How Car Loans Work

Buying into the Plan Are you in the process of buying a car? Are you nervous about financing? If you don’t know your way around the world of automobile financing, you have every reason to be nervous. There’s so much to know! And how do you know you’re getting the best deal if you don’t understand the terms? Don’t worry – our purpose here is to bring the unknown into the realm of the known, to bring the unexplained into the realm of the explained, and to bring the confusion into the realm of the understood. Sit back, read on, and learn.

Car loans were created for your convenience The original purpose of car loans was the same as for any big-ticket item – to allow those without huge bundles of cash, the opportunity to buy what they wanted now, and pay for it over a period of time. As car prices rose throughout the last few decades, more and more people needed to finance their auto purchases. Banks and other financial institutions were happy to oblige. Car loans became a good source of income for them. So back then, when you bought a new car, you’d shop around the lending companies for the best interest rate, borrow the money from them, take it to the dealer, and get your new car. Everybody was happy, right? Well, yes, but only for a time.

The Big Three automakers want in on the profits The car manufacturers were getting their money – they were being paid cash by the lending companies. But the lending companies were also making a tidy profit from these car loans. And the manufacturers, always looking for ways to increase their own profits, developed a system that would give them a share of the lending market. So the car manufacturers created a lending system of their own. They started offering auto financing through their dealerships. But they didn’t take the risk that the other lending companies had been taking – they passed that risk on. And that system is still the most common today. However, online car loans are becoming very popular, too. But back to the dealership loans.

Here’s how they work. You go to a dealership to buy a car. When you’ve made your choice, the dealer offers you financing. They first determine how much you want to, or can afford, to pay every month. The next thing they ask you is to fill out a credit application. You’ll need to give all the standard information, including your residential history, your employment history, and your credit history. Then they take that offer, and search their database of lenders, or assignees, to find one who’s willing to accept the risk of taking on your contract.

If you have a positive credit record, then you’ll be at the top of the list, and lenders will be happy to take your contract. If your credit history isn’t so good, then you move down the line on the list of lenders. There are many assignees who’ll take the higher-risk contracts, but to balance out that risk, they’ll charge a higher interest rate. But, no matter who takes the contract, the dealer still virtually gets paid cash for their car, by the lender. And on top of all that, before they give you the contract from the lender, they add a couple of percentage points on to the lender’s interest rate, which is extra profit for them. So their system indeed works very well for them – but it costs you more! There’s another reason to shop online for your car loan. Some preparation is required on your part As we mentioned before, when you apply for a car loan, you’ll need to make sure your credit report is in order.

Contact a CRA (credit reporting agency) to get a copy of your credit report. Make sure it’s accurate and free of any disparities. Remember, this information is the basis of a lender’s decision in granting you credit. They take that information, along with your credit application, and ask themselves 2 questions: Can you pay? And will you pay? That’s all they need to know to make a decision. Remember the first question the dealer asked you – how much can you afford? The only way you’ll know the answer to that is if you’ve done your homework. It’s important that you know your budget before you start shopping for a car. You need to look at how much you can pay, each and every month, for a few years, and still live comfortably. If you take on a loan that stretches your budget too far, you may end up eventually losing your car. And that will look really bad on your personal credit report. It’ll also help your shopping experience if you do as much shopping around as you can, before your first visit to the dealer. There’s a ton of information on the Internet, giving you all you need to know about models, prices, options, colors, etc. Again, do your homework, and you’re more likely to pass the test. Make sure you understand the financing terms before you sign Financing has a lot of jargon involved that you may not understand. Don’t be swayed by something you’re not sure of. You’ll always have an opportunity to negotiate – take full advantage of it!

Before you sign your contract, here’s what you need to do:
* Negotiate the price of the vehicle.
* Negotiate the down payment.
* Negotiate the Extended Service Contract.
* Negotiate credit insurance (your unpaid balance is paid if you die or are disabled).
* Know the amount financed.
* Know the APR (Annual Percentage Rate).
* Know the finance charge (the total dollar amount of the credit).
* Know if the APR is a fixed rate or a variable rate.
* Know the monthly payment amount.
* Know who the assignee is (you’ll be dealing with them throughout the term of your contract. That’s pretty well it. If you know how car loans work, you’ll have no problem financing your new or used vehicle. Follow the simple steps we’ve outlined above and your journey will be a smooth one. We can’t stress enough how important it is when you’re applying for a car loan that you know and understand exactly what you’re doing from the first idea that you want a new vehicle, to the time you drive out of the dealer’s lot with a smile on your face. Happy driving!