Buying a car, whether new or used, usually means having to borrow money. Roughly two-thirds of car buyers go the financing route, with that number increasing to nearly 90% when it’s a new car. For those who do borrow, the source of the loan is usually split down the middle between either the car dealership or another lender, such as a bank, credit union, or online financing site.
If you are thinking of buying a new car and know that you will need a loan to do so, it’s important that you know the different available types of car financing options.
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Explaining the Difference between a secured and an unsecured loan
In a secured loan, it is the vehicle that secures the financing. This is the loan that most new car owners go with. The bank or company that finances the vehicle will write a security interest into the title. This means that they can seize the car of the lender defaults on the loan. In many ways, a secured loan is a lot like a mortgage.
If you shop around, you may find some lenders who will offer an unsecured auto loan. In these instances, the lender has no security interest in the car or truck. What this means is that you are essentially buying the vehicle with a credit card. In order to land an unsecured auto loan, you are going to need to have a high credit score or have a high income and many valuable assets. Since the lender assumes much of the risk, the interest rate with an unsecured loan is usually higher than most.
Explaining the Difference Between Pre-Computed Interest and Simple Interest Loans
No-one likes interest, but it is essentially the price that you need to pay for using someone else’s money to make your purchase. Interest is either usually commonly computed or structured. With a simple interest loan, your monthly payment includes interest based on the outstanding balance of the loan. For example, if you bought a new car for $20,000 and have paid it down to just $5,000 remaining, it is the balance amount that you will pay interest on.
Pre-computed interest is different in that it is based on a calculation that figures out the sum total of interest over the course of the loan lifecycle. The final number is divided by the number of months that the loan has been signed for. What ends up happening here is that the interest amount is the same every month, no matter what the outstanding balance is on your financing.
If you make monthly payments all the way to the end of the loan term, but do not finish paying off sooner, there will be little difference in the amount of interest paid when comparing the simple and pre-computed loans side by side. If you pay a little more than the amount due each month and pay off your loan early, you will see a bigger savings when going with a simple interest loan. The reason for that is because each subsequent interest amount will be lower than expected.
Dealer Purchase Car Loans
There are plenty of banks and other financial institutions willing to offer car loans, but the car dealerships are also in the auto loan business. For many buyers, this is the easiest way to get a vehicle, picking the car they want and getting a loan in a single location. Most dealerships have deals in place with lenders, allowing them to offer you different loan options. While you can save time going this route, you are probably not going to save money. If you do a little auto loan shopping before you buy, you can easily secure financing that fits your budget. Your options are not quite so good when you get financing the dealer, as you are often given a take it or leave it ultimatum, often at interest rates that are not in your favor.
Dealerships use certain tricks to lure you in, running glitzy ads that offer low- or zero-interest loans to consumers. The downside here is that those offers are usually only made available to people with high credit scores. The positive here is that while you may not qualify for a low-interest loan, the dealer will do their best to secure the deal by ensuring that you get financed. Again, going this route means giving up the opportunity to shop for a loan on your terms.
Lease Buyout Car Loans
The lease buyout loan is another option available to you. In this scenario, a lender will loan you the money required to purchase a vehicle once your lease comes to an end. Depending on the situation, this may well be a good way to go. With a lease, you will have had the car long enough to know about its reliability and maintenance history. Think of it like an extended test drive where you learn all the positives and negatives of your vehicle. Another positive from buying your leased vehicle is that you will avoid potential penalties for things likes wear and tear or exceeding your mileage limit.
It is possible to go with the same lender that financed the lease when buying out, but there is always the chance that you will find a better rate elsewhere.
Private Party Purchase Car Loans
In terms of the process, obtaining a loan from a car dealership is not that far removed from getting a car loan form an individual lender. That said, there are usually a few extra steps in the process when going through a private party purchase.
The first thing that needs to be ascertained is whether the seller’s car loan is still outstanding. If that is the case, then the company financing that loan still has a legal interest on the car. That lender is unlikely to allow any type of deal until the money they are owed has been paid in full. In many cases, the seller is trying to sell the vehicle to raise funds to pay off the existing amount. In such cases, your finance company may well demand that an amount equal to the remaining value of the loan be put in escrow so that the other lender can get the money they are owed when the sale is completed.
Each of the aforementioned loans comes with a list of pros and cons. Before you decide which way to go, it’s important that you do some comparison shopping for an auto loan. You can potentially save a lot of money by landing the right type of loan at a great interest rate, while the chances of losing money are great if you don’t put in the work beforehand.