, so the lender does not have the right to seize the car if you fall behind on payments.
Personal loans, credit cards, and student loans are all examples of unsecured loans. Most auto loan agencies have a minimum amount you must borrow, so be sure to shop around. Taking out an unsecured loan carries more risk for the lender than a secured one, so be prepared to pay higher interest rates.
3. Simple Interest Loans
Simple interest loans calculate your outstanding balance periodically. During each period, interest will be calculated based on how much of the loan is outstanding. You can pay off these loans faster by making bigger payments with limited interest. These loans are more flexible, allowing the borrower more wiggle room with payments. The earlier you pay, the less overall interest you build up over the course of the loan.
Simple interest loans are a great option if you have some savings ready to go toward paying off your loan. However, it’s important to note that much of your early payments go toward interest, not the principal loan amount.
4. PreComputed Loans
Precomputed loans are similar to simple interest loans but lack flexibility. You must stick to a set payment schedule that includes a fixed rate for both interest and principle. This means you’ll know exactly how much you’re paying each month. Unlike simple interest loans, if you pay a pre-computed loan off early, you will not save on interest. Instead, the interest schedule will stay the same across the duration of your loan.
5. Direct Financing
When seeking an auto loan, direct financing is another viable option, requiring the buyer to communicate directly with the lender. This means you will send out individual applications to each loan agency rather than applying for the loan through the auto dealership. While this may seem tedious, having a direct relationship with the lender allows you to directly see the loan details and shop for the best rates. You will play a significant role in selecting your terms and conditions. Not every lender offers a direct financing option, but most do.
6. Indirect Financing
Indirect financing requires help from the dealership where you are buying your vehicle. You fill out one application that is then shared with various lenders. While filling out one application can save you some time and effort, it also requires the dealership to step in and act as a third party. Indirect financing gives you less control over the loan process but gives you a great choice of lenders with less effort. However, while acting as middlemen, the dealer can increase your APR and keep the difference as profit.
7. Pre-Approved Auto Loans
Sometimes your primary bank or credit union will pre-approve you for an auto loan based on your existing credit score. In this scenario, you receive the approval for a certain amount from the lender before you ever set foot on the car lot or have information about the type of vehicle you’re purchasing. However, keep in mind that pre-approval does not guarantee your rate is locked in for your final loan. Seeking a pre-approved auto loan can benefit you by providing better leverage for negotiating with your car dealership.
8. Buy-Here-Pay-Here Loans
Buy-here-pay-here loans are offered directly from the dealership. These loans are an option for those with a poor credit score who can’t qualify for other loan types. These often have high APRs and can be challenging to pay off. Usually, it is preferable to explore other auto loan options, which can be adjusted based on your creditworthiness. Although the interest and repayments may be higher, you may be able to get more flexible terms.
9. Lease Buyout Loans
Lease buyout loans are given when a buyer chooses to purchase a car at the end of its lease term. These loans can be a risk for the lender because the state of the vehicle may be unknown. Not all lenders offer them. When they do, expect a higher APR than for a new car.
10. Private-Party Car Loans
It’s no secret that buying a car from an individual seller is a more affordable option. If you take this route, you can qualify for a private party loan. Like lease buyout loans, lenders are not quick to give out these loans because of the risk involved, as the vehicle’s current condition may be unknown to you and the lender, and most states do not offer consumer protection for private car sales.
11. Title Loans
Using your current car’s title as collateral, you can get money to purchase a new one through a title loan. However, this is not a simple feat, as it could lead to both repossession and high APR rates. According to the Federal Trade Commission, title loan lenders can charge up to 300% APR.
Choose the Right Loan for You
The best car loan for you depends on several factors, including your finances, the value of the vehicle you’re interested in financing, and how good or bad your credit score is currently. Regardless of what type of loan you’re pursuing, remember that you can mitigate the risk of your car value depreciating below the amount you owe by putting a minimum of 20% down on your purchase. For the best APR and repayment terms, seek quotes from multiple sources before settling on a lender for your car loan.