Auto loans: Questions to ask before you owe
Factors to consider before taking out an auto loan
- A higher credit score generally qualifies you for a lower interest rate.
- Purchasing a car makes sense if you want to benefit from its resale value.
- Leasing is a good option if a lower monthly payment is the most important factor.
- Some lenders will be flexible with loan fees, if it means closing the loan.
- You can refinance an auto loan to get a more favorable rate or terms.
Television, radio, print and digital advertisers consistently bombard consumers with information about products and services. Auto-loan financing is a part of the daily blitz, so it’s important to think about your options if you’re considering a loan to purchase a vehicle.
Whether you’re financing a vehicle prior to a purchase, or refinancing an existing auto loan, there are several questions to keep in mind.
What determines my loan amount and rate?
Lenders determine auto-loan rates and amounts based on several underwriting criteria, but you also should begin the process with a budget in mind.
Your credit history will have a lot of influence over your ability to obtain a loan with good terms and rates. In general, as credit scores rise, so does a borrower’s eligibility for a low interest rate. It varies by lender, but credit scores generally can be divided into groups of super prime (781 and above), prime (661-780), nonprime (601-660) and subprime (501-600). Consequently, a borrower with a super prime score might qualify for a 3 percent interest rate on a specific vehicle, while someone with a subprime score might qualify at 11 percent.
Know your credit history and the potential hurdles to obtaining an auto loan. Clean up any delinquencies (missed or late payments) to get a lower interest rate.
It might seem obvious, but ask yourself and your lender if you can afford a loan. Set a limit on the monthly payment amount based on your cash flow and existing debt. If necessary, find expenses that can be eliminated from your budget. If your ideal vehicle is too expensive, have other options in mind. You might need to find a cheaper brand or forgo a new car in favor of a pre-owned model. Unexpected expenses can also be a factor, so building a buffer into your budget could be prudent. Missing a payment can damage your credit rating and missing too many payments can prompt a lender to repossess the vehicle.
Another consideration when it comes to loan payments is the down payment. Paying more upfront will mean a smaller monthly payment and less interest paid over the life of the loan. At a 3 percent interest rate, making a $10,000 down payment — versus $5,000 — on a $30,000 car purchase lowers your car payment by about $95 a month and saves you $750 in interest over five years.
Is buying a car my best option?
If you’re not going to drive very much, leasing could be a good option because it will significantly lower your monthly payment. Keep in mind that, with a lease, dealers cap your mileage — in the range of 15,000 miles per year on a four-year lease. In the long term, leasing ends up being more expensive than buying because you will always have a monthly payment — and the potential of significant added costs if you exceed the lease’s mileage limit. If you buy a car, after four to six years, depending on the term of the auto loan, you have no monthly payments and also own a vehicle outright that normally has some resale value.
There are a lot of fees associated with auto purchases and loans — such as loan-origination fees for processing the application. In addition, there are dealer-level charges such as title, license and registration fees, and even advertising and floor-plan fees for attracting buyers to the dealership and keeping vehicles in stock. They’re typically built into the loan. Sometimes they’re negotiable and sometimes they’re not. Look around at a variety of dealers and lenders before making a vehicle-buying decision.
In addition, some loans will have prepayment penalties, if you choose to pay off the balance early. Such penalties are often negotiable and avoidable, the Federal Trade Commission advises. Adjustable-rate loans can include residual, or balloon payments, that will keep monthly costs down in exchange for a larger payment at the end. Consider whether you can afford this option.
Finally, consider insurance costs. States don’t require drivers to carry collision and comprehensive insurance, which pays for theft or damage to your car, but most lenders, whether you’re buying new or used, will require it.
Questions to ask when you're refinancing
A common misconception among borrowers is that they’re stuck with an auto loan until it’s paid off. But auto financing is just like any other loan: You can refinance with another lender if you find better rates or terms.
If you’ve purchased a vehicle within the past three years, you may be a strong candidate for refinancing. If you’ve been making payments on time, your credit score will likely have improved, making you eligible for a lower interest rate.
How old is my vehicle?
Generally, if it’s less than eight years old and has fewer than 100,000 miles, it’s eligible for refinancing. With older vehicles, however, there’s little value on the resale market, making lenders less willing to refinance because your collateral, in case of default, isn’t worth as much.
Am I planning to keep the vehicle long term?
Refinancing could be the way to reduce your monthly expenses while keeping a vehicle you’ve grown attached to. If you’re comfortable extending the existing loan term on the vehicle, you also can lower your monthly payment by refinancing, even if the rate stays the same. Keep in mind, however, that the older a vehicle is, the higher the annual maintenance and repair costs tend to be.
What is the balance on my existing loan?
Many lenders won’t refinance loans with balances of less than $10,000. Also, study the details of your current loan (interest rate, monthly payment, payoff amount) and compare those to the anticipated terms after refinancing to make sure the numbers work to your advantage.
Have interest rates dropped?
That could be the signal it’s time to refinance. A four-year, $20,000 auto loan at a 5 percent rate, for instance, will cost you $812 more over the life of the loan than it would at a 3 percent interest rate. Even if interest rates haven't changed, you could come out ahead in terms of total loan costs by switching to a shorter loan term — with roughly $600 in interest payments saved, for example, by moving from a six-year to a four-year loan.