How Do Auto Loans Work?

Loan Terms

Most auto loans come as three, four, five or six-year loans. Buyers with excellent credit histories will most likely get the on-going market rate for interest rates. Websites like Bankrate.com provide a good service for comparing interest rates in the different areas of the country. See a link in resources below. The longer a loan term, the more a borrower pays eventually in interest. A good online calculator can also help in figuring out monthly payments and interest rates paid over the life of a loan as well as creating an amortization schedule.

For example borrowing $10,000 toward the purchase of a car at a 6 percent interest rate for five years will result in a monthly payment of $193.33. Like in most amortized loans, more of the monthly payment goes toward interest and less toward principal and vice versa as the loan ages. For the first month the interest payment will be $50 ($10,000 x 6% / 12). Therefore $50 of the monthly payment will go toward interest and the rest toward the principal. For the next month the interest payment will be slightly lower and the payment toward principal slightly higher, based on the new principal balance. This will go on until the principal balance is zero and the loan is paid off. A table showing how much of each monthly payment goes toward principal and interest payments for the life of the loan is called an amortization schedule. Paying a little extra each month will result in the loan being paid of early and savings in interest payments.

Shopping for an Auto Loan and for a Car

Before shopping for an auto loan or for a vehicle, it is best to get a copy of one's credit report and credit score. The lenders are going to be looking at the same information. Those with less than perfect credit typically get more expensive loans as their interest rates will be higher. It may be worth it to wait a few months and clean up credit problems before applying for an auto loan.

People with excellent credit typically get the best deals. These could include zero percent interest rate, rebates and 100 percent financing with very low or zero interest rate. Shopping for a loan and getting approved before going to a car dealership allows one to bargain like a cash buyer. Capital One has a blank check auto loan program. Once approved, the borrower gets a blank check that can be used to purchase a vehicle up to the maximum amount approved.

Car loans approved at car dealerships are not always the best deals. The atmosphere is not always conducive to taking one's time to read the fine print. People have been known to sign off on and accept loans that are not of the most favorable terms because they were being forced to rush through the paperwork by a sales person. If you must get a loan at a car dealership, make sure you take the paperwork home and read it before signing anything.