Cars are pricey, but you have a lot of options to help you pay for one. Auto loans are one of the most popular solutions for car buyers. Financial institutions lend borrowers money to buy a new or used car. The borrower then makes monthly payments for between two and seven years, depending on their contract, until the balance is zero. They’ll also pay interest on top of the car’s price.
How do lenders come up with the interest rate and monthly payment you’ll owe? They review your credit report. Other factors also influence interest rates, like market conditions and the type of institution from which you borrow. If you’re curious about how to get the best car loan, it can help to:
- Research your options
- Raise your credit score
- Pick the right lender
- Budget carefully
- Negotiate with lenders
The best auto loan is something different for everybody. The options vary for every person, depending on their financial history, their budget, their preferences, and their relationships with lenders. It’s important to understand the options available to you to avoid overpaying for your car loan.
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Where to Get a Car Loan
You can get an auto loan from a variety of different financial institutions, and partnering with the right lender can help you sign for a loan that works for you. Here are some of your options:
Car dealerships have relationships with a host of financial institutions like banks and credit unions, and they’re happy to sit down with you to help you find a loan. They submit applications to lenders on your behalf and advise you on your options.
This can be fast and convenient, and it requires minimal work on your end. The downside is that you have less involvement in the process, so you might not get the best deal out there. It’s also common for lenders to add a fee for the dealership’s involvement.
Working with the dealership’s finance team can be a convenient option if you want a professional to handle the complicated parts for you. Still, do your own research before heading into their office. Knowing what interest rates are available might give you some leverage for a better deal.
In plain terms, a captive lender is an auto manufacturer’s financial department. Big names like Toyota, Ford, and Kia have their own financial arm offering financing on their new or certified pre-owned vehicles. You might recognize these loans from automaker commercials that boast that “qualified buyers can earn 0 percent annual percentage rate (APR) for twelve months.”
Car manufacturers can offer those kinds of deals when other financial institutions have to obey market rates, which makes them appealing. And of course, you have to be a qualified buyer. When they say “qualified buyers,” they’re talking about people with excellent credit.
Captive lenders have options for borrowers with suboptimal credit, too. While the interest rate might not be as shiny as the ones in the television ads, captive lenders can sometimes bend to approve applicants with lower credit scores if the market justifies it. Captive lenders often offer shorter-term leases than other lenders, which means higher payments. Two- or three-year loans are standard.
When you get a loan from a captive lender, you make your payments directly to the manufacturer. These loans can be a wise option if you’re eyeing one particular make and model, as you can apply for financing directly with the captive lender before buying the car. Some dealerships also arrange for loans with manufacturers on buyers’ behalf.
Getting a loan directly from a bank without involving the dealership’s finance team might help you find a personalized solution with competitive terms. You can get pre-approved for a loan before choosing your new car, which can make car shopping a little easier. You know how much you can borrow, so you have a pretty clear budget to work with when you’re on the lot.
When you borrow from a bank, you might have to follow their rules. For example, some banks prefer to finance newer cars with low mileage and minimal damage. Basically, the better shape the vehicle’s in, the better your chances of getting good financing. Some also banks prefer you purchase from a reputable dealer instead of an independent seller.
Start by talking with banks where you already have an account. If you have a checking, savings, or credit account with a bank and you’re in good standing, it might serve as evidence that you’re a responsible borrower. This could help you when it’s time to get a quote. Different banks use different information and criteria to determine their offers. It’s good practice to get several quotes to compare. If one bank offers you a great rate, ask competitors if they can beat it.
An auto loan from your local credit union is also worth considering, especially if you have a few mistakes in your credit history. Unlike a bank, a consumer’s credit union is a nonprofit. Because they don’t intend to make a profit, they can offer competitively low rates. The National Credit Union Administration reported that the national average rate for a forty-eight-month used car loan from a credit union is 2.9 percent, while banks offer an average of 4.71 percent.
Every location is unique, but credit unions often offer a more personal experience than banks. They can also be more flexible in approving buyers with spotty credit. Some people might benefit from talking with a representative in person and explaining their situation. Maybe you’ve never borrowed before but can prove you’re a responsible person in other ways. Or maybe you missed a few payments on a previous account because of personal circumstances you’ve since overcome.
Online lenders are financial institutions that review applications and offer loans entirely online. They’re fast and convenient. You can usually get estimates quickly and compare different lenders’ rates. You might even prequalify instantly. Plenty of online lenders approve borrowers with poor credit reports, too. It can come at a price, though. Online lenders might assign especially high interest rates to borrowers with poor credit, so be wary.
It’s also important to make sure you’re working with a reputable lending company. Exercise caution when gathering quotes online. Anyone can make a website that looks legitimate. Before you input any sensitive personal or financial information, do a little research. If you can find evidence that the lender is trustworthy, you might proceed. If you see minimal proof of their existence or notice signs of predatory lending, stay away.
Tips for Getting a Great Auto Loan
When it’s time to find financing for a new or used car, consider the following tips to help you find the best auto loan:
Check Your Credit
Understanding what information lenders receive about you and how it affects you can help you get the best loan available. Banks, credit unions, captive lenders, and online lenders all use your credit report to quote you for a loan.
People with a history of using credit responsibly, paying bills on time, and managing accounts well appeal to lenders. These borrowers usually receive lower interest rates. Some leasing companies have reservations about lending to people with missed payments, charged-off accounts, high amounts of debt, or little credit history.
You can get a free copy of your credit report once a year through any of the three major credit bureaus: TransUnion, Experian, and Equifax. You can usually check your score for free through your bank, a reputable credit website, or a mobile app. It’s also important to know what your credit score communicates about you to lenders. The credit score ranges according to FICO are:
- 800-850: Exceptional
- 740-799: Very good
- 670-739: Good
- 580-699: Fair
- 300-579: Poor
If your score falls into the fair or poor category, it might be beneficial to spend some time improving your credit if you can. Sometimes, buying a car can’t wait, but if you have a few months to spare, aim to get your score a little higher. Borrowers with scores over 700 often receive the lowest rates. Here are some things that might help inflate your score:
- Dispute inaccurate information: Scour your report for any mistakes or errors and file a formal dispute. You’ll have to prove it’s inaccurate, so don’t waste your time trying to remove information that’s unsavory but true.
- Ask creditors for goodwill adjustments: If you missed a monthly payment or charged off an account, you can write what’s called a goodwill letter to the creditor explaining the reason it happened and asking them to remove it. They might deny or ignore you, but it never hurts to be optimistic.
- Make payments on time: Payment history is a key component of your credit score, and lenders typically want to know you’ll make your car payments reliably. Spend a few months paying every account you have on time to see if it boosts your rating.
- Pay down debt: If you’re carrying high balances on any accounts, it might be helpful to use any extra money to pay them down. Having open credit accounts with low or no balances is often favorable.
Talk to Different Lenders
Shopping around is crucial. It’s pretty unlikely that the first person you talk to will give you the best rate available. Having three to five different quotes can help you choose a loan that meets your needs. When you’re weighing options from multiple lenders, look for the loan that offers the lowest APR over the shortest loan term you can handle. That’s the loan that will cost you the lowest amount in the end.
Make a Big Down Payment
A down payment is a portion of the vehicle’s purchase price that you pay in cash when you buy it. Most buyers make a down payment to cover some of the car’s price, then finance the rest with an auto loan. Putting more money down can help you take out a smaller loan, which means less interest. It might also help you pay off your car sooner to lessen the impact of depreciation. Standard down payments are usually between 10 percent and 20 percent of the price. If you can save money for a bigger down payment, it might pay off later.
Get a Preapproval
Plenty of lenders preapprove borrowers. This means they run your information and tell you the rate they can likely offer you. The interest rate isn’t final, though, so you can still shop around a little more. A preapproval gives you three powerful benefits:
- Leverage: When it’s time to buy your car, tell the dealership the preapproval rating you have. If it’s the difference between getting your business and not, they might offer an even better rate.
- Budget: A preapproval sets a clear budget for your car before you meet with a salesperson. This way, you can limit your test drives to vehicles you can afford and skip any pricey add-ons.
- Security: A preapproval isn’t a guarantee, but it’s nice to know you can likely qualify for the loan you want. Plus, they lock in a rate so you’re not subject to markups at the dealer’s whim.
If you’re not ready for preapproval, you could also try to prequalify for a loan. Prequalifications are more casual than preapprovals. The lender checks your credit score, rather than running a full report, to get a basic idea of the rate they might offer you.
It’s a great way to avoid hard inquiries on your credit report while still getting some information about your options.
Opt for a Shorter Loan Term
It’s not just the loan amount that matters. The length of your loan is a crucial factor in your monthly payment. Here are some common loan terms:
- Twenty-four months (two years)
- Thirty-six months (three years)
- Forty-eight months (four years)
- Sixty months (five years)
- Seventy-two months (six years)
- Eighty-four months (seven years)
Longer contracts correlate to lower monthly payments. Shorter contracts correlate to higher monthly payments. When you’re weighing your options, remember that a lower payment isn’t necessarily the best option financially. The longer your loan lasts, the more interest you end up paying. Long-term loans, like those lasting seventy-two or eighty-four months, often come with high interest rates, too. While a low payment might entice you, especially if your budget is tight, think it through before signing.
Experts sometimes recommend 48- or 60-month loans. They typically balance manageable payments with reasonable time frames. Plus, you can pay it off sooner to gain equity. That way, if you choose to sell it, you’re not selling a car with an outstanding balance eating away at its value.
Pick a Car You Love
If you’re spending thousands of dollars on a new car, it should be one that suits your needs. Your budget is one of the most important factors when choosing a car, but your preferences also matter. Shop carefully to make sure you’re still happy with the car a few years down the line. When a car makes you happy, the payments might feel worthwhile. Value is sometimes more important than price. Here are some factors to think about when you’re test-driving cars:
- Style: Do you like how the car looks inside and outside?
- Condition: Does it need upgrades or are you happy with it as-is?
- Comfort: Is the seating plush and roomy enough for you?
- Technology: Does it have all the connectivity and entertainment features you want?
- Manufacturer: Do you like and trust the automaker?
- Performance: Do you have fun driving it?
- Trendiness: Will the car go out of style in a few years?
- Safety: Are you comfortable with the safety features and rating?
Don’t Let the Dealership Upsell You
Dealers have plenty of expensive additions to sell you once you’ve chosen your vehicle. They might emphasize the importance of gap insurance, which covers the deficit between your car’s value and the remaining loan balance if you total it.
They may tell you an extended warranty is a must-have if you want your car to last. Maybe there’s special insurance available to supplement the insurance you already bought. While these add-ons might be beneficial in specific situations, they’ll probably just tack on unnecessary costs.
Your loan absorbs the prices of these extra purchases. If an add-on is really important to you, then you can probably buy it later. Plus, you can research it to find the best deal. Dealerships might inflate their prices. Being aware of sales tactics can help you shave unnecessary costs off your car loan.
Consider Used Cars
Used cars cost less than new cars, so a car loan for a used car will probably be cheaper than one for a new car. Many used cars still have modern features, reasonable mileage, and minimal damage. Purchasing a used car with a car loan can help you avoid taking out a pricier loan on a brand-new car. If you already saved up for a down payment, it might go farther with a used car.
How Do You Finance a Car without an Auto Loan?
Auto loans aren’t the only way to buy a car. Here are some alternatives that you might consider if car loans aren’t right for you:
- Paying cash: If you have enough liquid cash to buy a car without hurting your finances, you could buy the car outright. This may be the cheapest option, but it’s important to make sure you can afford it.
- Taking out a personal loan: You could take out a personal loan instead of a car loan. These loans often have higher interest rates, so do your research before deciding.
- Using a credit card: Some dealerships accept credit cards if your limit is high enough. Be wary of making a large purchase like a car, especially if the card’s interest rate is higher than an auto loan.
Pros and Cons of Auto Loans
Before committing to a loan, stop and consider if a car loan is the best option for you. There are plenty of situations in which an auto loan makes sense. They’re common for a reason. But it’s also worth reflecting on the downsides.
Pros of Auto Loans
The advantages of paying for your vehicle with an auto loan include:
- Lower upfront costs: Cars are expensive. Putting a down payment on a car and then financing the rest with a loan leaves more money in your pocket, even if it costs a little more in the future.
- Credit history: A car loan can be an effective way to build and improve your credit history. Making regular, timely payments on your car might help you qualify for credit cards, personal loans, or mortgages.
- Lower rates than other loans: You could take out a personal loan or use a credit card to pay for a car. Auto loans, however, usually come with better interest rates.
- Expanded options: Most people can’t afford to buy any car they want with cash. But an auto loan can help you get a better car if you can pay for it in installments.
Cons of Auto Loans
The disadvantages of paying for your vehicle with an auto loan include:
- Interest: The most significant downside to car loans is the interest. You pay more over time than you would if you bought the car in cash.
- Commitment: Auto loans are a financial commitment that can last up to six years. Make sure you can manage the payments for your entire loan term.
- Insurance: If you have a car loan, the lender might require you to carry a full coverage policy, which has a higher premium.
- Depreciation: Cars gradually lose their value. After a few years, you might end up with negative equity, meaning you owe more than the car is worth.
Best Auto Loan Rates in 2022
Financial markets change often, so you might wonder what a good car loan even looks like right now. The Federal Reserve rose interest rates in July 2022. The government doesn’t directly control auto loan interest rates, but experts predict it might lead to higher APRs for borrowers. According to the National Credit Union Administration, here are the national average auto loan interest rates at banks as of June 2022:
- 36-month used car loan: 5.08 percent
- 48-month used car loan: 5.13 percent
- 48-month new car loan: 4.71 percent
- 60-month new car loan: 4.80 percent
And here are the average interest rates from credit unions from the same data set:
- 36-month used car loan: 2.94 percent
- 48-month used car loan: 3.06 percent
- 48-month new car loan: 2.90 percent
- 60-month new car loan: 3.01 percent
You can use these figures to help you understand what a good rate might look like for you. If you find a rate that’s lower than these rates, it’s probably a good deal. If it’s higher, keep shopping.
Key Takeaways About Getting a Great Car Loan
To summarize, here are some of the most important things to remember when shopping around for a car loan:
- Get quotes from multiple lenders.
- Aim for a credit score of 700 or higher.
- Pick a shorter-term loan to minimize interest.
- Consider other options for financing a car.
- The average interest rate for a five-year new car loan from a bank is 4.80 percent.
- Choose a car that fits your budget and suits your needs.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.