6 Things to Know — How Does an Auto Loan Work?
With over two hundred sixty million automobiles parked in the driveways and driving on the parkways across the US, it can be hard to imagine a life without them. But just a brief one hundred years ago, a measly Four.8 million vehicles were registered in the US — a little 1.8% of their current population.
In addition to the massive surge in the sheer number of vehicles, the average cost to purchase a fresh one has also dramatically enlargened. In 1917, a brand fresh Model T was $695, or about $14,480, when adjusted for inflation — less than half of the $33,560 a fresh car will cost you today.
The increase in the number of automobiles in America, despite their enhancing cost, is due, in part, to the advent of the auto loan. Similar to a mortgage loan used to purchase a house, the auto loan is a line of credit extended by a lender for the purpose of purchasing a vehicle.
1. Auto Loans Are Secured Loans
Most loans can be lumped into one of two categories: secured loans and unsecured loans. The main difference inbetween the two loan types is that secured loans are secured against default, generally by means of some type of collateral.
For auto loans, the collateral securing your loan is in the form of the vehicle you purchase. This means that in the event you default on the loan, the creditor can repossess your vehicle and sell it to recoup its losses.
In contrast, unsecured loans are just that: unsecured. Because borrowers don’t put down any collateral for an unsecured loan, the lender has to find a way to buffer itself from any losses in a potential default. It does this by charging much higher interest rates for unsecured loans.
This graph from Bankrate shows the average interest rate of an auto loan for a fresh car.
For example, the average auto loan has an APR around Four.4%. In contrast, a individual loan — a type of unsecured loan — can have an APR ranging from 10% all the way up to 25%. Over the course of a five-year loan, even doubling the interest rate can be expensive, let alone paying five (or more) times more.
The table above shows potential interest rates for a fresh car costing the average $33,000. As you can see, a two-digit interest rate can mean paying a five-digit interest rate. So, while you can technically use an unsecured private loan to purchase a vehicle — don’t. Furthermore, always shop around for the best rate on your auto loan, as pruning a little off your APR can have big results.
Two. Your Credit Impacts Your Loan Terms
While secured loans will have much lower rates compared with rates for unsecured loans, your actual auto loan interest rate will depend on your private creditworthiness. Even however the loan is secured by your vehicle, lenders don’t actually want to go through the involved process of repossession — they’d much rather you simply pay them as agreed.
Of course, most creditors don’t just assume you’ll pay them back. Instead, when you apply for an auto loan, the lender will request copies of your credit reports and scores from one (or more) of the three major bureaus, TransUnion, Experian, and Equifax.
After analyzing your credit reports and scores, the lender will assess your overall credit risk. Lenders will give the best interest rates to those borrowers who present the lowest risk of defaulting on their loan before it is repaid, which is generally those with the highest credit scores.
The borrowers more likely to default — determined by their low credit scores — are charged higher interest rates to protect the lender against potential losses in the event the borrowers can’t repay their loan. Poor financial behaviors, such as missed payments, maxed out credit cards, or bankruptcies, are all crimson flags to creditors.
Trio. The Bank isn’t Always the Best Financing Deal
Your creditworthiness isn’t the only thing impacting your auto loan interest rate. As with just about everything else you purchase, where you obtain your loan will have an influence on the interest rates you’re suggested.
And there are a lot of places to get an auto loan these days. Most dealerships, especially those proffering fresh vehicles, will have their own internal financing departments. However, while convenient, dealerships may not always suggest the best rates.
The same can be said of many major banks; in particular, those with lower credit scores may find it difficult to even get approved for a loan from a picky financial institution. Checking with local credit unions can be a good way to score a deal, but some of the best rates may actually be online.
In fact, not only are there superb auto loans online, but using an online auto loan network, such as our expert-rated picks below, can be the easiest way to compare rates from hundreds — or even thousands — of lenders, in just minutes.
6 Things to Know
6 Things to Know — How Does an Auto Loan Work?
With over two hundred sixty million automobiles parked in the driveways and driving on the parkways across the US, it can be hard to imagine a life without them. But just a brief one hundred years ago, a measly Four.8 million vehicles were registered in the US — a lil’ 1.8% of their current population.
In addition to the massive surge in the sheer number of vehicles, the average cost to purchase a fresh one has also dramatically enlargened. In 1917, a brand fresh Model T was $695, or about $14,480, when adjusted for inflation — less than half of the $33,560 a fresh car will cost you today.
The increase in the number of automobiles in America, despite their enlargening cost, is due, in part, to the advent of the auto loan. Similar to a mortgage loan used to purchase a house, the auto loan is a line of credit extended by a lender for the purpose of purchasing a vehicle.
1. Auto Loans Are Secured Loans
Most loans can be lumped into one of two categories: secured loans and unsecured loans. The main difference inbetween the two loan types is that secured loans are secured against default, generally by means of some type of collateral.
For auto loans, the collateral securing your loan is in the form of the vehicle you purchase. This means that in the event you default on the loan, the creditor can repossess your vehicle and sell it to recoup its losses.
In contrast, unsecured loans are just that: unsecured. Because borrowers don’t put down any collateral for an unsecured loan, the lender has to find a way to buffer itself from any losses in a potential default. It does this by charging much higher interest rates for unsecured loans.
This graph from Bankrate shows the average interest rate of an auto loan for a fresh car.
For example, the average auto loan has an APR around Four.4%. In contrast, a individual loan — a type of unsecured loan — can have an APR ranging from 10% all the way up to 25%. Over the course of a five-year loan, even doubling the interest rate can be expensive, let alone paying five (or more) times more.
The table above shows potential interest rates for a fresh car costing the average $33,000. As you can see, a two-digit interest rate can mean paying a five-digit interest rate. So, while you can technically use an unsecured individual loan to purchase a vehicle — don’t. Furthermore, always shop around for the best rate on your auto loan, as pruning a little off your APR can have big results.
Two. Your Credit Impacts Your Loan Terms
While secured loans will have much lower rates compared with rates for unsecured loans, your actual auto loan interest rate will depend on your private creditworthiness. Even tho’ the loan is secured by your vehicle, lenders don’t actually want to go through the involved process of repossession — they’d much rather you simply pay them as agreed.
Of course, most creditors don’t just assume you’ll pay them back. Instead, when you apply for an auto loan, the lender will request copies of your credit reports and scores from one (or more) of the three major bureaus, TransUnion, Experian, and Equifax.
After analyzing your credit reports and scores, the lender will assess your overall credit risk. Lenders will give the best interest rates to those borrowers who present the lowest risk of defaulting on their loan before it is repaid, which is generally those with the highest credit scores.
The borrowers more likely to default — determined by their low credit scores — are charged higher interest rates to protect the lender against potential losses in the event the borrowers can’t repay their loan. Poor financial behaviors, such as missed payments, maxed out credit cards, or bankruptcies, are all crimson flags to creditors.
Three. The Bank isn’t Always the Best Financing Deal
Your creditworthiness isn’t the only thing impacting your auto loan interest rate. As with just about everything else you purchase, where you obtain your loan will have an influence on the interest rates you’re suggested.
And there are a lot of places to get an auto loan these days. Most dealerships, especially those proffering fresh vehicles, will have their own internal financing departments. However, while convenient, dealerships may not always suggest the best rates.
The same can be said of many major banks; in particular, those with lower credit scores may find it difficult to even get approved for a loan from a picky financial institution. Checking with local credit unions can be a good way to score a deal, but some of the best rates may actually be online.
In fact, not only are there superb auto loans online, but using an online auto loan network, such as our expert-rated picks below, can be the easiest way to compare rates from hundreds — or even thousands — of lenders, in just minutes.